Shares Buyback cannot be equated with capital reduction

CA Suraj R. Agrawal

Brief of the Case:-

It is open to a company to buy back its own shares by following the procedure prescribed under section 77A/Section 68 or by following the procedure prescribed under section 391 read with Sections 100 to 104 of the 1956, Act.

Facts of the case:

• The assessee is a wholly owned subsidiary of Goldman Sachs (Mauritius) LLC (GS-M). It was set up to undertake merchant banking and security business in India. Registered under the STPI scheme, the it had set up a 100% export oriented unit in Bangalore to serve as a global support centre for the Goldman Sachs Group entities.
• On 24.11.2010, the assessee had remitted an amount Rs. 1,88,99,97,781/- to GS-M under a buyback of shares scheme, whereby 4,03,93,199/- equity shares having face value of Rs. 10 each were bought back from GS-M by the assessee @ Rs. 46.79/- per share.

• Taking into account the face value of Rs. 10 per share, the AO in his order, passed u/s. 201(1) and 201(1A) r.w.s. 195 of the Act, on 27.01.2014 held that the excess payment of Rs. 36.79/-per equity share for 4,03,93,199 shares bought back amounting to Rs. 1,48,60,65,791/- was nothing but its distribution of its accumulated profits to its ultimate beneficiary and the only shareholder i.e. GS-M, that the buyback of equity shares by the assessee from its holding company was a colourable transaction to avoid the payment of dividend distribution tax (DDT). The excess payment of Rs. 1,48,60,65,791/- was held by the AO to be in the nature of dividend as per provisions of section 2(22)(d) of the Act. As the assessee had not deducted any DDT u/s. 115 of the Act, such dividend income was found by the AO not to qualify for exemption u/s. 10(34) of the Act and therefore, was taxable in the hands of the recipient GS-M, namely.
• AO further held that on remittance of such amount to a non-resident representing its income by way of dividend, tax deduction was required to be made u/s. 195 of the Act. As the assessee company had not deducted any tax while making such remittance, it was held to be an ‘assessee in default’ in terms of the provisions of section 201 of the Act.
• Further, the assessee was also found to be liable to pay simple interest u/s. 201 (1A) of the Act. Tax at the rate of 5% of the gross amount of such dividend was determined by the AO as payable by the assessee in terms of para 2(a) of Article 10 of the India Mauritius Tax-Treaty.
• Aggrieved by the order of the AO, the assessee preferred an appeal before the First Appellate Authority (FAA). Before him, it was argued that a transaction of buy back of shares referred to section 2 (22) (iv) of the Act was different from a transaction of capital reduction dealt by section 2 (22) (d) of the Act, that the transaction in question was one of buy back of shares and not a case of capital reduction.
• After considering the submissions of the assessee and the order of the AO, the FAA held the AO had obtained the annual report of the assessee company for the five preceding years and from such annual reports he noticed that it had been earning profits after tax for each of those years, that the reserves and surplus increased from Rs. 81,01,34,000/-for the year ending 31.03.2008 to Rs. 3,46,03,20,000/- for the year ending 31.03.2010, that inspite of regular profits being earned by it Directors of the assessee-company did not recommend any dividend payment on its equity shares, that money had a time value and postponement of grant of a share in the profits to a shareholder would be for purposes of re-investment in the business for the purposes of enhancing future profits, that the assessee had not shown any such requirement or compulsion as a justification for the non-grant of dividend in the regular course, inspite of the continuous accumulation of profits in its books, that the AO had specifically required the assessee to explain the commercial reason, if any, for the non issue of dividend although the profits were being accumulated year after year, that it chose to remain silent on this show cause notice issued by the AO, that by permitting the profits to accumulate in its books it had avoided the payment of DDT that would have been payable if such accumulated profits had been distributed to its shareholders, that a portion of such accumulated profit was finally passed on to the sole shareholder on 24.11.2010 by way of payment on account of buy back of shares, that it had claimed the exemption available u/s. 2(22)(iv) of the Act that excluded any payment made by a company on the purchase of its own shares from a shareholder in accordance with the provisions of section 77-A of the Companies Act, 1956
• The FAA further observed that the definition of dividend given in section 10(22) of the Act was an inclusive definition that sought to extend the scope of amounts chargeable to tax as deemed dividend but payments in the nature of dividend would always be coming within the ambit of the term dividend, that the commercial significance of a transaction of a buyback of equity shares was normally for the purposes of consolidating the share-holding of the remaining share holders and to enhance the value of the shares remaining in the hands of the continuing share holders, that GS-M was the sole equity share holder of the assessee-company both prior to and after the buyback of shares by the it, that the arrangement of buy-back of shares would not lead to any consolidation or a change in the value of its holdings in the assessee-company, that there was no commercial purpose was served through the buyback arrangement, that the assessee was a wholly owned subsidiary of GS-M, that the latter was in a position to ensure that the returns out of the profits of the assessee-company would be given to it not through dividend, that payment of dividend would have been liable to DDT, that the transaction of the receipt of its share of profits in the assessee company was given an artificial colour of capital gains, that capital gain on such transaction was exempt from tax in the hands of the recipient, that the non-distribution by way of dividend of the accumulated profits, the transaction of buy back of shares offered by it and the exercise of such option by its sole shareholder was carried out not for any commercial reasons, that whole transaction was arranged for the purposes of enabling an evasion of taxes due on such distribution of Profits, that the receipt by GS-M would come within the ambit of income from a share-holding or a participation in the profits of a subsidiary, that the assessee through the recourse to the arrangement of the buyback of shares sought to give the colour to this transaction as not being in the nature of a receipt of dividend but a capital gain of the concerned share holder, that the arrangement was made to use of the provisions of section 46A of the Act and to claim exemption from tax in India on the basis of Article 13(4) of the India Mauritius Tax Treaty.
• He further held that section 100 to 105 of the Companies Act dealt with reduction of capital, that the annual accounts of the assessee showed that its share capital actually got reduced and was so reflected in the books after the buy-back of the shares, that buy-back of shares was one of the ways of capital reduction, that reliance by the AO on the provisions of section 2(22)(d) of the Act dealing with capital reduction, as including a transaction of buy-back of shares was justified, that the provisions of section 10(34) would apply only if DDT had been paid u/s. 115-0 of the Act, that no DDT was paid by the assessee, that the recipient would not be entitled to any exemption u/s. 10(34) of the Act, that the receipt in its hands would be chargeable to income tax, that the treatment by the AO of the assessee as an A-ID and the raising of demand u/s. 201(1) and 201(1A) r.w.s. 195 of the Act was justified. Finally, he decided the issue against the assessee.

