Buy Back Taxation: Amendment Before First Birthday of New Income Tax Act, 2025!
Tax laws sometimes behave like software updates. Just when taxpayers learn how one version works, a new patch arrives – followed by another patch to fix the previous patch. Share buyback taxation is perhaps the best example of this. Over the last fifteen years, the law has moved from shareholders to companies, back again, and now towards separate treatment for promoters and others. If stability is a hallmark of good tax policy, buyback taxation has taken the scenic route. To appreciate these repeated changes, it helps to trace how the law has evolved over the past fifteen years.
Before 2013: The Simple Capital Gains Era
Until 2013, the law was straightforward. When a company bought back its shares, the shareholder paid tax on capital gains – the difference between buyback price and purchase cost. For listed shares, long-term gains were often exempt (subject to STT conditions). For unlisted shares, gains were taxed normally. The rule was simple, predictable, and aligned with the principle that transfer profits should be taxed in the recipient’s hands. But simplicity in tax law often invites planning opportunities.
2013: Government Targets Promoter Buybacks:
The Government realised that promoters of closely held companies had found a clever alternative to dividends. Instead of declaring dividends, which suffered Dividend Distribution Tax (DDT), companies began distributing profits through buybacks. Economically, the promoter received money just like a dividend. But legally, it was taxed as capital gains – often at lower rates. To plug this gap, a new tax was introduced in 2013. The company itself had to pay tax on the distributed income under section 115QA and the shareholder’s receipt became exempt. The idea was simple: “If buyback is really a disguised dividend, tax it like one.” For unlisted companies, this change was effective. But the story did not end there.
2019: Buyback Tax Extended to Listed Companies:
Once unlisted companies came under this tax, listed companies quickly became the preferred route for buybacks. Large corporates started using buybacks extensively, and investors welcomed them because capital gains taxation was still relatively favourable. The Government again intervened in 2019. Buyback tax was extended to listed companies also. Now almost all domestic buybacks were taxed at company level, and shareholders received the money tax-free. For several years, this system appeared stable, and dividends and buybacks seemed finally aligned. But another reform soon changed the picture.
2024: Tax Shifted Back to Shareholders (And Trouble Began):
After DDT was abolished earlier and dividends began being taxed in shareholders’ hands, the buyback framework started looking inconsistent. Dividends were taxed at the shareholder level, while buybacks continued to be taxed at the company level. To bring parity, the law was changed again in 2024. Buyback tax on the company was withdrawn, and the receipt was taxed in the shareholder’s hands in a dividend-like manner. At first glance, this looked logical. But the actual design created a serious problem. The gross buyback receipt became taxable in the shareholder’s hands, while the cost of shares was not deducted from that income but was allowed separately as a capital loss. Because capital loss set-off is restricted, an investor could be taxed on the full receipt even though part of it was merely return of capital. In simple terms, a shareholder investing ₹100 and receiving ₹120 in buyback could be taxed on ₹120, even though his real gain was only ₹20. This amendment and its outcome were widely viewed as economically distorted, logically inconsistent, and widely criticized.
2026: Government Realizes the Problem and Revises Again:
The Finance Act 2026 now seeks to correct this distortion by prescribing separate treatment for promoters and other shareholders. The idea broadly is:
a) Promoters, who effectively control profit distribution decisions, are broadly kept within a dividend-type taxation framework.
b) Non-promoter investors, especially public shareholders, are treated differently so that their investment cost is more meaningfully recognized and the taxation does not fall on the gross receipt.
With this change, the Government aims to ensure that buybacks are not used as a mechanism for tax avoidance, while balancing the interests of different shareholders. The objective is to reduce the unintended consequence of taxing capital as income, while still preventing promoters from converting dividends into tax-efficient buybacks. In policy terms, this correction is sensible. But it also reveals something deeper.
Conclusion:
In barely fifteen years, buyback taxation has moved through multiple structures – from capital gains taxation to company-level levy, then back to shareholders, and now towards differentiated treatment. Each change tried to fix the weakness of the previous one. This is not merely policy evolution; it resembles policy experimentation.
Tax law, especially in areas affecting corporate finance, should ideally be stable and predictable. Companies take long-term decisions based on tax consequences, and frequent structural changes create uncertainty, complicate planning, and increase compliance costs. A mature tax administration anticipates behavioural responses, consults stakeholders, and designs provisions that can endure market realities. The Government’s objective throughout has been understandable – prevent profit distribution through tax arbitrage and ensure fairness between dividends and buybacks. But good intentions alone do not make good law. When a provision needs repeated redesign within a few years, the issue lies less in taxpayer ingenuity and more in legislative architecture. If India aspires to be a stable and predictable tax jurisdiction, laws must be framed with deeper foresight and long-term durability. A tax provision should not need buyback after buyback. Perhaps it is time the law itself stopped repurchasing its own mistakes – and started drafting them right the first time.
[Views expressed are the personal view of the author. Readers are advised to seek professional advice before taking any decisions. Readers may forward their feedback & queries at nareshjakhotia@gmail.com. Other articles & response to queries are available at www.theTAXtalk.com]
