Introduction
The Companies Act of 2013 allows companies to buy back their own shares from the market, which is known as a share buyback or repurchase. This strategic move help companies to:
(i) Increase EPS – As a share repurchase reduces the number of shares outstanding, it increases earnings per share (EPS).
(ii) Increase in the value of the shares – Increase in the EPS lead to increase in the market value of the remaining shares
(iii) Restructure debt-equity mix – A company can restructure its debt-equity mix by buying back shares through recapitalization.
(iv) Consolidate the Ownership – Through repurchases of its shares it can consolidate the ownership.
(v) Providing Security to the Investors – A buyback is clear indication that the company has extra cash. It gives more security to the investors about the company’s cash flow.
Companies typically announce a share buyback by stating that the board of directors has passed a “repurchase authorization”. This authorization details how much money will be used to buy back shares, or the number or percentage of shares that will be bought back.
There are two ways a company can buy back shares under the Companies Act:
- Shareholders’ Resolution: In a General Meeting
- Directors’ Resolution: In a Meeting of the Board of Directors
Taxation aspects of Buy Back of Shares 1999 to 2024:
Since the introduction of Section 77A in the Companies Act of 1956, the issue of taxation of Buy-Back of shares emerged. It has led to initiating a series of tax reforms under the Income Tax Act, 1961. Over time, the tax liability on share buy-backs has shifted repeatedly between shareholders and companies. The latest changes in the Finance Bill of 2024 propose further amendments, continuing this evolving journey. The discussion below outlines the transition of buy-back taxability from its inception through the latest proposals in the Finance Bill of 2024.
(A) 1999 – Introduction of S. 46A
The Companies (Amendment) Ordinance, 1998 introduced Section 77A to the Companies Act, 1956, allowing companies to buy back their own shares. This has resulted in to the query as to whether the buy-back would be considered deemed dividend under Section 2(22) or whether it would trigger capital gains for shareholders. To address this issue
(a) A new Section 46A was introduced whereby the difference between the cost of acquisition and the consideration received by shareholders during the buy-back is to be treated as capital gains.
(b) A subsection 2(22)(e)(iv) was introduced so as to exclude the payment received for buying back its shares in accordance with Section 77 of the Companies Act, 1956 from the definition of the dividend.
(B) 2013 – Introduction of Section 115QA of income Tax Act to unlisted companies
Section 115-O imposes Dividend Distribution Tax (DDT) on companies when they distribute, declare, or pay dividends to shareholders. As a result of DDT, the dividend received by shareholders is exempt from being included in their total income. However, when a shareholder receives consideration from the buy-back of shares, it is not considered a dividend but instead taxed as capital gains under Section 46A of the Act.
As such government realised that unlisted companies have been using buy-backs as a tax avoidance strategy to bypass DDT, particularly in cases where the capital gains tax for shareholders is lower or non-existent.
To prevent this, Chapter XII-DA (Section 115QA) was introduced.
As per the amended provision the excess consideration paid by a company for buying back its unlisted shares over the amount initially received at the time of issuing those shares (referred to as “distributed income”) brought under the ambit of taxation. The company made liable to pay an additional income tax of 20% on the distributed income, similar to DDT.
The exemption as provided u/s 2(22)(e)(iv) continued to the shareholders.
The rationale for the introduction of the provision was that unlisted companies resorted to buyback of shares in order to avoid dividend distribution tax.
This amendment was introduced as an anti-tax avoidance measure.
(C) 2019 – Extension of S. 115QA of income Tax Act to listed companies.
The Union Budget 2019 announced the said section to be applicable to the listed companies as well. The amendment is effective for all buybacks post-July 5, 2019, vide Finance Act (No.2) 2019.
(D) 2024 – The Finance Act of 2024 has withdrawn provisions related to the Buy-Back Tax (BBT) for companies effective from 01 October 2024, shifting the taxation of buyback proceeds to the shareholders who receive them. It is
The relevant Extracts from memorandum to Finance Bill 2024 as under
Widening And Deepening Of Tax Base And Anti-Avoidance:
Special provisions relating to tax on distributed income of a domestic company from buy-back of shares were introduced by Finance Act, 2013, in line with the then schema of dividend distribution tax. Prior to the amendments made by the Finance Act, 2020, a company had to pay dividend distribution tax (DDT), on the distributed profits by way of dividends in addition to the income-tax chargeable in respect of the total income for any assessment year. DDT was done away with by the Finance Act, 2020.