Contentions of Appellant:

The assessee had bought back the shares as per the resolution passed in the general meeting in the Board of Directors on 4.11.2010 (Pg 14 of PB), that the offer for buy back opened on 5.11.2010 and closed on 20.11.2010, that the shareholder tendered the shares on 23/.11.2010, that after the amendment to section 77A of the Company’s Act there was no need to approach the courts to buy back the shares if the percentage of buy bought shares were less that a certain limit, that correspondingly provisions of sec. 2(22)(d) of the Act were amended w.e.f 1.6.2001, that sub clause of (iv) of Section 2(22)(d) of the Act dealt with the dividends, that the amount in question was to be assessed under the head capital gains, that even after amendment to section 115QA of the Act burden of payment of tax has not been shifted to shareholders , that the AAR had not considered the provisions of sub clause (iv) of section 2(22) of the Act while deciding the application filed before it, that the payment made by the assessee was for the purchase of shares, that there was no reduction in capital.

Contention by Revenue:

The facts of the case decided by the AAR were applicable to the case under appeal, that the buy-back was not genuine, that it was a case of colourable device, that the scheme had resulted in reduction in capital, that the FAA had rightly held that provisions of section 2(22)(d) of the Act were applicable.

Ruling of Honorable ITAT/Court:

• Section 100-105 r.w.s. 391 of the Companies Act deal with reduction of capital and obtaining permission of the Court. Clearly, both deal with different situations.
• The observations in the case of Capgemini India Private Limited (Company Scheme Petition No.434 of 2014 dated 28.04.2015) of the Hon’ble Court does not leave any doubt that buyback of shares cannot be equated with reduction of capital.
• Buy back of shares and reduction of share-capital are different concepts, that buyback of shares of a corporate entity cannot to be characterized as deemed dividend, that profit arising out of the buyback schemes had to taxed under the head capital gains.
• It is worth mentioning that provisions of section 115Q have been amended w.e.f. 01.04.2013 and profit arising out of buyback of shares is to tax at a particular tax rate. But, the AY., before us, is prior to the April, 1st, 2013. Therefore, ITAT have to decide the issue as per the prevailing law applicable on the date of the transaction in question. There is no ambiguity about the provisions that would govern the buyback of shares. Section 2(22)(d)(iv) r.w.s. 46A of the Act would be applicable to the buyback scheme. Accordingly, the transaction cannot be treated deemed dividend.
• Issue of treating the assessee as A-I-D for not deducting tax at source. Once it has been decided that the profit arising out of buyback would be taxed as capital gains the next step is to determine as to whether the capital gains are taxable in the hands of parent company of the assessee in light the Indo-Mauritius Tax Treaty. Article 13 of the said DTAA provides that capital gains would not be taxable in the hands of GS-M. If the assessee was not liable to deduct taxes as per the provisions of section 195 of the Act, it cannot be held A-ID. For invoking the provisions of section 201 of the Act, non deduction of taxes at source is a precondition. ITAT also find force in the alternate argument raised by the assessee. Even if the payment to GSM is considered as dividend u/s. 2(22)(d) of the Act, then the taxes on the same have to be charged by way of DDT as per section 115-O of the Act. As per section 10(34) of the Act, any income by way of dividend referred to in section 115-O of the Act does not form part of total income in the hands of the recipient and company declaring dividend will be in default as per section 115Q. So, the provisions of TDS would not be applicable for dividend covered under section 2(22) (d) of the Act.
• If an assessee enters into a deal which does not violate any provision of the Act of applicable to a particular AY. The deal cannot be termed a colourable device, if it results in non-payment or lesser payment of taxes in that year. The whole exercise should not lead to tax evasion. Non-payment of taxes by an assessee in given circumstances could be a moral or ethical issue. But, for that the assessee cannot be penalized. In light of the above discussion, ITAT reversed the decision of the FAA and deciding the effective ground of appeal in favour of the assessee.