The changing face of Share buy-backs

Buyback of shares means repurchasing of shares by the company that issued them. The company pays the shareholders the market value of the shares and reclaims the ownership. Buyback is governed by section 68 of the Companies Act, 2013.? A Company may buy-back its Shares from existing shareholders or from open market or from odd-lot holders. Buy back is an excellent opportunity for the shareholders to get an exit opportunity at premium and on the other hand, it offers an opportunity for the company to use its liquidity position to extinguish its shares today and issue them again in future.

The provisions in the Income Tax Act, 1961 relating to Buyback of shares kept on changing over the years.

Provision upto 30th September 2024

• The provisions under Section 115QA of the Income Tax Act, 1961 outline the framework within which transactions of buyback of shares and other securities are taxed.
• When a domestic company buys back its shares, it is liable to pay tax at the rate of 20% on the distributed income.
• This income is calculated as the difference between the buyback price and the amount received by the company for issuing those shares. (It is to be noted that even if the shares are further sold by the shareholder, the amount to be reduced will be the issue price)
• Additionally, Surcharge at 12% and Health and Education Cess at 4% are applicable, bringing the effective tax rate to 23.296%.
• The company must pay this tax to Government within 14 days from the date of payment of the buyback price to the shareholder.
• From the perspective of shareholders receiving the buyback proceeds, such income is exempt under Section 10(34A) of the Income Tax Act. This exemption ensures that shareholders are not subject to taxation on the buyback amount received from the company.
• It is crucial to note that no deduction or credit of tax paid under Section 115QA is allowable to the company or the shareholder.

Provision w.e.f. 1st October 2024

Both dividend as well as Buy-Back are methods for the company to distribute accumulated reserves and thus ought to be treated similarly. In addition, there is extinguishment of rights for the shareholders who are tendering their shares in the buy-back by domestic company, to the extent of shares bought back by such company from shareholders.

Following changes are proposed by Finance Bill 2024

• Provisions of section 115QA will not longer be applicable and there would be no tax impact in the hands of the Company buying back the shares.
• The buyback paid by a domestic company shall be treated as deemed dividend under section 2(22)(f) in the hands of shareholders and shall be charged to income-tax at applicable rates.
• No deduction for expenses shall be available against such dividend income while determining the income from other sources.
• The cost of acquisition of such shares would generate a capital loss in the hands of the shareholder as these assets have been extinguished.
• Therefore, when the shareholder has any other capital gain from sale of shares or otherwise subsequently, he would be entitled to claim his original cost of acquisition of all the shares (i.e. the shares earlier bought back plus shares finally sold).

Distribution of Dividend

Dividend Distribution Tax is not payable by the Company. Such Dividend is taxable in the hands of shareholders at applicable rates. For shareholders in higher tax brackets, it would be taxed at 30% (plus applicable surcharge and cess)

Dividend Distribution Tax is not payable by the Company. Such Dividend is taxable in the hands of shareholders at applicable rates. For shareholders in higher tax brackets, it would be taxed at 30% (plus applicable surcharge and cess)

Buyback of Shares

Buyback Tax under section 115QA is payable by the Company at 20% (plus surcharge and cess). The Buyback price was exempt in the hands of shareholders under section 10(34A). So, inspite of having shareholders with incomes in higher tax brackets, such income would continue to be taxed at 20% (plus surcharge and cess).

Buyback Tax is not payable by the Company. Such Buyback Price is taxable in the hands of shareholders at applicable rates. For shareholders in higher tax brackets, it would be taxed at 30% (plus applicable surcharge and cess). Cost of Acquisition would be carried forward as Capital Loss to be set off in future against Capital Gains.

Conclusion

The taxation of buyback as dividends may potentially increase tax burden on investors. Earlier, buybacks were taxed at 20 per cent (plus surcharge and cess) but after the amendment, the taxpayers in higher tax bracket will have to shell out more tax. Since the tax impact of buyback and distributing dividends now is same, companies will be now using buyback option only wherever they genuinely feel the need for capital reduction and not for distribution of profits.

There can be a steep reduction in the number of buybacks, with companies possibly choosing to allocate surplus funds towards capital expenditures instead.

Contributed by Kedar Junnarkar - TransPrice Tax Advisors