CA Komal S. Chhabra

Mr. P. Chidambaram, plugged one of the most common tool of profit distribution used by unlisted companies. Finance Act 2013, introduced Sections 115-QA to 115-QC in the Income Tax Act — effective from June 1, 2013 — to tax income distribution by unlisted companies through buyback of shares u/s 77A of the Companies Act 1956. However, as convenient as it may seem to restrict foreign companies this section does not seem to have followed the concept of “natural justice” for domestic companies. Here is why:

Section 115QA

“(1)   Notwithstanding anything contained in any other provision of this Act, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount of distributed income by the company on buy-back of shares (not being shares listed on a recognised stock exchange) from a shareholder shall be charged to tax and such company shall be liable to pay additional income-tax at the rate of twenty per cent on the distributed income.

Explanation. -For the purposes of this section,-

(i) “buy-back” means purchase by a company of its own shares in accordance with the provisions of section 77A   of the Companies Act, 1956

(ii) “distributed income” means the consideration paid by the company on buy-back of shares as reduced by the amount which was received by the   company for issue of such shares.”

(2) Notwithstanding that no income-tax is payable by a domestic company on its total income computed in accordance with the provisions of this Act, the tax on the distributed income under sub-section (1) shall be payable by such company.

(3) The principal officer of the domestic company …… referred to in sub-section (1).

(4) The tax on the distributed income by the company shall be treated as the final payment of tax in respect of the said income and no further credit therefor shall be claimed by the company or by any other person in respect of the amount of tax so paid.

(5) No deduction under any other provision of this Act shall be allowed to the company or a shareholder in respect of the income which has been charged to tax under sub-section (1) or the tax thereon.

An analysis of this section indicates that it is an overriding section in the Act and it has in effect made Section 46A redundant as far as unlisted shares are concerned.      This section is a charging section and has provided a mechanism of computing gains on buyback and the tax thereon. The tax paid under this section is nether creditable nor deductible. There are other errors as well while drafting this section which I have not discussed in this article.

The following situations have not been considered while drafting the section:

Benefit of Indexation and Capital Gain of 20%

Consider a situation where a shares have been held since the year 2000 at Face Value of Rs. 10 and are being bought back in the year 2015 at Rs. 100.

ParticularsAmount in Rs.
Sales Consideration100
Cost of Acquisition after indexation25
Net Gain75
Cap Gain Tax @ 20%15
BuyBack Tax after insertion of 115QA 20% (100-10)18
Loss to shareholder per share3

No Indexation and Capital Gain of 10%

Consider a situation where a shares have been held since the year 2010 at Face Value of Rs. 10 and are being bought back in the year 2015 at Rs. 100.

ParticularsAmount in Rs.
Sales Consideration100
Cost of Acquisition without indexation10
Net Gain90
Cap Gain Tax @ 10%9
BuyBack Tax after insertion of 115QA 20% (100-10)18
Loss to shareholder per share9

No Set off Capital Losses

Section 115QA does not even allow set off of capital losses which the shareholder may have incurred in the past.

Amount of consideration received

If shareholders have sell their shares to other at a premium and later the shares are bought back by the Company, this shareholder will be at a further loss because the company will compute distributed income only based on the amount received by the company and ignore the premium at which the shareholder purchased the shares.

Conclusion:

This Section is rightly introduced to curb the measures used foreign companies however, it would have been “fair” had it allowed for a mechanism to address the above demonstrated loss to the shareholders, atleast by providing a tax credit for domestic transactions. Currently this section is regressive to domestic transactions and perhaps domestic buyback may just end up being a theoretical section in the Act unless we see an amendment in the coming budget.

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