Income Tax on Buyback of Shares

Buyback of shares ordinarily means repurchasing of shares by the company that issued them. The company pays the shareholders the market value of the shares and reclaims the ownership that was previously distributed.

Budget 2024 - Changes in Buyback Taxation

The finance minister announced a complete revamp of the buyback taxation. At present tax on buyback is to be paid by the Company on the difference between the buyback price and the issue price of the shares, as more particularly described in the subsequent paras of this article.

It was introduced in 2013 in line with the then applicable dividend distribution tax. In, Finance Act, 2020, DDT has been abolished and the dividend tax has been made applicable in the hands of the recipient. So, now to make the tax on buyback in line with the tax on dividend distributed, it is proposed to remove the tax on buyback in the hands of the Company through this July, 2024 budget.

Hence, as per the amendment in Budget 2024, tax on any buyback made after 1st October, 2024 will not be applicable in the hands of the Company. However, the tax will be payable by the recipient shareholder on the total amount received from the buyback as deemed dividend in accordance with the newly inserted provision of Section 2(22)(f).

You must be wondering what will happen to the cost of acquisition of the shares that were offered for buyback, will it be allowed against deduction against such deemed dividend income? No, such cost of acquisition of shares will not be allowed against the dividend income in the form of buyback. However, the said cost will be carried forward as deemed capital loss and can be utilised against the future gains from the sale of remaining shares. 

Reasons for Buyback

A company raises share capital by distributing shares and raising capital. Therefore it may seem contradictory for companies to buy back the shares and pay money to shareholders. The reasons for the same can be as follows:

• Compact Ownership: Substantial shareholding implies widespread ownership and higher costs to the company. So in order to serve both the motives that is to bring compactness in ownership and reduce the cost of capital, buyback of shares comes into the picture.
• Share Price Correction: The market price of the shares can be highly undervalued due to various reasons. Hence a buyback supports the correction of the market price.
• Attractive Financials: The buyback of shares can also make a company’s financials look more attractive. With a reduced number of shares, the Earning per Share of the company looks more attractive.
• Increased Shareholding of Promoters: Buyback is often used if the promoters of a company are planning to increase their shareholding.

Income Tax Provisions For Buyback of Shares

The provisions of Income Tax with regard to buyback of shares are covered under Sec 115 QA of the Finance Act, 2013 which applied to only unlisted companies which warranted a tax of 20% on the distributed income.

The rationale for the introduction of the provision was that unlisted companies resorted to buyback of shares in order to avoid dividend distribution tax. 

As the buyback was charged as capital gains in the hands of the shareholder and dividend distribution tax was charged to the company. Therefore the amendment was introduced as an anti-tax avoidance measure. 

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.

Illustration

The following illustration will bring clarity to the changes effected by the amendment.

Delta Ltd repurchases 500 shares in August 2024 (before amendment), with a market price of Rs. 650 with an issue price of Rs. 50.

• The company is now liable for a buyback tax of 20% on the distributed income that is Rs. 600, the difference between market price and issue price (650-50).
• The individual shareholders are no longer liable to pay taxes.

Delta Ltd repurchases 500 shares in November 2024 (after amendment), with a market price of Rs. 650 with an issue price of Rs. 50.

• Now, the company is not liable to pay tax on buyback.
• However, the recipient shareholder will pay tax on the total amount received from the buyback as a deemed dividend as per their income tax slab in accordance with the newly inserted provision of Section 2(22)(f).

Tax Rate Under Section 115QA

Under Section 115QA of the Income Tax Act, any domestic company that buys back its own shares is liable to pay additional income tax on the distributed income at an effective tax rate of 23.296% of distributed income [Rate of tax - 20% (plus surcharge @ 12% plus Health and education cess @ 4%)]. This tax is known as ‘Buy-Back Tax’ or ‘Buy-Back Distribution Tax’ (BDT). 

How is Tax Computed on the Buyback of Shares?

In the case of listed and unlisted companies, tax is levied on buyback income or distributed income.

Distributed Income = Consideration paid by the company on account of buyback – amount received by the company for the issue of such shares.

When the buyback is through the open market, the shares are traded through many hands. Thus, the company cannot determine the purchase price at which individual investors would have bought shares from the open market. In such cases, the tax is levied in the hands of the company on the difference between the buyback price and the price at which the company issued its shares (irrespective of the market price at which the buyer had bought it).

It is to be noted that in accordance with Budget 2024,  tax on any buyback made after 1st October, 2024 will not be applicable in the hands of the Company. However, the tax will be payable by the recipient shareholder on the total amount received from the buyback as deemed dividend in accordance with the newly inserted provision of Section 2(22)(f).

Due Date of Buyback Tax

The tax should be paid within 14 days from the date of payment of any amount to the shareholders on the buyback of shares. In the case the tax is not paid within the due date, the company is liable to pay simple interest at the rate of 1% per month on the amount of the tax for the period starting from the last date on which such tax should have been paid.