Income Tax on Buyback of Shares

What is a Buy-back of Shares?

Buyback of shares refers to the process of repurchasing the shares of the company issued by them. The company generally buys the shares at market price or a higher price. This is done to regain the ownership of the company's shares and repay the money of the shareholders. The provisions for the buy-back of shares are laid out in Section 115QA of the Income Tax Act of 1961.

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Why do Companies Buy-back Shares?

In FY 2023, Indian companies announced a buyback of more than Rs.48,000 cr. Having said that, here are some reasons why companies consider buying back their shares and what are its benefits -

• Consolidated Ownership: Holding a significant portion of shares leads to broad ownership and higher expenses for the company. Thus, to achieve a balance between compact ownership and minimizing capital costs, share buybacks are employed.
• Share Price Adjustment: The market value of shares may be substantially undervalued due to various factors. Therefore, a buyback initiative aids in rectifying the market price.
• Enhanced Financial Appeal: Share buybacks can enhance a company's financial appeal. By reducing the total number of shares in circulation, the earnings per share (EPS) of the company increase.
• Promoter Stake Increase: Buyback strategies are frequently utilized when the promoters of a company intend to increase their stake in the company.

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Why is Buy-back Tax Levied on Companies?

Previously, when companies paid dividends, they had to pay Dividend Distribution Tax (DDT). However, when they distributed funds to shareholders through share buybacks, the tax responsibility shifted to the shareholders in the form of capital gains. The company itself didn't have to pay any tax for the buyback.

Because capital gains tax rates are usually lower, and not all shareholders earn income above the basic exemption limit, companies, especially unlisted ones, started preferring share buybacks over dividend payouts to avoid taxes.

Some foreign companies took advantage of tax treaties to avoid taxes on capital gains. They encouraged investee companies not to pay dividends but to buy back shares, resulting in tax-free capital gains for the foreign entities.

To prevent tax avoidance, the government introduced section 115QA under the Income Tax Act in 2013 for unlisted companies. In July 2019, these rules were extended to cover share buybacks by listed companies as well.

However, buyback tax levied on companies will be a thing of the past as the 2024 budget includes a new rule that will take effect on October 1, 2024. This rule states that any buyback amount received by shareholders will be considered a form of dividend and will be taxed as such (In the hands of the shareholders). The cost of the shares bought back by the company will be treated as a capital loss. This loss may be offset against any other capital gains throughout the year, and if the capital gains for the year are insufficient. If there are not enough capital gains to offset the loss in the current year, it can be carried forward and offset against capital gains in future years, up to a maximum of 8 years.

Buyback tax before and after 30th September

Prior to the 2024 budget, the tax for share buybacks was paid by the company itself. For instance, when Company ABC repurchased its shares, the company would bear the tax liability associated with the buyback. Any amount subsequently received by the shareholders was tax-free. This system effectively meant that the investors benefited from the gains, while the company bore the tax burden. This old rule remained in place until September 30, 2024.

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What are the Income Tax Provisions for the Buy-back of Shares?

As per Section 115QA of the Income Tax Act, the following are the provisions for the buy-back of shares by companies -

• Both listed and unlisted companies are obligated to pay additional income tax on the distributed income from share buybacks. This tax liability applies to the company regardless of whether it is otherwise liable to pay income tax.
• The tax rate for the distributed income (i.e., the buyback amount) is set at 20%, along with a 12% surcharge and applicable cess.
• The company must settle this tax within 14 days from the date of payment to shareholders for the buyback.
• This tax payment on buybacks is considered a final settlement, with no further tax credits available to the company or any other party.
• Since companies are now responsible for this tax, shareholders are relieved of any tax obligation on income arising from share buybacks.

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What are the Examples of Buy-back of Shares?

A plastic manufacturer announces a buyback of 1,000 shares at a market price of Rs. 650. The company issued these shares 10 years back at Rs. 50.

Here, the tax in the company’s hands will be calculated as follows -
Net Distributed Income = (1000 shares x Rs 650 per share) – (1000 shares x Rs 50 per share) = Rs 6,00,000.
Tax applicable on buyback = (Rs 6,00,000 x 23.296%) = Rs 1,39,776.
Therefore, the company has to pay a tax of Rs.1,39,776 as a buyback tax.
However, as per section 115QA, the tax in the hands of investors or shareholders will remain nil.

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What is the Due Date for Paying the Buyback Tax?

The company has to pay the tax within 14 days of paying any amount to the shareholders on the buy-back of shares under section 115QA of the ITA. If the company fails to pay the tax by the due date, then it is liable to pay simple interest @1% per month or part thereof on the tax amount starting from the date immediately after the due date till the date on which the tax is paid.

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How is Tax Calculated on Buy-back of Shares?

Tax is imposed on the income from buybacks for both listed and unlisted companies. The distributed income is calculated as the buyback payment minus the amount received for the shares initially issued.

In cases where buybacks occur through open market transactions, making out individual purchase prices is difficult. Nevertheless, taxation still applies to the company based on the difference between the buyback price and the initial share issuance price, regardless of market prices.

Income or gains from buybacks are tax-exempt in the hands of shareholders under section 10(34A) of the Income Tax Act, 1961, to prevent double taxation. Shareholders should be aware of the considerations under Section 14A.

Unlike before, companies now cannot avoid taxation by opting for the buyback route instead of paying dividends. After the amendments introduced in the Finance Act 2020, distributing dividends is now a more tax-efficient option for companies as they are not liable to pay tax on dividends. Planning a share buyback and want to maximize tax savings? Reach out to Tax2win’s tax experts, who navigate through 300+ tax provisions to find the best one for you that is tailored to your needs. Get Buyback Tax Consultancy Now!

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