Buyback of shares is a corporate financial strategy where a company repurchases its own shares from shareholders, reclaiming ownership that was previously distributed. This maneuver can have various strategic implications for the company, including simplifying ownership structure, correcting share prices, and enhancing financial attractiveness. With recent changes proposed in the 2024 Budget, understanding the taxation on buyback of shares has become crucial for companies and investors alike. This article delves into the mechanics of share buybacks, reasons behind them, and the tax provisions governing these transactions.
1. What is Buy Back of Shares?
Buyback refers to the procedure where a company repurchases the shares issued by it from it’s shareholders. The company pays the market value of shares to it’s shareholders and reclaims the ownership that was previously distributed.
2. Reasons for Buy Back of shares?
A company gets money by issuing shares. So, it might seem odd for companies to buy back shares and pay shareholders. Here are some reasons why:
- Compact Ownership: Substantial shareholding means many people own shares, which increases costs for the company. To simplify ownership and lower capital costs, companies buy back shares
- Share Price Correction: The share price in the market can be very low for different reasons. A buyback helps to raise the market price of shares.
- Attractive Financials: Buying back shares can make a company’s finances look better. Fewer shares mean higher Earnings per Share and attracts potential investors.
- Increased Shareholding of Promoters: Buyback is often used if the promoters of a company are planning to increase their ownership in the company.
3. What are the Income Tax Provisions for the Buy-back of Shares?
According to Section 115QA of the Income Tax Act, here are the rules for companies buying back shares:
– Both listed and unlisted companies must pay extra income tax on money given to shareholders from buybacks, even if they don’t usually pay income tax.
– The tax rate on the buyback amount is 20%, plus a 12% surcharge and additional fees which is usually calculated as 20%+12%+4% = 23.296%
-In situations where a buyback occurs on the open market, shares are exchanged among many parties. The purchase price at which individual investors would have acquired shares on the open market is something the corporation is unable to determine. Therefore, regardless of the market price at which the buyer would have purchased, the corporation still has to pay tax on the difference between the buyback price and the price at which it issued its shares.
– Companies need to pay this tax within 14 days after paying shareholders for the buyback.
– This tax payment is final, meaning no further tax credits can be claimed by the company or anyone else.
– Shareholders do not have to pay any tax on buyback of shares.
Budget 2024 – Changes in Buyback Taxation
The finance minister announced changes to buyback taxation. Currently, companies pay tax on the difference between the buyback price and the issue price of shares. This system started in 2013 when dividend distribution tax was in place. In 2020, this tax was removed, and now dividends are taxed for the recipient. To align buyback tax with dividend tax, the proposed budget for July 2024 will eliminate the buyback tax for companies after October 1, 2024. Instead, shareholders will pay tax on the total amount received from the buyback as deemed dividend u/s 2(22)(f).
You might wonder about the cost of shares offered for buyback. This cost cannot be deducted from deemed dividend income but can be carried forward as a deemed capital loss to offset future gains from selling remaining shares.
Lastly, the tax collection system under the Income Tax Act, 1961, is clear and organized. However, organizations and investors need to stay updated on changing rules and tax laws. This knowledge helps them make better decisions and adjust their strategies accordingly.
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Authors: CA Prashant Taparia, Partner | Contact No – 90295 07606; CA Sohil Shah, Manager | Contact No – 8169470196; Shivam Thakur, Associate Consultant. For inquiries, please email [email protected] or contact +91 98709 25375, +91 99305 98581.
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