The Budget for July 2024 has introduced significant amendments impacting the corporate landscape, one of the most noteworthy being the treatment of share buybacks as deemed dividends. This change is poised to have far-reaching implications for companies and their shareholders. This article delves into the intricacies of this amendment, its implications, and the broader context within which it has been introduced.
Understanding Share Buybacks
Share buybacks, or repurchases, occur when a company buys back its own shares from the marketplace. This strategy is often employed to enhance the value of remaining shares by reducing the number of outstanding shares, signaling the company’s confidence in its financial health, and utilizing excess cash efficiently.
The Budget 2024 Amendment
Historically, the taxation of share buybacks and dividends has been treated differently under Indian tax laws. Dividends were subject to Dividend Distribution Tax (DDT), which has been abolished since April 2020, making dividends taxable in the hands of shareholders. On the other hand, the buyback of shares was subject to a Buyback Tax at the company level, introduced in 2013, to curb the misuse of buybacks as a tax avoidance tool.
The Budget of July 2024 has introduced a pivotal change by categorizing share buybacks as deemed dividends under certain conditions. This means that buybacks will be taxed similarly to dividends, directly impacting the taxation framework for companies and shareholders.
Key Provisions of the Amendment
1. Taxation of Buybacks: Buybacks will now be considered deemed dividends and subjected to tax in the hands of shareholders. This aligns the tax treatment of buybacks with that of traditional dividends.
2. Threshold and Conditions: The amendment specifies a threshold and conditions under which buybacks will be treated as deemed dividends. Companies exceeding the specified limit will fall under this new regime.
3. Compliance and Reporting: Enhanced compliance and reporting requirements have been introduced for companies undertaking buybacks, ensuring transparency and adherence to the new tax norms.
Implications for Companies and Shareholders
1. Tax Burden Shift: The tax burden shifts from the company to the shareholders, potentially impacting investor sentiment and the attractiveness of buybacks as a corporate strategy.
2. Financial Planning: Companies will need to reassess their financial strategies and capital allocation plans, considering the tax implications of buybacks versus dividends.
3. Investor Impact: Shareholders, especially high-net-worth individuals and institutional investors, may experience changes in their tax liabilities and returns on investment.
Rationale Behind the Amendment
The government’s rationale for this amendment is multifaceted:
1. Revenue Mobilization: By taxing buybacks as deemed dividends, the government aims to mobilize additional revenue.
2. Equity in Taxation: This move seeks to bring parity between the taxation of buybacks and dividends, preventing companies from favoring one over the other for tax advantages.
3. Curbing Tax Avoidance: The amendment addresses potential loopholes and tax avoidance strategies employed by companies using buybacks.
Understand with the help of an example
- 100 shares bought in 2020 @Rs. 40/- per share
- Total cost of acquisition Rs. 4000/-
- 20 shares bought back in 2024 @Rs. 60/- per share
- Income taxable as deemed dividend Rs. 1200/- and taxable as per slab
- Capital loss on such buyback (Rs. 40 *20) Rs. 800/-
This loss can be offset when there is a capital gain from equity. It can also be carried forward,
- 50 Shares sold in 2025 @Rs. 70 per share
- Capital Gain (3500 – 2000) Rs. 1500
- Chargeable capital gain after set off Rs. 700 (1500-800)
Earlier:
- Buyback was tax free (company would pay 20% tax): Rs. 1200
- Tax on Rs. 1500 at the rate of 10%: Rs. 150 + Rs 6 (4% of Rs. 150). So net gain = Rs. 1344.
- Total gain: Rs. 1200 + Rs. 1344 = Rs. 2544
Now:
- 1200 buyback will be taxed as per slab
- Assuming a Rs. 10 Lakhs income in the new tax regime, this Rs. 1200 will incur an additional tax of Rs. 187
- Net gain from buyback = Rs. 1013.
- Tax on Rs. 700 (net capital gain) at the rate of 12.5%: Rs.87.5 + Rs 3.5 (4% of Rs. 87.5).
- So net gain = Rs. 1500 (actual captial gain) minus Rs. 91 = Rs. 1409
- Total gain: Rs. 1013 + Rs. 1409 = Rs. 2422
- Effective loss: Rs 2544 – Rs. 2422 = Rs 122. The effective loss can be significant or otherwise depending on the income slab, the actual capital gain, the buy back price etc.
Conclusion
The Budget of July 2024’s reclassification of share buybacks as deemed dividends marks a significant shift in the Indian tax landscape. While it aims to create a level playing field and augment revenue, it necessitates careful consideration and strategic planning by companies and investors. As the corporate world adapts to these changes, the true impact of this amendment will unfold, shaping the future of corporate financial management and investor behavior in India.
Navigating these changes will require companies to stay abreast of regulatory updates and engage in proactive financial planning to optimize their capital strategies in this new tax environment.
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Disclaimer: “Neither this article nor the information contained herein shall in any way be construed as forming a contract or shall constitute professional advice required before acting upon any matter. CA Sharad Kumar Sharma has taken all due care in the preparation of this article for accuracy in its contents at the time of publication. However, no liability shall be accepted by him in the event of any direct, indirect or consequential damages arising out of or in any way connected with the use of this article or its contents. “
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