Taxation of Buy Back of Shares

Company

♦ Section 115QA, which provides for the levy of tax, on account of buy-back of shares, at an effective rate of 23.296% (20% + 12% SC + 4% H&EC)

♦ Buy-Back Tax has to be paid by the company on the distributed income which is nothing but the consideration paid by the company on buyback of shares, as reduced by the amount received by the company on the issue of such shares, determined in the manner prescribed under Rule 40BB of the Income Tax Rules, 1962 (ITR). Also, such Buy Back Tax has to be paid by the company over and above the tax paid by it, if any, on its total income.

Shareholder

♦ Buy Back Tax is levied at the level of the company, the consequential income arising in the hands of shareholders is exempt from tax, as per Section 10(34A) of the ITA.

BUY-BACK OF SHARES – WHETHER SECTION 56(2)(x) GETS INVOKED? 

♦ When a company carries out buy-back of its shares, then, whether the provisions of Section 56(2)(x) can be invoked on such company. If yes, then when the company does buyback of its shares by paying considerably less than the Fair Market Value (FMV) of the shares, determined in accordance with Rule 11UA of the ITR, then the differential amount (i.e. FMV of the shares Less Consideration paid) will be taxable, in the hands of the company, under Section 56(2)(x) of the ITA.

♦  As per Section 56(2)(x) of the ITA, where any person receives, in any previous year, from any person or persons:-

1. any property, other than immovable property,—

2. without consideration, the aggregate fair market value of which exceeds fifty thousand rupees, the whole of the aggregate fair market value of such property;

3. for a consideration that is less than the aggregate fair market value of the property by an amount exceeding fifty thousand rupees, the aggregate fair market value of such property as exceeds such consideration :

Then such difference is taxable as income under the head’s income from other sources in the hands of the person receiving such property.

♦ “Property” is defined in Clause (vii) of Sub-section 2 of Section 56, which defines “Property” means the following capital assets of the assessee namely

(ii) Shares and Securities.

• Thus, the primary condition for invoking the provision of Section 56(2)(x) is that the property (in the present case shares) should become “Property” in the hands of the recipient. In other words, for Section 56(2)(x) to be made applicable on a company, buying back its shares, the shares so bought back should become the “Property” of such company.
• Section 68 of the Companies Act, 2013 sets out the provisions apropos Buy-Back of shares by the company. As per Sub-Section (7) of Section 68 “Where a company buys back its own shares or other specified securities, it shall extinguish and physically destroy the shares or securities so bought back within seven days of the last date of completion of the buy-back..”
• Thus, in a scheme of buyback, shares bought back are no more in existence as they are extinguished by writing down the Share Capital. Hence, when a company buys back its shares, such shares do not become “property” or assets of the company.
• As a result, provisions of Section 56(2)(x) cannot be invoked in the case of any company buying back its own shares. 
• ITAT Mumbai Bench in the case of Vora Financial Services P. Ltd. [2018] 171 ITD 646 (Mum), held that buyback of shares is not covered under the ambit of section 56(2)(viia). It was observed that for the purpose of taxing buy-back under section 56(2)(viia), shares should become “property” of recipient-company whereas, in case of buy-back, such shares are mandatorily canceled and cannot become the property of a company. Accordingly, buyback of shares should be out of the ambit of section 56(2)(viia) of the Act.
• The aforementioned decision has been rendered in the context of Section 56(2)(viia) which was effective till 31.03.2016. With effect from 1.04.2017, a new clause (x) has been inserted to sub-section (2) to Section 56. Provisions of Clause (viia) are similar to clause (x) which is applicable to all the persons, including unlisted companies. Thus, the ratio laid down by ITAT, Mumbai Bench in the case of Vora Financial Services P. Ltd. (Supra), shall apply with equal force in the present times, wherein, Clause (x) to Sub-Section 2 to Section 56 is applicable.

BUYBACK OF SHARES – WHETHER SECTION 50CA GETS INVOKED?

• Section 50CA is a special provision, which provides that in case of transfer of unquoted shares, FMV of such shares should be considered to be the “Full Value of Consideration” for the purpose of Section 48, if greater than the actual consideration received or accrued as a result of the transfer. For such purposes, the FMV of the shares has to be determined in accordance with Rule 11UAA of the ITR.
• As discussed hereinabove, the taxability of buyback of shares is governed by Section 115QA, introduced by Finance Act, 2013. Section 115QA(1) starts with “Notwithstanding anything contained in any other provision of this Act”. Thus being a non-obstante clause it shall supersede other provisions, in relation to buy back in the ITA.
• Further, Section 10(34A), also introduced through Finance Act, 2013, provides for exemption of “any income” arising to an assessee, being a shareholder, on account of buyback by a company, as referred to in Section 115QA. Thus, whatever income arises to a shareholder of an unlisted company on account of buyback of shares is exempt.
• As per Section 115QA, read with Section 10(34A), the incidence of tax on buyback of shares by the company arises at the company level and thereafter no tax is required to be paid by the shareholder. Thus, shareholders need not calculate any income under the head Capital Gains, in accordance with Section 46A, read with 48, of the ITA.
• Since there is no taxability, under the head Capital Gains, of the income arising to the shareholder on buyback, computational provisions as contained in Section 48 are not invoked. Resultantly, there is no applicability of Section 50CA.
• In view of the aforementioned discussion, one can conclude that in the case of buyback of shares by a company, neither Section 56(2)(x) nor Section 50CA of the ITA can be invoked.

DETERMINATION OF VALUE OF SHARES FOR BUYBACK

• Determination of value to be assigned to the shares, by the company, for the purpose of buyback, is not required to be done in accordance with Rule 11UA and 11UAA, being applicable for the purpose of Section 56 and Section 50CA respectively. Rule 11UAA sets out the FMV of the shares to be determined in accordance with Rule 11UA.
• Although, there does not appear to be any bar on the company, to determine the value at which the buyback of the shares can be undertaken, however, still, the value of the shares has to be determined on some basis.
• The value determined should not be higher than the FMV of the shares of the company, as otherwise, the differential amount can be charged to tax as deemed dividend u/s 2(22)(e), if the relationship between the shareholder and company, as provided under that section is satisfied.

ITAT Bangalore Bench in the case of Fidelity Business Services India (P.) Ltd. [2017] 164 ITD 270 (Bangalore – Trib.) held that payment in the name of buyback of shares made by the assessee, to its related party, in excess of FMV of the share of the assessee company would fall in the ambit of Section 2(22)(e), i.e. Deemed Dividend. ITAT in the said case held that in case the buyback price is not based on the real valuation and it is “artificially inflated” by the parties then it is certainly a device for transfer of the reserves and surplus to the holding company by avoiding the payment of tax and therefore it will be treated as a colorable device. The aforementioned judgment of ITAT, Bangalore Bench, has been subsequently affirmed by the Karnataka High Court [[2018] 257 Taxman 266 (Karnataka)]