Tax Impact on Share Buybacks: Old Vs New Law
The Finance Act (No. 2) of 2024 introduces sweeping changes that will come into effect on October 1, 2024. These revisions alter how companies and shareholders handle the tax implications on buyback of shares. As we dive into these new regulations, it’s important to know both the existing rules and the new rules to understand the potential impact on investors and companies alike. Here is an overview of the same:
What is Shares Buy Back?
A share buyback, or share repurchase, occurs when a company buys back its own shares from shareholders. This reduces the number of shares in circulation, which can improve the company’s financial ratios. Historically, buybacks were a tax-efficient way for companies to distribute surplus profits to shareholders.
Existing Law applicable till 30.09.2024:
1. At present, the taxation of buyback is governed by Section 115QAand Section 10(34A) of the Income Tax Act.
2. Any gain to the shareholder arising fromthe buyback transaction was exempt in the hands of the Shareholder by virtue of Section 10(34A) of the Income Tax Act.
3. The tax in respect of buy back of shares is payable by the companies. Section 115QAprovides that tax shall be charged on distributed income by the Domestic Company on buy-back of its shares from the shareholders @ 23.24% [Tax @ 20% plus surcharge @12% and cess @4% as applicable).
[According to Section 68 of the Companies Act 2013, a company cannot make a new offer to buy back its shares within one year from the date when the last buyback was completed].
To summarize, under the existing law, taxpayers were not at all liable for any tax liability on the buyback of shares and it was totally exempt U/s 10(34A). The tax burden was totally on the company & it was tax friendly for the majority of the taxpayers.
New Tax Law Applicable from 1st October 2024:
1. Starting from 1st October 2024, Section 115QA and Section 10(34A) shall not apply in respect of Buy Back of Shares.
2. A new sub clause (f) is added to Section 2(22) of the Income-tax Act to treat the entire amount paid pursuant to buy back as “Dividend” w.e.f. October 1st, 2024. As a result, any amount received will be treated as dividend income & will be taxable at the applicable slab rates for shareholders. Further, shareholders cannot claim deduction towards any expenses from dividend so received while calculating the “Income from other source”.
3. Even the cost incurred for acquiring the shares will not be deductible from the dividend income but it would be treated as capital loss. Such loss can only be set off against capital gains income and unutilized losses are allowed to be carried forward for set off against capital gain income only.
TDS on amount paid on Buy Back of Shares:
Dividend income is liable for TDS U/s 194 @10%. Now, the sub-clause (f) has been added in section 194 w.e.f 01.10.2024 which means that any amount paid on buy back will be liable for TDS if such amount exceeds Rs. 5,000/-. If the payee does not provide a Permanent Account number (PAN), tax shall be deducted @ 20%.
To summarize, the tax burden now has been totally shifted from company to the shareholders. Under the old law, the net tax outflow on buyback was @ 23.24% for all categories of the shareholders. Under the new law, such proceeds in case of resident shareholders would be taxable as per slab rate which may be from 0% to 42.74% depending on the total income of such person. The tax impact would be substantially higher in case of High Net worth individuals (HNI). Non-resident shareholders will be taxed at 20% under domestic law or according to relevant tax treaties. Depending on the type of shareholder, the effective tax outgo on buy back transactions may differ.
Rationale behind New Law:
The explanatory memorandum to the Finance Bill No. 2 of 2024 explains the logic for amendment as under:
“Both dividend as well as buy- back are methods for the company to distribute accumulated reserves and thus ought to be treated similarly. In addition, there is extinguishment of rights for the shareholders who are tendering their shares in the buy-back by domestic companies, to the extent of shares bought back by such companies from shareholders. The cost of acquisition of such shares also needs to be accounted for in some manner.”
With above justification, the new law is designed to remove the favourable tax treatment enjoyed by the majority of the shareholders.
Conclusion:
Buyback of shares and dividend distribution are two popular methods adopted by Indian companies for distribution of profits to investors. Undeniably, buyback provision was being used by the companies to get benefit through tax arbitrage.
While the new amendment aims to level the playing field between these methods by addressing tax arbitrage, it introduces a law which defies logic. As per the new law, the capital loss will be adjustable against either STCG or LTCG which may have a tax rate of 20% or 12.50% as against dividend income which may be liable for tax rate of around 42% in case of HNI. The elimination of deductions for the cost of acquiring shares against dividend income might add an unexpected burden.
[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]
