Introduction
A buy-back of shares occurs when a company purchases its own outstanding shares to reduce the number of shares available on the open market. The tax regulations for companies buying back their own shares have evolved significantly over the years. Historically, the liability to pay tax on these transactions rested with the company. However, amendments to the Income-tax Act, 1961 ('Act') introduced by the Finance Act, 2024 (‘FA 2024’), which received presidential assent on 16.08.2024, have shifted this liability.
Position prior to amendment
Prior to 2000, the Companies Act, 1956 ('CA 1956') lacked provisions for the buy-back of shares. The introduction of s. 77A into the CA 1956 in 2000 allowed companies to buy back shares under specific conditions.
Concurrent with s. 77A, amendments to the Act made buy-back of shares taxable as capital gains in the shareholders' hands under s. 46A.
In 2013, s. 115QA was introduced in the Act, making unlisted domestic companies liable for tax on the buy-back of shares. S. 10(34A) was also introduced, exempting shareholders from this tax, which was extended to all domestic companies in 2019.
Companies were required to pay tax at a rate of 20% under s. 115QA of the Act, with such payment considered the final tax on the buy-back.
Position after amendment
Ss. 115QA and 10(34A) of the Act will no longer apply to buy-back of shares after 01.10.2024.
The definition of ‘dividend’ under s.2(22) of the Act has been amended. Payments made by a company to purchase its own shares are now classified as dividends.
Consequently, the proceeds from the buy-back of shares received by shareholders will be taxed as dividends at their applicable rates rather than the flat rate previously under s. 115QA of the Act.
S. 46A of the Act has been amended to deem the value of consideration received by shareholders from the buy-back of shares as nil. Thus, the amounts received by the shareholders would not be subject to capital gain tax.
The cost of acquisition for shares bought back will be considered a capital loss, which can be set off and carried forward against other capital gains.
Comment
The proceeds from buy-back transactions will be considered dividends and taxed according to the shareholders' tax rates. This change benefits shareholders with an effective tax rate below 23.30%. However, those in higher tax brackets may face increased tax liabilities. While the option to set off losses from the buy-back of shares against other capital gains may offer some relief, this is contingent on the presence of such gains, potentially leading to financial difficulties for some shareholders.
Authored by Sanket Pisal of Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.