A buyback refers to a company repurchasing its own shares from shareholders. It reduces the available shares in the market, potentially increasing the value of remaining shares. Buy-back also consolidates ownership among existing shareholders, enhances control, and provides an exit mechanism for investors. Additionally, companies often use buybacks to distribute surplus cash due to tax arbitrage.
Presently, an Indian company pays approx. 23.3% tax on the difference between the buy-back price and the initial share issuance price, regardless of the market prices. Since the proceeds of buy-back are taxed in the hands of the company, these are exempt for shareholders.
Legislative History and Rationale of the Amendment
Earlier, shareholders were subjected to capital gains tax on the proceeds from buy-back. There is lesser tax impact on capital gains versus DDT on dividends. Thus, several companies started distributing profits via buy-back. This was utilized by foreign companies in Mauritius, Singapore, etc. who would claim treaty benefits on the resulting capital gains arising from their investees in India (these treaty benefits have since been eliminated from 2017 onwards).
To counter this, in 2013 the Government introduced buy-back tax on unlisted companies. Further clarifications were provided in 2016 by specifying rules to compute the amount of taxable income. In 2019, the tax on buy-back was extended to listed companies as well.
DDT was abolished in 2020 and dividends became taxable at the hands of shareholders at their applicable slab rates. The amendment in buy-back tax is proposed on similar footing.
The proposed amendment also resolves the incidence of double taxation that arises in case of listed companies undertaking buy-back under open-market route. Transactions in open-market route are reported like other share trades and the seller is not aware about buyer’s identity. This was leading to double taxation as the seller would pay capital gains tax on share transfer despite the company having already paid buy-back tax.
Proposed amendment:
It is proposed in the Finance (No. 2) Bill, 2024 that:
No tax will be payable by companies on buy back
Proceeds arising from buy-back will be deemed as dividend. Companies will deduct TDS @ 10% and shareholders will pay tax on the deemed dividend as per the slab rates.
No deduction of any expenses will be allowed for such dividend income.
Shareholders will be allowed a capital loss equivalent to the cost of the shares.
The capital loss will be classified as either long-term or short-term, depending on period of holding. This loss can be offset against other capital gains or carried forward for up to 8 years.
These amendments are proposed to take effect from October 1, 2024, and will apply to any buyback of shares that takes place on or after this date.
Impact:
The proposed amendments have brought tax neutrality for distribution of surplus profits. The taxation of buyback as dividends may potentially increase tax burden on investors as those in higher tax bracket will faces higher taxes. Hence, for ownership restructuring or providing exit to investors as well, buy-back may no longer be the preferred route. The shareholders may face delays in realizing tax benefits of the capital losses in the absence of capital gains during the year of buy-back.