Summary: In normal course of business, a company may cancel its shares for various reasons such as capital reduction, buyback, forfeiture of shares etc. The tax authority closely examines any such cancellation of shares to the extent that it does not amount to evasion of tax. But what if the tax authority itself mis-interpret the mode of cancellation of share and applies wrong law. Here is one such incident where the tax authority recharacterized the cancellation of share done through the Capital Reduction scheme as Buyback. In the case of Seaview Developers Pvt. Ltd. v. DCIT (ITAT Delhi), ITA Nos. 2621 & 2719/Del/2024, Pronounced on 8 July 2026, one of the main issue before the tribunal was to clear the confusion regarding the whether Capital reduction is same as buyback? The tribunal held that capital reduction cannot be treated as buyback under Section 115QA. Unlike buyback, capital reduction directly extinguishes shares pursuant to a statutory scheme, without purchasing them back from shareholders. The 2016 amendment which widened the scope of transaction under buyback did not change the nature of distinction.
Background
The assessee, Seaview Developers Pvt. Ltd., is engaged in the business of developing real estate in SEZ in Noida, Uttar Pradesh. The assessee Company had cancelled 36,768 shares of BREP IV for the purpose of Capital reduction. BREP India Office Holdings IV Pte. Ltd. (BREP IV) is a Singapore-incorporated company and a tax resident of Singapore that held shares in the assessee company. The Singaporean Company was remitted ₹4,74,98,74,080 upon the cancellation of shares.
The tax treatment of the amount received by BREP IV is as follows:
| Particulars | Amount (₹) |
|---|---|
| Total amount received on cancellation of shares | 4,74,98,74,080 |
| Less: Amount treated as deemed dividend | (1,36,74,90,634) |
| Balance consideration | 3,38,23,83,446 |
| Less: Cost of acquisition | (3,21,09,89,533) |
| Short-Term Capital Gain | 17,13,93,913 |
Out of the total amount, ₹136,74,90,634 was treated as deemed dividend and the assessee company paid dividend distribution tax on it. The remaining amount of ₹3,38,23,83,446 resulted in short-term capital gain of ₹17,13,93,913, which was taxed in the hands of BREP IV.
The tax department flagged the entire scheme of Capital reduction as Buyback. The reasoning given by the department is that when the company cancelled its share, it is effectively same as buyback. It has also categorised this scheme as a “colourable device” so as to facilitate the tax evasion. On the basis of this, the AO applied 115QA instead of treating it as simple capital reduction. Thus, the dispute was not merely about cancellation of shares but recharacterizing capital reduction as buyback.
Capital Reduction
Section 2(22)(d) of the Income-tax Act states that if a company reduces its share capital and pays shareholders, then the part of payment that has come out of the accumulated profit is treated as Deemed Dividend.
For instance, A company had issued 600 Paid up equity share capital on the face value of Rs 10/-. After 2 years, they decided to reduce their share capital by way of capital reduction. The company cancelled 100 shares and distributed Rs 100 per share. The accumulated profit per share was Rs 80/-. This accumulated profit is called “Deemed Dividend” under section 2(22)(d) and the company is liable to pay Dividend Distribution Tax under section 115-O. The balance amount of Rs 20 is capital return, of which Rs 10 is the cost of acquisition of the share and the excess of Rs.10/- is treated as Capital gain.
In the Companies Act 1956, the scheme of Capital reduction is brought u/s 100 to 104 whereby the Company has to propose the scheme in general meeting or extra-ordinary General meeting. Upon approval, the Company has to seek prior HC permission to reduce the Capital. Once, it is approved by the High Court, the company proceeds with directly cancelling shares
Buyback of shares
Income tax act defines buyback as purchasing of its own share The law on Buyback taxation in India has changed multiple times in last 15 years. Till 2013, Buyback shares were treated as normal sale of shares where the shareholders were liable to pay capital gain tax. The computation was buyback price minus original cost of acquisition.
The first change came in 2013 where the finance act introduced Buyback distribution tax under section 115QA.The tax burden had shifted from investor to the company who now had to pay 20% buyback distribution tax along with surcharge and cess.
The second change came in October 2024 where the entire payout received for buyback was treated as dividend. The tax burden shifted from company to the individual shareholders who had to pay tax directly based on their personal income tax slab. The final amount received was taxed without subtracting cost of acquisition. As the investors were majorly caught in the trap of paying tax on entire proceed of buyback, the government cancelled the dividend label and brought back capital gain for the taxation of buyback. It became operative from 1st April 2026. The tax burden sits with shareholder who had tendered their share for buyback.
This case relates to year 2016, where Buyback distribution tax was applicable under section 115QA of the Income tax act. When a company purchases its own unlisted share then it has to pay 20% additional tax plus surcharge on the distributed income. The distributed income is the difference between the amount paid by the company to the shareholder and the amount it had originally received while issuing shares.
For instance, a company issued shares at face value of Rs 10/- and decided to buyback at Rs 100/- per share. The tax incidence would be the difference between amount it is paying to the shareholders i.e. Rs 100/- and the original issued price of Rs 10/-. So, it is liable to pay tax on (Rs 100 – Rs 10) on Rs 90/- per share at the rate of 20% plus surcharge.
