Summary: The buyback of shares is a strategic corporate tool used for ownership consolidation, maintaining stock prices, enhancing financial ratios, and utilizing surplus cash. It is regulated under the Companies Act, 1956/2013, and the Income Tax Act, 1961. Initially, the Companies Act, 1956, allowed buybacks through capital reduction with tribunal approval, fearing potential manipulation of stock prices. The introduction of Section 77A in 1999 streamlined the process, with the Companies Act, 2013, continuing similar provisions under Section 68. From a tax perspective, the treatment of buybacks has evolved. Before 1999, they were treated as dividends under the Income Tax Act. After Section 77A, they were treated as capital gains, but with the 2013 Act, a corporate dividend tax was imposed on companies. The Finance Act, 2024, further shifted the tax burden to shareholders, categorizing buyback proceeds as “Income from Other Sources” and allowing capital loss adjustments. This evolution reflects the ongoing adjustments in law to address the complexities of buybacks in corporate and tax regulations.
Buyback of shares is a common tool of corporate restructuring. The primary purpose of buyback to consolidate ownership, preserve stock prices, return stock prices to real value, boost financial ratios, or reduce the cost of capital by using the surplus cash available with the company.
Buyback of shares is applicable in case of Companies.
We can analyze the buy back of shares from the perspective of:
1. Companies Act 1956/ 2013 and
2. Income Tax Act 1961
1) Buyback under Companies Act Provisions:
The companies are primarily regulated by Companies Act 2013 (erstwhile Act was Companies Act 1956).
Buyback was allowed for companies by introduction of Section 77A under the Companies Act 1956 w.e.f year 1999. Prior to introduction of section 77A, only way of buy back was by following the capital reduction process under section 100 of Companies Act 1956 which was subject to approval of Tribunal.
The primary reason for not allowing buyback till the year 1999 was the feeling that allowing companies to buy-back their shares may give rise to undesirable practices (like insider trading) of trading in their own shares leading to unhealthy influences on stock prices.
Section 77A allowed buy back of shares subject to stringent requirements like passing of special resolution, maintenance of certain debt-equity ratio etc.
After the amended Companies Act 2013 was passed, Buy Back of Shares As Per Companies Act, 2013 find its place under section 68 of the Act which is very much similar to erstwhile section 77A in substance.
2) Buyback under Income Tax Act Provisions:
Taxation treatment of Buyback under Income Tax Act have seen different phases from treating the same as
a) dividend (prior to introduction of section 77A under Companies Act 1956),
b) treating them as capital gain in hands of shareholders (post introduction of section 77A),
c) corporate dividend tax in hands of company (with introduction of Companies Act 2013) and
d) finally treating this as dividend (Income from other sources) in the hands of recipient under Finance Act 2024.
Let’s analyse each of these periods of taxation:
a) dividend (prior to introduction of section 77A under Companies Act 1956)
As mentioned earlier buy-back of shares was not allowed prior to introduction of section 77A in the year 1999. So alternate way of buy back was by following the process of Capital Reduction under section 100 of the Companies Act 1956.
Capital reduction is a process of reducing the capital of the company with the approval of Tribunal either with or without making any payment to its shareholders.
The following are the most likely situations by which a reduction in share capital is undertaken:
1. Reduction in the face value of shares; or
2. Reduction in the number of shares (Cancellation of shares).
Section 2(22)(d) of the Income Tax Act 1961 provides that any distribution by a company to its shareholders, on the reduction of its capital, to the extent of accumulated profits, whether capitalized or not, would be treated as deemed dividend.
Let’s understand this with example:
X Ltd balance sheet as on 31st March XXXX is as below:
| Liabilities | Amount | Assets | Amount |
| Equity Share Capital (1,20,000 shares of Rs 10 each) | 12,00,000 | Machinery | 10,00,000 |
| Securities Premium | 3,00,000 | Other Assets | 8,00,000 |
| Bank | 2,00,000 | ||
| Retained Earnings | 5,00,000 | ||
| 20,00,000 | 20,00,000 |
The cost of each share for shareholder was Rs 11 per share (assumed).
Company decided to reduce its number of shares by 20,000 shares and agreed to pay
(a) Rs 1 Lacs, (b) Rs 2 Lacs, (c) Rs 10 Lacs, (b) Rs 14 Lacs,
What will be tax treatment in the hands of shareholder receiving this consideration and in hands of the company.
Solution:
The income tax treatment in the hands of shareholders and company varies for different time period (as provisions of income tax keeps on changing from time to time)
Tax treatment for the Prior to introduction of section 77A (in the year 1999) of Companies Act 1956:
Here total accumulated profit (including capitalised) is Rs 8,00,000 (3,00,000 + 5,00,000).
The cost of shares proposed to be reduced is Rs 2,20,000 (20,000 * 11).
