Share buyback: another emerging front for a long drawn tax litigation
Sub-clause (f) has been inserted in section 2(22) of the Income-tax Act, 1961 (IT Act), which defines the word ‘dividend’, is worded differently from other sub-clauses of section 2(22).
The net effect of the amendment is as under:
1. Payment made by the company in a share buyback under section 68 of the Companies Act, 2024 will be treated as ‘dividend’ income in the hands of the shareholders regardless of the fact whether the company possesses accumulated profits or not.
2. This actually means that a share buyback even out of the securities premium account, or the proceeds of the issue of any shares or other specified securities, will be deemed to be ‘income’ in the hands of the shareholders. It is elementary that a company cannot distribute dividends out of securities premium or proceeds of issue of shares or other securities.
3. The shareholders will be allowed a loss under the head ‘Capital Gains’ equivalent to the cost of acquisition of the relevant shares, and they may set-off and/or carry forward such loss for set-off in future as per applicable provisions of the IT Act.
4. The FB 2024 was passed by the Lok Sabha on 07.08.2024 without making any change in the above.
5. It appears that the new regime for share buyback taxation may become another front for a long drawn tax litigation for the following reasons:.
Firstly, as regards non-resident shareholders, they may explore the possibility, depending upon the language of the applicable tax treaty, if any, as to whether for the purposes of the tax treaty, the consideration received for share buyback should be examined for computation under the head ‘Capital Gain’ only. If they choose to make such a claim, they may expect it to go into a long drawn litigation.
The resident shareholders will not have the above-referred option. They will have to offer the income under two heads of income, viz. ‘Income from Other Sources’ (dividend income) and ‘Capital Gains’ (loss equivalent to cost of acquisition of the relevant shares). The loss under the head ‘Capital Gains’ cannot be set-off against ‘Income from Other Sources’. Depending upon the facts, a particular shareholder may or may not be able to set-off such loss against other capital gain in the same year or in succeeding 8 years. In case a shareholder is not able to set-off such loss, the cost of acquisition of shares will be a ‘dead’ loss for him.
The issue which may possibly arise in such a case is as to whether it is correct to split a transaction for taxability in two heads of income without any rational basis.
The case of a capital reduction (under which the taxability may arise in two heads of income) may not be considered comparable since the same is based on accumulated profits.
