Analyzing The Liberal Nature of Buyback Provisions under Section 115QA and Section 10(34A): Budget 2024’s Response to Curb Potential Misuse and Tax Arbitrage
Summary: The previous tax rules under Section 115QA and Section 10(34A) of the Income Tax Act provided a tax-friendly environment for shareholders during company share buybacks, where the tax burden was shifted from shareholders to the company. This allowed shareholders to exploit tax arbitrage, as they were exempt from tax on income from buybacks while companies paid a 23.296% tax on distributed income. However, the 2024 Budget introduced significant changes to curb this practice. Effective from October 1, 2024, the income from buybacks will be treated as dividend income, taxable at the applicable slab rates for shareholders, with no deduction allowed for the cost of acquisition of shares. This aims to align the tax treatment of buybacks with that of dividends, eliminating the tax advantage previously enjoyed by shareholders. Additionally, capital losses from buybacks can only be set off against capital gains, with unutilized losses carried forward. These changes are designed to close loopholes and ensure a more equitable tax system, discouraging frequent buybacks used to reduce the effective tax rate for shareholders.
Introduction: Whether the previous rules for share buybacks under Section 115QA, along with Section 10(34A), were too generous and easy for shareholders, making them a tax-friendly option. It also asks whether the changes made in the 2024 Budget were designed by tax authorities to fix any issues or prevent shareholders from taking unfair advantage of the buyback process.
Background:
A buyback, also known as a share repurchase, is when a company buys back its own shares from the stockholders. This reduces the number of shares available in the market, which can increase the value of the remaining shares. Companies might do a buyback to return surplus cash to shareholders, improve financial ratios, or to signal that they believe their shares are undervalued.
Let’s first discuss the Existing provision (applicable till 30th September 2024) and its implication to company and its shareholders: –
As per the existing Provision 115QA of the Income Tax Act, 1961, Tax shall be charged on distributed income by the Domestic company on buy-back of its shares from shareholder at the rate of 23.296% (tax @ 20% plus surcharge @12% and cess @4% as applicable). Any gain arising from the such buy back transaction was made exempt in the hands of the Shareholder by virtue of Section 10(34A) of the Income Tax Act.
Further according to Section 68 of the Companies Act 2013, a company cannot make a new offer to buy back its shares within one year from the date when the last buyback was completed.
The provision was being exploited by the People whereby, instead of paying/distributing dividend, the burden was shifted from promoter or shareholders to Company to get benefit through tax arbitrage. And the Company were doing buy back transaction very often and by that way, the effective rate of tax in the hands of the shareholders were reduced to the extent of, tax was required to be paid on such income by Shareholders.
Since the tax was paid by the company on the buyback amount, the investor or the shareholder were able to enjoy tax arbitrage as company was obligated to pay tax on distribution of amount by way of buy back, resulting tax exempt in shareholder’s hands OR, this amendment was proposed to bring taxability of Buyback at par with taxability of dividend income in the hands of shareholders as it amounts to distribution of accumulated profit.
Rational behind the change:
As highlighted in Budget memorandum 2024 that” Both dividend as well as buy-back are methods for the company to distribute accumulated reserves and thus ought to be treated similarly. In addition, there is extinguishment of rights for the shareholders who are tendering their shares in the buy-back by domestic company, to the extent of shares bought back by such company from shareholders. The cost of acquisition of such shares also needs to be accounted for in some manner.”
With effect from October1, 2024, now the company is not required to pay the taxes on the buyback of the shares as the whole amount of buyback, which has been received by the shareholder’s, shall be treated as dividend in their hands and tax is payable by the recipient as per slab rates applicable to them. However, cost of acquisition of shares or cost of investment shall not be allowed to be reduced from the dividend amount received by the shareholders and shall be considered as capital loss, which allowed to be set off against the capital gain only. Unutilised capital loss if any shall be allowed to be carried forward as per the provision of the income tax act. It may sound unreasonable as the tax is being levied on the dividend income in the year of receipt and deferring the capital loss to the year in which one will have capital gain income to set off with brought forwarded capital losses.
