CA Aishwaryaa V
In a recent ruling that will have a bearing on the buyback activities, the Bombay High Court held that the premium paid for buyback of shares shall be tax deductible as business expenditure. (CIT v. Chemosyn Ltd).
Companies resort to buyback of shares for a variety of reasons. Lack of investment opportunities in their core business, companies that are cash-rich, provision of exit route to shareholders, exercising put/call options under investment agreements.
In this instant case, the assessee was directed by the Company Law Board (‘CLB’) to buy back the shares, to facilitate the smooth running of the company. There was a dispute between the two groups of shareholders of the taxpayer company, following which CLB directed the company to buy back shares at a premium price. The Tribunal had relying on the decision in the case of Echjay Industries Ltd v.DCIT 88 TTJ 1089 (Mum ITAT) and on identical facts and circumstances, held that the premium paid on buyback was a revenue expenditure.
Similar tax deductions have been held by the Pune ITAT in DCIT v. Brahma Corp. Hotels & Resorts Ltd. (ITA No.772/PN/2013) and Mumbai ITAT in USV Ltd., Vs. JCIT (ITA No.376/M/2001).
In all the above judgments, it may also be noted that the facts regarding the slowdown of business via low profit numbers and the subsequent recovery post the settlement were recorded as evidence to prove the nexus to the smooth functioning of the business.
The key contention of the revenue in the above cases was that the improving profit margins show that the company has been granted an enduring and long lasting benefit even though no new assets are created. Further, as the receipt of premium on issue of shares is being treated as a capital receipt, expense of same nature should also be treated as ‘capital’. These contentions were negated by the Tribunal by holding that even though an enduring benefit arises; such benefits could not be construed as fixed capital assets.
One key point cited by the Supreme Court in the capital v. revenue discussion in the case of CIT vs. Ashok Leyland Ltd. (1972) 86 ITR 549 (SC) is that firstly, the enduring benefit in itself is not a conclusive test. Secondly, it is necessary to consider whether the enduring advantage consisted merely facilitating the assessee’s operation or enabling the management and conduct of the assessee’s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, then such expenditure would be on revenue account. Thirdly, the question must be viewed in a larger context or business necessity or expediency.
The buyback of shares in the instant cases are driven by the need to secure harmony and a smooth management of the company. Such buybacks involve an expenditure incurred for a smooth and efficient functioning of a company to avoid a possible winding up and therefore are in the nature of business expenditure. Business expenditure, under the provisions of the Income-tax Act, 1961 (‘IT Act’) are deductible while computing the total income of the tax payer.
There are broadly two kinds of buyback under Companies Act, 2013. (A) Buyback under Section 68 of Co Act (Section 77A under Companies Act, 1956) or (B) Buyback pursuant to National Company Law Tribunal order under Chapter XV. While the above judgments apply to buyback under type (B) above, which again needs to be determined on a case to case basis, it would not be applicable to a buyback under Section 68 of the Co Act, especially considering that such buyback proceeds are exempt in the hands of the shareholder as per Section 10(34A) of the IT Act, while being subject to a distribution tax at a rate of 20% under Section 115QA of the IT Act.