Under the Companies Act 1956, Section 77A governs Buyback in which there are certain Conditions required to be met by the company. Firstly, the statutory limit to purchase its share through buyback is 25% in a year. Secondly, the scheme should not exceed the Debt: equity ratio of 2:1.
Point of Confusion
The source of Confusion stems from the amendment brought by Finance Act, 2016 which widened the scope of buyback under section 115QA. The definition of buyback was changed by replacing the words “section 77A of the Companies Act, 1956” with “any law for the time being in force relating to companies.” The Revenue mis-interpreted the above amendment and concluded that since the capital reduction is also extinguishing and cancelling of shares akin to buyback, both are same. Therefore, the scheme of capital reduction should be taxed under the provisions of buyback.
However, the tribunal clarified that the object behind the amendment was to broaden the scope of section 115QA so that the companies could not escape the buyback tax by using provisions other than section 77A, such as schemes brought under section 391-393 of the companies act, 1956. Importantly, the amendment never intended to include capital reduction under its purview.
Another point of contention was on the dispersal of “distributed Income”. The term “distributed income” appears in both buyback and capital reduction, but the income tax act draws a strict line between its tax computation. Under 2(22)d of the act, distribution on capital reduction is deemed dividend to the extent of accumulated profit and the tax incidence is limited on the accumulated profits only. While in buyback, the tax incidence is borne by the company and it is calculated on the difference between amount paid to the shareholder and original issue price at the rate of 20% and applicable surcharge and cess. The implied reasoning herein is that the revenue decided to tax it as buyback was to enlarge the tax base.
Analysis
In this case, the assessee company had passed a resolution to cancel up to 53000 shares out of the issued 68,489 shares. They also filed the capital reduction scheme before Hon’ble Bombay High court so as to meet the statutory requirement laid down under sections 100-104 of the companies act,1956. The Bombay High court approved the scheme upon receiving no objection from any regulatory body. Subsequently, the company cancelled 36,768 shares out of 68,489. The cancellation percentage is 53.7%, which is more than the 25% limit rule for the buyback. It shows that the assessee company has been consistently following the procedure for Capital reduction and not of Buyback.
Capital reduction is the scheme brought by company for its own benefit. The shares are directly cancelled in contrary to buyback where shares are first purchased from the shareholder and kept in physical or in Demat form before cancelling or extinguishing. Also, the purchase of its own share transfers the ownership from shareholder to the company unlike in the Capital reduction, there is no transfer of share or ownership.
In Capital reduction, the shareholders don’t have any option to accept or reject the scheme while in Buyback, they can either choose to tender their shares at the favourable price or reject it altogether.
Also, the law is clear on the point that a company shall not utilize the borrowing for the purpose of buyback. It can be done by utilizing free reserves, Securities premium account and proceeds of fresh issue of shares. In this case, the assesse company had carried out capital reduction with borrowings, reserves & surplus, and securities premium account. Since, a large portion of payout was funded through borrowings, this was another point supporting assessee’s position that the said transaction is capital reduction and not buyback.
The mandate of legislature is clear regarding the separation of these two statutes, but the Revenue deliberately tried to merge both the pathways.
Computation under Rule 40BB and the prevention of Double taxation
The importance of Rule 40BB becomes clear when we look at how “distributed income” is calculated for the purpose of buyback tax. The sub-rule (3) of 40BB states that-
“40BB (1) …. (3) Where the company had at any time, prior to the buy-back of the share, returned any sum out of the amount received in respect of such share the amount as reduced by the sum so returned shall be the amount received by the company for issue of said share: Provided that if the sum or any part of it so returned was chargeable to additional income-tax under section 115-O and the company has paid such additional income tax then such sum or part thereof, as the case may be, shall not be reduced.
Rule 40BB governs the computation of “distributed income” to levy buyback tax under 115QA. Normally, if a company has previously returned some portion of original issued capital in the past, that returned money must be subtracted from the initial issued price to find the lower value of the share.
However, the proviso of sub rule 3 provides an exception to this rule. If the past returned capital had been already taxed under 115-O as dividend then the company ought not to reduce the initial base. This sub-rule prevents the same amount being taxed twice in this case as the assessee company had already carried out capital reduction and had paid Dividend Distribution Tax under section 115-O. Later, the revenue christened it as Buyback and levied buyback tax under 115QA. Since the computation of buyback under 115QA has to strictly follow the rule under 40BB, the sub rule 3 of 40BB acts as safeguard against double taxation as the company had already discharged its tax liability under 115-O and hence it cannot be forced to pay a secondary buyback tax on the same pool of income twice.
Conclusion
The ITAT Delhi has made it clear that both the mechanisms are different and cannot be treated as the same merely because both involve cancellation of shares and payment to the shareholders in form of distribution income. In this case, the assessee had followed the statutory procedure for capital reduction at every step. Therefore, after analysing the core of both mechanisms, the tribunal ruled in favour of the assessee.
Refrences
1. Seaview Developers Pvt Ltd v DCIT, Circle-23(2), Delhi, ITA Nos 2621 & 2719/Del/2024 (ITAT Delhi, 8 July 2026).
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About the Author: Keshav Kumar is a tax enthusiast and legal researcher. He closely tracks corporate restructuring, international taxation, and tribunal cases under the Direct Tax domain. He can be reached at [[email protected]](mailto:[email protected]).