Treating of Buyback amounts as Dividend Income in the hands of Shareholders and its tax implications
Starting from 1st October 2024, Section 115QA (Buy Back of Shares) and Section 10(34A) shall not apply in respect of Buy Back of Shares.
Starting from 1st October 2024, a new sub clause (f) was added to Section 2(22) of the Income-tax Act, which treats the amount paid during a buyback as dividend: –
“(f) any payment by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 68 of the Companies Act, 2013.”
Meaning thereby any money, a domestic company pays to buy back its own shares will be considered as dividend income in the hands of shareholders, who receive that payment from such buy back. This income will be taxed at the regular rates.
Allowability of Deduction against dividend Income:
Starting from 1st October 2024, a new proviso has been added to Section 57 of the Income-tax Act, 1961, which addresses the disallowance of deductions for expenses associated with dividend income-
“Provided further that no deduction shall be allowed in case of dividend income of the nature referred to in sub-clause (f) of clause (22) of section 2.”
Meaning thereby shareholders cannot deduct any expenses from the dividend income they receive when calculating their total taxable income from other sources.
Capital gain or Capital Loss When company buy back its own shares.
A new proviso was also inserted in Section 46A of the Income Tax Act with effect from the 1st day of October, 2024, namely: ––
“Provided that where the shareholder receives any consideration of the nature referred to in sub-clause (f) of clause (22) of section 2 from any company, in respect of any buy-back of shares, that takes place on or after the 1st day of October, 2024, then for the purposes of this section, the value of consideration received by the shareholder shall be deemed to be nil.”
Meaning thereby when a company buys back its shares, capital loss shall be generated in the hands of the shareholder because the shares are no longer owned and extinguished, and the cost they paid for those shares can’t be recovered.
When a shareholder later sells other shares and makes a profit, they can use the original cost of all the shares they owned (including those bought back by the company) to figure out their taxable gain. Here’s how the calculation works:
1. The value of the shares bought back by the company is considered zero when calculating any loss.
2. Any loss from the buyback is calculated as the original cost minus zero (since the value is considered zero).
3. This loss can be carried forward (for 8 Assessment Years immediately the AY in which buy back transaction was executed) and used to reduce taxable gains when the shareholder sells other shares in the future.
This can be explained with an example: (Taken from Budget Memorandum 2024)
√ 100 shares bought in 2020 @Rs. 40/- per share
√ Total cost of acquisition 4000/-
√ 20 shares bought back in 2024 @Rs. 60/- per share
√ Income taxable as deemed dividend 1200/-
√ Capital loss on such buyback (Rs. 40 *20) 800/-
√ Sold 50 Shares sold in 2025 @Rs. 70 per share
√ Capital Gain (3500 – 2000) 1500
√ Chargeable capital gain after set off 700
What happens if shares are sold in the secondary market instead of being tendered under a Buyback scheme?
Selling the shares directly in secondary market would attract short term tax (20%) or long-term tax (12.5%) subject to Exemption on Capital Gain – 1.25 Lacs. Short term or long term is dependent upon the period for which shares are held by the shareholders.
Tax Withholding on Dividend: (from Company Stand point)
Sub-clause (f)” shall be inserted with effect from the 1st day of October, 2024, in section 194 of the Income-tax Act, which read as follows:
The company paying dividend is mandated to deduct TDS under Section 194 of the Income Tax Act if the shareholder’s total dividend in a year exceed INR 5000.If the payee does not provide a Permanent Account number (PAN), tax shall be deducted at the rate of 20%.
Tax Treaty Benefit to Non-Resident:
Since the income from share buybacks is proposed to be taxed as a dividend in the hands of shareholders, any treaty benefits related to dividends should also apply subject to the satisfaction of necessary condition given under Provision.
Disclaimer: View are personal and should not to be taken as professional advice. For any suggestion or query, please feel free to contact me at [email protected]
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