Summary: Following the abolition of the Dividend Distribution Tax in April 2020, the Finance (No.2) Bill, 2024 proposes significant changes to the taxation of income from the buyback of shares. Previously, income from buybacks was exempt for shareholders, mirroring the tax treatment of dividends. However, starting October 1, 2024, buybacks will be treated as deemed dividends, taxable in the shareholders’ hands. This new provision mandates that the payment received for buyback of shares by a domestic company be taxed as dividend income, with no deduction for related expenses. Consequently, shareholders will need to adjust their capital gains calculations to account for capital losses incurred due to the buyback. For example, if shares bought at Rs. 50 are later bought back at Rs. 75, the deemed dividend tax will be Rs. 7,500, and the capital loss on the buyback will be Rs. 5,000. This loss can be used to offset future capital gains, reducing taxable gains. The new rules aim to enhance tax fairness and align buyback practices with dividend taxation principles.
TAXATION OF DISTRIBUTED INCOME FROM BUY BACK OF SHARES OF DOMESTIC COMPANY
Post the abolition of the Dividend Distribution Tax, making Dividends taxable in the hands of the shareholders w.e.f. April 2020, Buy-back of Shares has been a very popular method which allowed Companies to utilise its excess cash reserves in an effective way buy reducing its outstanding shareholding, resulting in enhancing the value of the remaining shares.
Earlier upto March 2020, the taxation on distributed income of a Domestic Company from buyback of shares was similar to taxation on distributed income by way of Dividends. The companies were paying Dividend Distribution Tax of Dividends distributed or Consideration Distribution Tax on Distribution of Income through Buy-back of shares accordingly. The income received by the shareholders in either case was Exempt as per the provisions of Section 10(34) & 10(34A) of the Income Tax Act, 1961.
Post April 2020, when the Dividend Distribution Tax was abolished, making Dividends taxable in the hands of the shareholders, Corporates preferred the route of Buyback of shares for Distribution of Income as it still allowed them to distribute income by paying Consideration Distribution Tax and making it Exempt in the hands of the Shareholders.
The Finance (No.2) Bill, 2024 has proposed to tax the Distribution of Income through Buy-back of Shares as Deemed Dividends in the hands of the shareholders.
It has been proposed that, the sum paid by a domestic company for purchase of its own shares shall be treated as dividend in the hands of shareholders, who received payment from such buy-back of shares and shall be charged to income-tax at applicable rates.
Further no deduction for expenses shall be available against such dividend income while determining the income from other sources.
Thus, the cost of acquisition of the shares which have been bought back would generate a capital loss in the hands of the shareholder as these assets have been extinguished. Therefore when the shareholder has any other capital gain from sale of shares or otherwise subsequently, he would be entitled to claim his original cost of acquisition of all the shares (i.e. the shares earlier bought back plus shares finally sold).
It shall be computed as follows:
(i) deeming value of consideration of shares under buy-back (for purposes of computing capital loss) as nil;
(ii) allowing capital loss on buy-back, computed as value of consideration (nil) less cost of acquisition;
(iii) allowing the carry forward of this as capital loss, which may subsequently be set-off against consideration received on sale and thereby reduce the capital gains to this extent.
Example :
500 shares bought in 2021 @Rs. 50/- per share
Total cost of acquisition Rs. 25000/-
100 shares bought back in 2024 @Rs. 75/- per share
Income taxable as deemed dividend Rs. 7500/-
Capital loss on such buyback (Rs. 50 *100) Rs. 5000/-
Remaining 400 Shares sold in 2025 @Rs. 100 per share
Capital Gain (40000 – 20000) Rs. 20000/-
Chargeable capital gain after set off of Capital Loss Rs. 5000 will be Rs.15000/-
These amendments are proposed to take effect from the 1st day of October, 2024, and will accordingly apply to any buy-back of shares that takes place on or after this date.
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