Income Tax on Buyback of Shares

INTRODUCTION:

• Section 46A : states that any gain on transfer of listed shares pursuant to Buy Back of shares scheme will be taxable under head ‘Capital Gains’. Further, while computing the Capital Gain on said buy back, Cost of acquisition is deducted from Buy Back price. For E.g. Mr. A acquired 1,000 share of Infosys at Rs. 500 in F.Y. 2009-10. Then in F.Y. 2017-18, the company decided to buy back its 5% shares at Rs. 1,400 per share. Mr. A opted for the said scheme and transfer 50 shares (i.e. 5% of 1000 shares) to the company under buy back scheme. In this transaction Mr. A has made Capital Gain of Rs. 900 per share (Rs. 1,400- Rs. 500) and in total Rs. 45,000. However, as per Income Tax Act, after considering the Indexation of Cost of acquisition, the Capital Gain amount is Rs. 24,054. On this Capital Gain of Rs. 24,054, Mr. A will liable to pay tax at 20% (being Long Term Capital Gain) or he can pay 10% tax on Capital Gain without availing indexation benefit.
• Section 115QA deals with the Income Tax on Buy Back of shares by the Unlisted Companies. In case of buy back of shares by unlisted company, the company shall be liable to pay Tax on Buy Back of Shares at 20% and consequently, the Capital gain accrued to the shareholders will be exempt in their hands by virtue of Section 10(34A) of Income Tax Act.
• The intention behind introduction of Sec. 115QA is that, a company, having distributable reserves, has two options to distribute the same to its shareholders either by declaration and payment of dividends to the shareholders, or by way of purchase of its own shares (i.e. buy-back of shares) at a consideration fixed by it. In the first case, the payment by company is subject to DDT and income in the hands of shareholders is exempt. In the second case the income is taxed in the hands of shareholder as capital gains.
• Unlisted Companies, as part of tax avoidance scheme, are resorting to buy-back of shares instead of payment of dividends in order to avoid payment of tax by way of DDT particularly where the capital gains arising to the shareholders are either not chargeable to tax or are taxable at a lower rate.
• In order to curb such practice it is proposed to amend the Act, by insertion of new Chapter XII-DA, to provide that the consideration paid by the company for purchase of its own unlisted shares which is in excess of the sum received by the company at the time of issue of such shares (distributed income) will be charged to tax and the company would be liable to pay additional income-tax @ 20% of the distributed income paid to the shareholder. The additional income-tax payable by the company shall be the final tax on similar lines as dividend distribution tax. The income arising to the shareholders in respect of such buy back by the company would be exempt where the company is liable to pay the additional income-tax on the buy-back of shares.
• On 20th September 2019, the government has introduced Taxation Law Amendment Act, 2019. As per the said amendment act, the Government has extended the applicability of Sec. 115QA to Listed Companies as well (earlier it was applicable to unlisted companies only). As per the amendment, now listed companies are responsible to pay Income Tax on Income component distributed in the buy back scheme. However, it is to be noted that this amended provision is applicable for Buy Back of shares announced on or after 5th July, 2019. Needless to mention that Capital Gain on the buy back on or after 5th July , 2020 is exempt in the hands of shareholders.
• Rule 40BB prescribes the determination of Cost of acquisition to be deducted for computation of Income Tax Liability under Sec. 115QA.
• The said Rule covers various scenarios of buy back, however in normal scenario to calculate Income Tax of Buy Back of Shares, Amount received by the company is to be deducted from the Buy- Back price. This is because, the intention of Income tax Act is to tax INCOME distributed by the Company. Hence, if a Company buy backs its shares from secondary market, the Income component in the Buy Back price = Buy Back price – Issue price of shares.
• Illustration: Mr. A bought 50 shares of Company A in IPO at Rs. 300 (Rs. 10 FV & Rs. 290 Premium). He sold these shares to Mr. B at Rs. 800 on the date of listing of shares on exchange and made gain of Rs. 500 per share. Mr. A will pay Capital Gain Tax on this transaction. Now comes to Mr. B, Mr. B purchased shares from Mr. A at Rs. 800. After 2 years, the Company A come up with Buy Back scheme where Buy Back price is fixed at Rs. 2,000 per share. Mr. A offered his shares in the said scheme and made gain of Rs. 1200 (Rs. 2000 – Rs. 800) per share. Here, the company will pay tax on DISTRIBUTED INCOME component of Rs. 1,700 (Rs. 2000 – Rs. 300). Consequently, the Capital Gain of Rs. 1200 will be exempt in the hands of Mr. B.
• It is to be noted that Gain made by Mr.A is from Sale of shares in secondary market, however, gain made by Mr.B is result of Income distributed by the company.

Hope this article will bring clarity on the Income Tax implications in the Buy Back Transactions. If you have any query, drop a mail on ninadmankar88@gmail.com