Considering the recent amendments in Income Tax Act, distribution to shareholder / promoter has become challenging, specifically post introduction of section 2(22)(e). The most viable options to distribute / pull out funds for promoter are incentive pay-out, dividend distribution and buy-back. It is worthwhile to note that dividend income is now taxable in hands of the shareholder and no longer exempt. Thus, off the 3 options listed above, buy-back is preferred option for an investor / shareholder / promoter to pull out the funds from direct tax angle. Though, entity needs to ensure adherence to other regulations specially the requirements / limits prescribed under the Companies Act, 2013 & relevant rules.

Analysis:

Please see below tabulated tax impact under 3 alternatives i.e. dividend distribution (section 115O & 115BBDA), buy-back [115QA & 10(34)] and incentive pay-out (section 17):

Taxation in the hands of 115O & 115BBDA 115QA & 10 (34) 17
Shareholder
  • Individual’s → Prevailing tax slab rate
  • HNI → @ MMR i.e. 42.74%
  • Corporate → varies between 25.17% to 34.94%
Exempt u/s 10 (34)
  • Individual’s → Prevailing tax slab rate
  • HNI → @ MMR i.e. 42.74%
Company
  • Declared before April 1, 2020 → 20.56%
  • Declared after April 1, 2020 → Nil
Taxable → @ 23.296% Nil

 Conclusion:

Considering the above, most of the Companies will prefer to switch to buy-back option instead of distributing incentive or dividend to its shareholder / investor from a taxation perspective, but this may not always be feasible. The entity must be mindful of the fact that buy-back comes with inherent limitations. To say, the maximum amount that can be pulled out is 25% of the Company’s existing paid up capital & free reserves at a time, which is not the case in dividend & incentive pay-out. Also, debt : equity ratio cannot be more than twice the capital & free reserves. Needless to mention the compliance / adherence to regulations under Companies Act are cumbersome.

Reference:

1. Section 115BBDA – https://www.incometaxindia.gov.in/pages/acts/income-tax-act.aspx

2. Section 10(34) – https://www.incometaxindia.gov.in/pages/acts/income-tax-act.aspx

3. Section 115QA – https://www.incometaxindia.gov.in/pages/acts/income-tax-act.aspx

4. Section 17 – https://www.incometaxindia.gov.in/pages/acts/income-tax-act.aspx

Author Bio

Qualification: CA in Job / Business
Company: Convergent Finance LLP
Location: MUMBAI, Maharashtra, IN
Member Since: 28 Mar 2020 | Total Posts: 13
I am a competent Chartered Accountant with proficient understanding and working knowledge IFRS, Indian GAAP, Direct Tax and Corporate Laws. 6+ years of post-qualification experience in preparation and analysis / review of Financial Statements of various Companies in varied industries including finan View Full Profile

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