Tax on Income Distributed By Way of Buy-Back of Shares By Unlisted Companies- Anti Abuse Provision

Dear Friends, payment of taxes is the duty of every citizen of this country. The Governments utilises taxes paid by us into different types of economic and socio works. Non payment or avoidance of taxes shall be punishable monetarily as well as confinement into prison. The Corporates uses various tactics to avoid payment of taxes to the government. Any profit distributed by a corporate body is called dividend and DDT will be applicable on that. The companies generally use Buy-Back of shares to avoid payment of Dividend Distribution Tax (DDT).

Since any distribution of dividend is exempt in the hand of shareholders under provisions of Section10(34) of the Income Tax Act, 1961.

The Companies generally Buy-back its shares to share it retain profit with its shareholders and to increase its image in general public, that it is a best company for investment. The outstanding shares purchased by company will increase its earning per share and added value in the financial statement of the Company.

It is one of the corporate financial strategies to enhance capital return by optimising the capital structure to suit the current market environment.

 LET’S CONSIDER BUY-BACK OF SHARES UNDER COMPANIES ACT, 2013

Section 68, 69, and 70 of The Companies Act, 2013 along with Rule 17 of The Companies (Share Capital and Debentures) Rules, 2014, governs the procedure of Buy-Back of shares and other specified securities by Unlisted Companies.

Unlisted companies are those companies whose shares are not listed on a recognised stock exchange and therefore not available for trading by the general public. An unlisted company can be a Private or Public company.

LET’S CONSIDER TAXABILITY OF BUY-BACK UNDER INCOME TAX ACT, 1961;

SECTION 115QA: was introduced as an Anti-Abuse provision to check the practice of unlisted companies resorting to buy-back of shares instead of payment of dividends to avoid payment of DDT. This process of avoidance of tax was preferred by shareholders of unlisted companies, because the tax payment through this process is much less than, DDT paid on payment of dividend.

This type of process to avoid payment of tax on distribution of dividend is also applied by some listed companies also.

 Lets’ consider below mentioned cases;

1961: Mac Consultancy Ltd., is engaged in technical consultancy and provides consultancy services in India and abroad. 70% of shares of Mac Consultancy Ltd., are held by Mac Holding Ltd., (date of issue; April 1,2001 and Share Price: Rs. 10). Both companies are Indian company and shares of Mac Consultancy Limited are listed on Bombay Stock Exchange. Buy back offer was given by Mac Consultancy Limited on Feb 1, 2017 to distribute Rs. 1000 crores to its shareholders. As shares of Mac Consultancy Ltd., are listed and hence it is not liable to pay Dividend Distribution Tax (DDT) under Section 115QA. Securities Transaction Tax is applicable in case of buy back of shares of listed companies, the shareholders (including Mac Holding) will get exemption from payment of tax u/s. 10(38) of the Income Tax Act, 1961. Now in this case Mac Consultancy Limited has transferred Rs. 1000 Crores to its shareholders including Rs. 700 crores to Mac Holding Limited, without payment of any amount of tax.

 Exemption under Section 10(38) is not available if shares transferred after April 1, 2018. Lets’ suppose buy back of shares held on June 6, 2018 to distribute Rs. 2000 crores to shareholders, now in this case additional information is as follows;

Market value of shares on January 31, 2018: Rs. 2,800/- per share

Bonus shares 1:1 offered on May 1, 2018

Quotation: Rs. 3000/- cum bonus and Rs. 1600/- ex bonus

Offer price for buy back of shares June 6, 2018: Rs. 1700/- per share 

Note: in this case Mac Consultancy will not pay any tax on buy back on distribution under section 115QA. The shareholders will not have any exemption under provisions of Sections 10(34A) and 10(38) of the Income Tax Act, 1961. 

The income of shareholders will be taxable under Section 112A as;

Particular Amount (Rs.)
Full value of consideration (buy back of 1 share)

Less; Cost of acquisition under Section 55(2) (ac) [ fair market value of original shares on 31/01/2018]

1,700.00

 

1,700.00

Long term Capital Gain NIL

Note: in this case also there is no tax in the hand of shareholders, even after withdrawals of exemption under provisions of Section 10(38) of the Income Tax Act, 1961.

AMENDMENT IN PROVISIONS OF INCOME TAX ACT, 1961;

The Central Government has extended scope of provisions of Section 115QA i.e. existing anti abuse provisions to all companies (including companies listed on stock exchanges). Thus, any buy-back of shares on or after July 5, 2019 from a shareholder by a company listed on any recognised stock exchange, shall be covered by the provisions of Section 115QA and in same way scope of provisions of Section 10(34A) are extended to shareholders of listed companies also.

LET’S ANALYSE ABOVE PROVISIONS;

  Exemption to Shareholders U/s. 10(34A) Tax on distributed income under Section 115QA payable  
Buy-back of shares of Unlisted Companies (during June 1, 2013 to July 4, 2019) Exemption Available Tax payable by Company U/s. 115QA.
Buy-back of listed shares (during June 1,2013 to March 31, 2018) Exemption not available. However, exemption may be available U/s. 10(38). Tax on distributed income U/s. 115QA, not applicable.
Buy-back of listed shares (during April 1,2018 to July 4, 2019) Exemption not available. However, tax is payable by shareholders in the case of long-term capital gain within provisions of Section 112 A. Tax on distributed income U/s. 115QA, not applicable.
Buy-back of unlisted/ listed shares (on or after July 5, 2019) Exemption is available. Tax payable by the Company under Section 115QA.

 RATE OF TAX: Section 115QA provides for levy of additional income tax at the rate of @20%(+SC+HESC) effective Tax Rate will be @23.296% of the Distributed Income on account of buy-back unlisted shares of the Company. This tax will be applicable in the hand of company and consequential tax in the hands of shareholders will be exempted under provisions of Section 10(34A) of the Income Tax Act, 1961.

Conclusion:  from above referred write up, we shall conclude that the tendency of corporate world is to avoid payment of taxes to the government. The companies engage themselves in various types of tax avoidance activities. Buy-back of share is one of those activities through which companies distributing surplus to their shareholders, without payment of taxes. Initial stage provisions of Section 115QA are applicable to unlisted companies, but after July 5, 2019, it became applicable to listed companies also.

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