Rajesh Gandhi & Priya Narayanan
Under the existing provisions of the income-tax law, transfer of shares in an Indian company by a shareholder (which includes buy-back of shares under section 77A of the Companies Act, 1956) is subject to tax under the head “capital gains”. However, in the case of a non-resident shareholder the tax treaty provisions would apply, to the extent they are more favorable. Typically, under the tax treaties India has entered into with Mauritius, Cyprus and Singapore, capital gains is not taxable in India, but in the foreign country. Many of these countries do not levy capital gains under their domestic tax laws. Consequently, buyback of shares may not be subject to tax either in India or in the foreign country. This route has been commonly used by non-residents to mitigate the dividend distribution tax of 16.23% which is otherwise payable when profits are distributed as dividends.
The Budget 2013 has now proposed to levy an ‘additional income-tax’ on distribution of income by way of buyback of shares by unlisted companies. Interestingly, even before this amendment, in March 2012, the Authority for Advance Rulings (“AAR”) held that distribution of accumulated profits through a scheme of buy back of shares could be deemed as colorable and therefore subject to tax withholding under a tax treaty. The taxpayer has filed an appeal against this order and the final verdict is awaited.
Coming back to the Budget provisions, a new Chapter titled “Chapter XII-DA Special Provisions Relating to Tax on Distributed Income of Domestic Company for Buy-Back of Shares” is proposed to be inserted. Accordingly, besides the standard corporate income-tax chargeable, an additional income-tax will be charged on any amount of distributed income of unlisted companies. The company implementing the buyback scheme shall be liable to pay the taxes at the rate of 20% on the difference between consideration received by the shareholder on buyback as reduced by the amount received by the ‘company’ for issue of such shares. This will be further increased by a surcharge (@ 10%) and education cess (@3%) resulting in an effective rate of tax (22.66%).
However, depending on the issue price of shares, it may still be beneficial for a company to distribute profits through a share buy-back rather than distributing the same as dividends.
Some of the other aspects of this proposed amendment are:
- The amendment is operative from June 1 2013.
- This levy is mandatory irrespective of whether the company is liable to tax or not on its income;
- The tax shall be deposited with the Government within 14 days from the date of payment of any consideration to the shareholder;
- The aforesaid taxes are not creditable by any person under the provisions of the Indian income-tax law; and
- In case of failure to deposit taxes on time, the principal officer or the company:
- Shall be deemed to be ‘assessee in default’; and
- Will be subject to simple interest at the rate of 1% of every month or part thereof.
Fortunately, this amendment is not retrospective! Does it mean that the buyback transactions executed by companies upto June 1 2013 cannot be questioned by revenue authorities?
Some of the other issues which arise out of the amendment are as under:
- Since the tax will be levied on the Indian company making the share buy-back, a non-resident shareholder will not be able to reduce the impact of the tax by claiming treaty protection.
- A mechanism to claim credit in the foreign country may be explored. This could be evaluated either in terms of the provisions of underlying tax credit under certain tax treaties or depending on the domestic tax laws of the non-resident shareholder where tax credit may be available for the foreign sourced income. However, for companies that have suffered a corporate tax and additionally pay income-tax on buyback, the total tax credit claim may be lower than the tax liability on the income in the foreign country.
- Since deduction is allowed only for the issue price in determination of distributed income, increase in cost of acquisition of shares through a share transfer will not be considered. This means that the proposed law is even harsher as compared to a situation where capital gains tax would have been levied on share buy-backs. It would have been preferable to levy the tax at a lower rate on the gross consideration.
To conclude, the Government has taken yet another step to unilaterally take away some of the benefits under the tax treaty. This proposal will reduce the attractiveness of the Mauritius and Singapore route especially in the case of long term investors who don’t look at a quick exit from India.
 Subject to certain conditions prescribed
 AAR No. P of 2010 dated 22nd March, 2012
(Rajesh Gandhi is ‘Senior Director’ at Deloitte Haskins & Sells and Priya Narayanan is Manager at Deloitte Haskins & Sells.)