Calculation of deemed dividend and capital gain in hands of shareholder is as below:
| S.N | Particulars | Case (a) | Case (b) | Case (c) | Case (d) |
| A | Proceeds received on capital reduction by shareholder | 1,00,000 | 2,00,000 | 10,00,000 | 14,00,000 |
| B | Less: Amount treated as deemed dividend (to the extent of accumulated profits of the company) | 1,00,000 | 2,00,000 | 2,00,000 | 2,00,000 |
| C | Consideration received for the purpose of capital gains (A-B) | – | – | 8,00,000 | 12,00,000 |
| D | Less: Cost of acquisition for the shareholder | 2,20,000 | 2,20,000 | 2,20,000 | 2,20,000 |
| E | Capital Gains/ (Loss) (C-D) | (2,20,000) | (2,20,000) | 5,80,000 | 9,80,000 |
In the hands of Company there is no income tax effect.
b) Post introduction of section 77A (in the year 1999) of Companies Act 1956 and till introduction of Companies Act 2013:
Post introduction of Sec 77A in the year 1999, Companies did have two options of buy back. Firstly, by adopting section 77A which was subject to certain limit and secondly by way of capital reduction for limits beyond the threshold specified in section 77A.
Income tax treatment varied depending upon the application of section 77A or 100 of Companies Act 1956.
If buy back was undertaken under section 100 of Companies Act 1956, then the taxation provision was same as mentioned above. However, if the same was undertaken u/s 77A of Companies Act 1956 then the same was considered as capital gain and not as dividend.
Let’s understand this with example:
X Ltd balance sheet as on 31st March XXXX is as below:
| Liabilities | Amount | Assets | Amount |
| Equity Share Capital (1,20,000 shares of Rs 10 each) | 12,00,000 | Machinery | 10,00,000 |
| Securities Premium | 3,00,000 | Other Assets | 8,00,000 |
| Bank | 2,00,000 | ||
| Retained Earnings | 5,00,000 | ||
| 20,00,000 | 20,00,000 |
The cost of each share for shareholder was Rs 11 per share (assumed)
Company decided to buy-back its 20,000 shares and agreed to pay
(a) Rs 1 Lacs, (b) Rs 2 Lacs, (c) Rs 3 Lacs, (b) Rs 4 Lacs,
What will be tax treatment in the hands of shareholder receiving this consideration and in hands of the company.
Solution:
The cost of shares proposed to be bought back is Rs 2,20,000 (20,000 * 11).
Calculation of capital gain in hands of shareholder is as below:
| S.N | Particulars | Case (a) | Case (b) | Case (c) | Case (d) |
| A | Proceeds received on buyback by shareholder | 1,00,000 | 2,00,000 | 3,00,000 | 4,00,000 |
| B | Less: Cost of acquisition for the shareholder | 2,20,000 | 2,20,000 | 2,20,000 | 2,20,000 |
| C | Capital Gains/ (Loss) (A-B) | -1,20,000 | -20,000 | 80,000 | 1,80,000 |
In the hands of Company there is no income tax effect.
c) Post introduction of Companies Act 2013 till Finance Act 2024:
Through Finance Act 2013, section 115QA was introduced which casted responsibility on companies to pay tax on any amount of distributed on buy-back of shares u/s 77A. However in the year 2016 (on account of High Court ruling in case of Capgemini India Pvt Ltd in the year 2015) scope of section 115QA was expanded to buy-back under any law instead of restricting the same to sec 77A.
Let’s understand this with example:
X Ltd balance sheet as on 31st March XXXX is as below:
| Liabilities | Amount | Assets | Amount |
| Equity Share Capital (1,20,000 shares of Rs 10 each) | 12,00,000 | Machinery | 10,00,000 |
| Securities Premium | 3,00,000 | Other Assets | 8,00,000 |
| Bank | 2,00,000 | ||
| Retained Earnings | 5,00,000 | ||
| 20,00,000 | 20,00,000 |
The cost of each share for shareholder was Rs 11 per share (assumed)
Company decided to buy-back its 20,000 shares and agreed to pay
(a) Rs 1 Lacs, (b) Rs 2 Lacs, (c) Rs 3 Lacs, (b) Rs 4 Lacs,
What will be tax treatment in the hands of shareholder receiving this consideration and in hands of the company.
Solution:
The cost of shares proposed to be bought back is Rs 2,20,000 (20,000 * 11).
Calculation of capital gain in hands of shareholder is as below:
There will be no income tax liability in hands of shareholder since company is paying Tax on Distributed Income to shareholders u/s 115QA.
The cost of shares acquired (which is bought back) will not be treated as capital loss either and will have no treatment for calculation of tax.