2. References have been received stating that pay-outs on buy-back of shares should be taxed in hands of recipients, in line with similar regime in place for taxation of dividend.
3. Both dividend as well as buy-back are methods for the company to distribute accumulated reserves and thus ought to be treated similarly. In addition, there is extinguishment of rights for the shareholders who are tendering their shares in the buy-back by domestic company, to the extent of shares bought back by such company from shareholders. The cost of acquisition of such shares also needs to be accounted for in some manner.
4. It is therefore, 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. No deduction for expenses shall be available against such dividend income while determining the income from other sources. 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.
Related amendments made in the act:
| (i) | Section 2 (22)(f): Newly Inserted | Any payment by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 68 of the Companies Act, 2013 |
| (ii) | Section 10(34A): Newly inserted Proviso | Provided that this clause shall not apply with respect to any buy back of shares by a company on or after the 1st day of October, 2024 |
| (iii) | Section 115QA: Newly inserted Proviso | Provided further that the provisions of this sub-section shall not apply in respect of any buy-back of shares, that takes place on or after the 1st day of October, 2024 |
| (iv) | Section 46A: Newly inserted Proviso before the Explanation | Provided that where the shareholder receives any consideration of the nature referred to in sub-clause (f) of clause (22) of section 2 from any company, in respect of any buy-back of shares, that takes place on or after the 1st day of October, 2024, then for the purposes of this section, the value of consideration received by the shareholder shall be deemed to be nil. |
| (v) | Section 57:
(i) Amendment in clause (i) and (ii) Newly inserted proviso |
In clause (i), after the words “in the case of dividends,”, the words, brackets, letter and figures “other than that referred in sub-clause (f) of clause (22) of section 2” shall be inserted with effect from the 1st day of October, 2024
Insertion of second proviso to S. 57 – Provided further that no deduction shall be allowed in case of dividend income of the nature referred to in sub-clause (f) of clause (22) of section 2.”. |
| (vi) | Section 194: Amendment | In section 194 of the Income-tax Act, after the word, brackets and letter “sub-clause (e)”, the words, brackets and letter “or sub-clause (f)” shall be inserted with effect from the 1st day of October, 2024. |
Implications on account of the amended provisions in relation to buy-back on or after October 1, 2024
The abolition of buy-back share taxation would have impacts on both to the companies and shareholders
Increased Tax Burden to shareholders – Currently, the company pays a 20% tax on the distributed income during a buy-back and shareholders are exempt from tax on the proceeds. With the amendments as made in the finance act 2024, the tax burden would now shift to the shareholders, who would be taxed on the buy-back proceeds as dividend income or capital gains, depending on the structure.
Higher Tax Rates: As the payment received from buy back arrangement is taxable u/s 56, Shareholders in the higher tax bracket, need to pay the taxes at higher rates.
Increased Tax Filing compliance: Shareholders receiving buy-back proceeds would now have to report this income in their tax returns, leading to increased compliance and administrative burden.
Impact on Non-Resident Shareholders: For non-resident shareholders, they require to refer Double Taxation Avoidance Agreements (DTAAs) in order to avoid the double taxation as well as to ensure preferential rates on such income.
Reduction in attractiveness of Buy-Back Activity: Abolishing buy-back tax could reduce the attractiveness of buy-backs as companies.
Impact on Share Price: A reduction in buy-back activity could slow the growth in EPS and may negatively affect the stock prices of companies.
Parity Between Buy-Backs and Dividend: The abolition of the buy-back tax would create parity between dividends and buy-backs.
Increased Dividend Payout: The elimination of buy-back tax benefits could lead companies to hold onto their reserves, invest in growth opportunities or increase dividend payouts.
Potential Increase in Tax Revenue: As per present taxation system, personal tax rates are generally higher than the corporate taxes, as such it could lead to higher tax collections, especially from high-income individuals.
References
https://www.lawrbit.com/
https://www.investopedia.com/
https://www.forbes.com/
https://kb.icai.org/
Finance act 1999.
Finance act 2013.
Finance act 2019
Finance act 2024.
Author: Suhas Kulkarni | Retired Additional Commissioner of Income Tax, Pune
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