The Finance Act, (2), 2024 has made certain changes relating to levy of income tax on consideration received on buy-back of shares resulting significant impact on income tax liability to shareholders. This change impacts all future buy back proposals. Corporates houses are evaluating different strategies to minimise the tax impact. Legal experts challenges taxing buy back consideration received as deemed divided under section 2(22)(f) of Income Tax Act, 1961.
1. BACKGROUND
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With this amendment, investors offering shares for buy-back will be obligated to pay higher taxes. At present, companies are paying 23.40% (with surcharge and cess) tax on buy-back of shares with no additional tax to shareholders. On 23rd July, 2024, Hon’ble Finance Minister, Nirmala Sitharaman proposed taxing income from share buy-back in the hands of the recipient shareholders instead buy-back tax payable by the Company. |
On 23rd July, 2024, Hon’ble Finance Minister, Nirmala Sitharaman proposed taxing income from share buy-back in the hands of the recipient shareholders instead buy-back tax payable by the Company.
2. BUYBACK HISTORY IN INDIA
Before we go into further details on the taxation part of buy-back, lets trace its history in India.
Companies Act, 1956, amended Section 77A, 77AA and 77B permitting companies in India to buy-back its shares w.e.f. 1998. Prior to the amendment, buy-back of shares was not permitted under Companies Act, 1956. The only exception was reduction of share capital.
Consequent to amendment to section 77A of the Companies Act, 1956, separate rules were framed for buy-back of shares by listed and unlisted companies separately.
3. WHAT IS BUY-BACK OF SHARES?
Buy-back of shares means purchase of its own shares by a company which has issued earlier. The company usually buys shares either at the market price or higher. The company’s intention of buy-back offer is to reward its shareholders; restructure the capital structure of the firm; prevent hostile takeovers; or utilize its reserves in an efficient way.
According to Prime Database, in 2023, 48 companies have spent ₹48,079 crore via share buy-back programs.
Within a month of budget announcement, more than 16 companies announced buy-back of shares worth more than Rs. 4,300 crore (source: BSE as on 17/8/2024) and many companies are in the process of planning for a buy-back of shares to reward their shareholders in a tax efficient way.
Sources of buy-back: As per Section 68 of Companies Act, 2013, a company may purchase its own shares or other specified securities (hereinafter referred to as buy-back) out of—
a. its free reserves;
b. the securities premium account; or
c. the proceeds of the issue of any shares or other specified securities.
No buy-back of any kind of shares or other specified securities to be made out of the proceeds of an earlier issue of the same kind of shares or specified securities.
The buy-back of shares is permitted:
| Approval | Limits |
| With approval of Board of Directors | Buy-back up to 10% of paid-up capital and free reserves of the company |
| With approval of Shareholders | More than 10% but less than 25% of paid-up share capital and free reserves |
3.1 Reasons for Buy-back
- Returning surplus cash to shareholders;
- Improving Earnings Per Share (EPS);
- Supporting share prices;
- Efficient capital structure management;
- Preventing hostile takeovers;
- Utilizing unused cash reserves;
- Increasing promoters’ stake and as tax efficiency.
4. PROCESS OF BUY-BACK IN LISTED AND UNLISTED COMPANIES
Listed Company: The buy-back is carried out in 2 different ways:
| Tender route | Open Market route |
| Company puts an offer to the shareholder to surrender the company’s shares held by them in exchange for the proceeds distributed by the Company based on the terms of buy-back | Company makes an announcement and buys its shares in the open market at a particular price |
Unlisted Company: As the shares of the unlisted company are not listed on the stock exchange, the only way to buy-back shares is by placing the offer in front of the shareholders and re-purchasing shares from them.
*A company cannot buy-back partly paid shares.
5. TAXATION ON BUY-BACK OF SHARES IN INDIA
As mentioned supra, buy-back of shares were permitted under Companies Act, 1956 effective from the year 1998. From 1998 until 2012, consideration received on buy-back of shares was taxed in the hands of shareholders as capital gains earned by them.
Capital gain was the amount received in excess of the cost of acquisition or indexed cost of acquisition. The formula for calculating capital gain in case of buy-back is as follows:
Capital Gain = (Buy-back price x number of shares bought back by the Company) – (Amount paid by the investor at the time of allotment of those shares).
5.1 BUY-BACK TAX
During this regime (1999-2012), companies used to pay Dividend Distribution Tax (DDT) on the amount of dividend declared to shareholders.
However, in case of buy-back of shares, shareholders were liable for payment of capital gain. There was no taxability in the hands of the company for the buy-back of shares.