In the hands of Company which has bought-back shares will pay Tax on distributed income u/s 115QA (very much like Dividend Distribution tax) at different rates prescribed from time to time.
d) Post Finance Act 2024:
Finance Act 2024 has provided that w.e.f 01.10.2024, following changes will be made:
| Existing | Proposed |
| 1) Companies buying back will have to pay Tax on Distributed Income to shareholders u/s 115QA. | 1) Companies are not required to pay tax u/s 115QA. |
| 2) Shareholders are not required to pay any tax on amount received against buy back | 2) Shareholders are required to treat whole amount received under buy back as “Income from Other Sources” |
| 3) Cost of shares (to shareholders) which has been bought back will not be considered at all in any calculation of income. | 3) Cost of shares (to shareholders) which has been bought back will be treated as long / short term capital loss, depending upon period of holding. |
The above can be understood with help of below example:
X Ltd balance sheet as on 31st March XXXX is as below:
| Liabilities | Amount | Assets | Amount |
| Equity Share Capital (1,20,000 shares of Rs 10 each) | 12,00,000 | Machinery | 10,00,000 |
| Securities Premium | 3,00,000 | Other Assets | 8,00,000 |
| Bank | 2,00,000 | ||
| Retained Earnings | 5,00,000 | ||
| 20,00,000 | 20,00,000 |
The cost of each share for shareholder was Rs 11 per share (assumed)
Company decided to buy-back its 20,000 shares and agreed to pay
(a) Rs 1 Lacs, (b) Rs 2 Lacs, (c) Rs 3 Lacs, (b) Rs 4 Lacs,
What will be tax treatment in the hands of shareholder receiving this consideration and in hands of the company.
Solution:
The cost of shares proposed to be bought back is Rs 2,20,000 (20,000 * 11).
w.e.f 01.10.2024, calculation of capital gain in hands of shareholder is as below:
| S.N | Particulars | Case (a) | Case (b) | Case (c) | Case (d) |
| A | Proceeds received on buyback by shareholder | 1,00,000 | 2,00,000 | 3,00,000 | 4,00,000 |
| Income from other Sources | 1,00,000 | 2,00,000 | 3,00,000 | 4,00,000 | |
| B | Cost of acquisition for the shareholder | 2,20,000 | 2,20,000 | 2,20,000 | 2,20,000 |
| Capital (Loss) | -2,20,000 | -2,20,000 | -2,20,000 | -2,20,000 |
In the hands of Company which has bought-back shares there will be no requirement of paying Tax on distributed income on buy-back u/s 115QA.
So by looking at the whole journey of buy-back or reduction of capital, we have reached to the same stage of buy-back when the same was treated as reduction of capital (i.e prior to year 1999). The only difference in the erstwhile provision was that the amount to the tune of accumulated profit was treated as dividend and beyond that it was treated as capital gain, however now the whole amount received under buy-back is treated as Income from other sources.
It may be noted that above amendment will have adverse impact on shareholders. It can be explained with following example:
| S.N | Particulars | Case 1 | Case 2 | Case 3 | Case 4 |
| A | Cost price | 5,000 | 5,000 | 5,000 | 5,000 |
| B | Buy back price | 5,200 | 5,200 | 5,200 | 5,200 |
| C | Tax on buy back (assuming slab rate of 30%) | 1,560 | 1,560 | 1,560 | 1,560 |
| D | Period of holding before buy back | < 1 Year | < 1 Year | > 1 Year | > 1 Year |
| E | Type of Capital Loss | Short Term | Short Term | Long Term | Long Term |
| F | Capital loss amount | -5,000 | -5,000 | -5,000 | -5,000 |
| G | Type of other sufficient amount Capital gain Available | Short term | Long Term | Short term | Long Term |
| H | Tax rate on capital gain (as mentioned in G) | 20.00% | 12.50% | 20.00% | 12.50% |
| I | Capital loss available for set off | 5,000 | 5,000 | – | 5,000 |
| J | Tax saving on Capital Loss set off (H*I) | 1,000 | 625 | – | 625 |
| K | Net tax saving / (outflow) (J-C) | (560) | (935) | (1,560) | (935) |
In case 1, suppose Mr X purchase shares for Rs 5,000. Buyback price is Rs 5,200. Assuming Mr X is in tax slab of 30% (ignoring Education cess, Surcharge etc), his tax on buy back is Rs 1,560 (30% of Rs 5,200).
Assuming his period of holding is less than 1 year, so cost of Rs 5,000 will be treated as Short Term Capital Loss, which can be set off against both long term and short term capital gain.
Assuming Mr X has sufficient amount of short term capital gain from other shares. So he can set off this loss of Rs 5,000 against that income and his saving of tax would be Rs 1,000 (i.e 20% of Rs 5,000).
So in nutshell, Mr X has paid a tax of Rs 1,560 on buy back amount received and saved short term capital gain of Rs 1,000. So his net incurrence of tax is Rs 560 which is much higher than the net earning of Rs 200 (i.e Rs 5,200 – Rs 5,000) made on buy back.
He will be in worst scenario if he does not have sufficient amount of capital gain to be set off against such capital loss or capital gain available for set off happens to be long term capital gain as mentioned in case 2, 3 and 4.
The above provision as introduced for taxability of buy back may be beneficial under following circumstances:
- Buy back price is much higher than prevailing market prices so that shareholder can get substantial additional income on buy back. (i.e it makes sense for the shareholder to bid for buy back rather than selling in open market).
- The shareholder income is in lower tax brackets (i.e slab rate applicable to shareholder is lower than tax rate applicable on capital gain)
Due to above reasons, companies may not get enough bid for buy back and may prefer not to go for buy back post 30.09.2024.
Also Read:
Guide to Buyback of Shares in India under Companies Act & Tax Considerations
Buy Back of Shares: Methods, Sources, Conditions and Procedures
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