Income Tax on Shares Buy Back by Unlisted Companies

As we know, a company is a safer form of doing business. A company is a separate person than its shareholders/ members; it has its own personality and having power to assessed separately. The shareholders or members of the company are the real owners of the assets of the company. The company is doing business for the benefit of its stake holders. The Shareholders may appoint Board of directors to do business and take care of management for their behalf.

Section 2(22) of the Companies Act, 2013, defines a company limited by shares as “a company having liability of its members limited by the memorandum to the amount, if any, unpaid on the shares respectively held by them.”

Section 68 of the Companies Act, 2013 ; empowers the company to purchase its own securities, it provides that;

1. Notwithstanding anything contained in this Act, but subject to the provisions of sub section(2) a company my purchase its own shares or other specified securities ( hereinafter referred to as buy back of shares) out of-

(a) Its free reserves;

(b) The security premium account; or

(c) The proceeds of the issue of any shares or there specified securities.

Provided that no buy back of any kind of shares or specified securities shall be made out of proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.

2. No company shall purchase its own shares or other specified securities under sub section (10 unless-

(a) The buy back is authorized by its articles;

(b) A special resolution has been passed at a general meeting of the company authorizing the buy back

Provided that nothing contained in this clause shall apply to a case where-

(i) The buy back is, ten percent , or less of the total paid-up equity capital and free reserves of the company ; and

(ii) Such buy back has been authorized by the Board by means of resolution passed at its meeting;

(c) the buy back is twenty five percent, or less of the aggregate of Paid-up capital and Free Reserves of the company;

Provided that in respect of the buyback of equity shares in any financial year , the reference to twenty five percentage ,in this clause shall be construed with respect to its total Paid-up equity capital in that financial year.

(d,) the ratio of the aggregate of secured and unsecured debts owed by the company after buy back is not more than twice the Paid-up capital and its Free Reserves;

Provided that the Central Government may, by order, notify a higher ratio of the debt to capital and free reserves for a class or classes of companies;

(e) all shares or other specified securities for buy back are fully paid;

(f) the buyback of shares or other specified securities listed on any recognized stock exchange is in accordance with the regulations made by the Securities and Exchange Board in this behalf; and

(g) the buy back in respect of shares or other specified securities other than those specified in clause (f) is in accordance with such rules as may be specified;

Provided that no offer of buy back under this subsection shall be made within a period of one year reckoned from the date of closure of the preceding offer of buy back if any.

The company has to comply some other sub sections of Section 68, while buying back its shares from its shareholders or employees.

Companies under Income Tax Act, 1961; Section 2(17); the company is defined to mean the following:

a. Any Indian Company; or

b. Anybody corporate incorporated under laws of a foreign country; or

c. Any institution, association or a body which is assessed or was assessable/assessed as a company for any assessment year commencing on or before April 1, 1970; or

d. Any institution, association or a body, whether incorporated or not and whether Indian or non Indian, which is declared by general or special order of Central Board of Direct Taxes to be a company.

Indian Company; Section 2(26); An Indian company means a company incorporated under provisions of the companies Act, 1956 or companies Act, 2013 and includes;

a. A company formed and registered under any law relating to companies formerly in force in any part of India other than the state of Jammu and Kashmir and some Union Territories as specified in Clause (e);

b. A corporation established by or under a Central, State or Provincial Act;

c. Any institution, association or body which is declared by the Board to be a company under Section 2(17);

d. A company formed and registered under any law in force in the state of Jammu and Kashmir;

A company formed and registered under any law for the time being in force in the Union territories of Dadra and Nagar Haweli, Goa, Daman and Diu and Pondicherry.

Provided that in the aforesaid cases, a company, corporation, institution, association or body will be treated as an Indian company only if it’s registered office is in India.

Domestic Company; means an Indian Company or any other company which, in respect of its income liable to tax under the Act, has made prescribed arrangement for the declaration and payment of dividends within India in accordance provisions of section 194 of the Income Tax Act, 1961.

The main aim of a company is to benefit its shareholders and other stakeholders. A company having distributable Reserves benefits its members in two ways;

1. By declaration of dividend and paying Dividend Distribution Tax. The dividend is not taxable in the hand of Shareholders of the company. Now in this case Dividend Distribution Tax has been paid by the company to the government and DDT is not subject to provisions of Avoidance of Double Taxation Agreements.

2. By purchasing its own shares from existing shareholders of the company at a price fixed by the company. Now in the case of Buy Back of shares, no tax is payable and same will be taxed in the hand of shareholders as Capital Gain Tax. This type of arrangement is covered under provisions of avoidance of Double Taxation Agreements. The Capital Gain Taxed will be governed by provisions of Section 46A of the Income Tax Act, 1961.

The unlisted companies, as a part of tax avoidance arrangement has started to buy back shares instead of declaration of dividend and payment of DDT under provisions of Section 115O of the Income Tax Act, 1961. The Capital Gain Tax applicable in case of buy back of shares in the hand of shareholders are governed by provisions of 46A , are eight her not chargeable to tax or charged at the lower rate due to exemption available under Section 45 to 55 and because of operation of avoidance of Double Taxation Agreements.

Finance Act, 2013 introduced Chapter XII-DA containing sections 115QA, 115QB and 115QC with effect from June 1, 2013 to curb aforesaid practice of avoidance of tax due to buy back of shares by unlisted companies.

SECTION 115QA; Provisions of applicable when;

1. A domestic company distributes income to its shareholders through Buy Back of shares;

2. Section 115QA is now applicable on listed as well as unlisted companies (Amendment made by Finance Act, 2019)

3. Such company is liable to pay an additional income tax @20% (SC+EC+SHEC) on distributed income;

4. The additional income tax under Section 115QA shall be in addition to the income tax chargeable on Net Income of the company;

5. The additional tax under Section 115QA is payable irrespective of the fact whether regular income tax is payable by company on its total income or not;

6. The amount of tax under Section 115QA will be remitted to the government within a period of 14 days from the date of payment of buy back consideration to the shareholders;

7. No deduction from the tax payment will be allowed to the company as well as the shareholders in this case.

SECTION 115QB; provides for payment of interest on late payment of additional taxes, the interest @1% per month (or part of the month) will be charged after the last date on which tax was payable and ending with the date of actual payment.

SECTION 115QC; provides that in case of failure of payment of tax, the principal officer of the company and the company shall be deemed to be an assessed in default in respect of the amount of tax payable and all provisions of the Income Tax Act, 1961 relating to demand ,recovery and collection of taxes shall apply.

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