Being treated as capital gain, income tax was paid at a lower rate on the buy-back of shares, as the percentage of capital gain tax was lower. Also, not all the shareholders had income more than the basic exemption limit. To minimise tax liability, unlisted companies started using the buy-back route to distribute money to their shareholders rather than declaring dividends.
5.2 Buy-back Tax for Un-listed Companies
As an anti-tax avoidance measure, Finance Act, 2013 introduced section 115QA under Income Tax Act, 1961, levying buy-back tax @ 20% on buy-back of shares by unlisted companies.
5.3 Buy-back tax for listed Companies
Provisions of Section 115QA of Income Tax Act, 1961 was extended and made applicable to listed companies also by Finance Act, 2019. With this amendment, both listed and unlisted companies were brought on equal footing. Hence after amendment, all companies were liable for buy-back tax @ 23.40%. History of taxing buy-back consideration is as follows:
|
Type of Company |
Year | What next | |||
| 1999 – 2013 | 2013-2019 | 2019 – 23.7.24 | After 23.7.2024 | ||
| Unlisted Companies | Capital gain tax* | Buy-back tax$ | Buy-back tax$ | Deemed dividend# u/s 2(22)(f) of Income Tax Act,1961 | ? |
| Listed Companies | Capital gain tax* | ||||
*Taxed in the hands of recipient shareholders.
$ Tax to be paid by the company.
# Deemed dividend in the hands of recipient.
5.4 HOW TAX IS COMPUTED ON THE BUY-BACK OF SHARES
Distributed Income = (Consideration paid by the Company on account of buy-back) – (the amount which was received by the company for the issue of such shares).
Taxability in the hands of shareholders
The income or gain earned by investors and shareholders in case of buy-back was exempted from tax to avoid double taxation as per section 10(34A) of the Income Tax Act, 1961.
To neutralize tax impact between dividend declaration and buy-back, Finance Bill, (2) 2024 has made significant changes to Buy-back tax.
6. IMPACT OF BUDGET CHANGES
6.1 Section 115QA of Income Tax, 1961, has been withdrawn and Section 2(22)(f) was inserted.
6.2 As per the amended section, “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, is treated as deemed dividend.”
6.3 Insertion of proviso to Section 46A whereby treating sale consideration of buy-back of shares as ‘nil’ so that such cost will become capital loss on offering the shares for buy-back.
The amendment and impact are as follows:
| Section | Clause before amendment | After amendment | Impact |
| Insertion of 2(22)(f) | NA | 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, is treated as deemed dividend | Due to insertion, this amount has become deemed dividend |
| Deletion of clause (iv) of section 2(22) exclusion | (iv) any payment made by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 77A of the Companies Act, 1956 (1 of 1956); | Omitted | Due to deletion, amount received on buy-back will be charged as deemed dividend |
| Proviso to Section 46A | NA | 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. | This amendment creates capital loss to be set off against capital gain during next 8 years. |
| 10(34A) | any income arising to an assesses being a shareholder, on account of buy-back of shares by the company as referred to in section 115QA was exempted. | Omitted | Consequent to above changes exemption has been withdrawn, as amount is taxed as dividend income |
Impact of above changes are as follows?
a. Amount received by a shareholder on offering shares for buy-back will be taxed as dividend under the head ‘income from other sources. This will attract income tax at the applicable slab rates to recipient shareholders which may go up to 39% (maximum rate)
b. If a recipient shareholder is body corporate, then applicable rate depends upon rate applicable to the company.
c. Company may claim relief under section 80M of Income Tax Act, 1961 subject to certain conditions.
d. Entire amount received on buy-back is taxable without any deduction for cost of investment.
e. The cost of investment is treated as capital loss (short term or long term) which can be set off against capital gain during next 8 years.
These provisions are applicable from 1st October, 2024.
7. WHAT IS DIVIDEND?
As per the recent amendment by Finance Act (2) of 2024, buy-back consideration received by a shareholder is taxed as ‘deemed dividend’ under section 2(22)(f) of Income-tax Act, 1961. Let’s understand the concept of dividend and deemed dividend as per tax law. Dividend, generally, means the sum paid to or received by a shareholder in proportion to his shareholding in a company out of the total profit distributed pursuant to Section 123 of Companies Act, 2013. The word ‘deemed dividend’ has not been defined anywhere in the Act.
Section 2(22) of Income Tax Act, 1961 defines dividend as follows
(22) “dividend” includes—
a. any distribution by a company of accumulated profits, whether capitalised or not, if such distribution entails the release by the company to its shareholders of all or any part of the assets of the company;
b. any distribution …….
c. any distribution made to the shareholders of a company on its liquidation, to the extent to which the distribution is attributable to the accumulated profits of the company immediately before its liquidation, whether capitalised or not;
d. any distribution to its shareholders …
e. any payment by a company, not being a company in which the public are substantially interested ….
f. 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 * but “dividend” does not include—
(i) a distribution made ….
(ia) a distribution made ….
(ii) any advance ….
(iii) any dividend paid by a company …
(iv) any payment made by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 77A of the Companies Act, 1956 (1 of 1956);*
(v) any distribution of shares…
Note*: Amended vide Finance Act, (2) of 2024 and applicable w.e.f. 1.10.2024.
Consequent to above amendments, whole of the amount received on buy–back consideration would be charged as dividend income. Consideration in respect of buy -back of shares is taken as nil; and cost of acquisition of buy -back shares is allowed as a capital loss to be set off or carry forward and set off against other capital gains on transfer after 1-10-2024.
The Finance Bill, thus attempts to rewrite the transaction of transfer consideration and breaks in three parts:
i. full value of consideration is treated as dividend received in hands of shareholder;
ii. value of consideration received by the shareholder shall be deemed to be ‘nil’ for the purpose of capital gain calculation resulting capital loss;
iii. the cost of acquisition of shares in buy-back is capital loss to be set off, allowed against other capital gains.
8. CAN A DIVIDEND BE PAID OUT OF CAPITAL OF SHARE PREMIUM?
The dividend can only be paid out of profits earned by the company but not out of capital or share premium. However, buy-back can be made either out of accumulated profits or out of proceeds of earlier issue or out of share premium account. Hence, if a buy-back is made out of share premium account or proceeds of earlier issue, it is not correct to treat such buy-back amount as deemed dividend, as the amount received by the shareholder is out of share premium account or proceeds of earlier issue, which is not profit earned by a company.
Further, dividend is a pro-rata payment to a shareholder in respect of shares held in a company through distribution either out of profits or reserves. Whereas buy-back consideration is paid when shareholder extinguishes his ownership rights.
In view of the above, taxing buyback consideration received as dividend is not correct.
The proposed amendment has the effect of increasing the tax liabilities of the shareholders, as tax on dividend income attracts slab rates which may go up to 39 % (with surcharge and cess). Also, the company needs to deduct TDS at the rate of 10% on the entire consideration paid.
8.1 Tax Planning:
If a shareholder of listed company offers his shares for buy-back, then he has to pay tax on such amount at a higher rate which may extend up to 39%. Instead, if he sells the same in the market, it will attract capital gain tax @ 12.5%.
The amendment has anomalies, creates confusion to investor and seems to be contrary to legal, accounting and commercial concepts; requires reconsideration and be dropped.
References: Provisions of Income tax act, 1961, Companies act, 2013 and finance act (2) of 2024.
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- Illustration
M/s. ABC Private Limited issued 1,00,000 equity shares at Rs. 300 in the year 2013. Nominal value of the share is Rs. 100/- (Share premium Rs. 200)
The Company announced Buy-back of 10,000 equity shares at a price of Rs.300 per share. Mr. X, shareholder offered 10,000 shares for the buy-back offer.
| Particulars | Before Amendment (Rs.) | After Amendment (Rs.) |
| Buy-back Consideration | 30,00,000 | 30,00,000 |
| Cost of Investment | 30,00,000 | 30,00,000 |
| Tax paid by: | Company | Shareholder |
| Tax Rate | 23.3% | 39% (Maximum Rate) |
| Amount on which tax is payable | NIL
(Rs. 30 Lakh (-) Rs. 30 Lakh) |
30,00,000 |
| Tax amount | NIL | 11,70,000
(30,00,000*39%) |
| Capital Loss | NIL | 30,00,000 (To be set off within next 8 years) |
The Buy-back consideration received Rs.30,00,000 (10,000*300) is taxable @ 39% (maximum rate). Tax liability is Rs. 11,70,000
Tax outgo before amendment was Rs. NIL However, due to amendment, shareholder need to pay Rs. 11,70,000 as income tax
Budget impact
Additional tax outgo due to amendment is Rs.11,70,000/-.
Income tax saving on Capital loss
Cost of investment of shares bought back is treated as capital loss and this can be set off against any other capital gain during 8 years.
Tax implications are as follows:
This capital loss is available for set off for only 8 years.
Even if we set off capital loss against other capital gain, the tax saved on account of set off is 12.5% (if the capital gain is long term)
In view of the above, buy-back of shares will have a huge tax impact after 1st October, 2024. Unless amended, buy-back deals will come down to a great extent.
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