Bye bye to Share Buybacks

– Finance Bill 2024 puts buybacks to a biting tax proposal w.e.f. 1st October, 2024

-Team Corplaw | corplaw@vinodkothari.com

Among the tax law changes proposed by Finance Bill, 2024, the one on share buybacks, explained as one intended to remove tax inequity, is perhaps the most unexplainable.  The proposed change, by introduction of a new sub-clause (f) to section 2 (22) [deemed dividend], and simultaneous amendments to sec. 46A and sec. 115QA, not only shifts the tax burden from companies to shareholders, but surprisingly, brings to tax the entire amount paid on buyback, irrespective of the excess realised by the shareholder. It  leaves the cost of shares to be claimed as capital loss and set off against potential capital gains, of course only if such gains arise  within the prescribed timelines for carry forward and set off.

Buyback of shares is the only way a company seeks to scale down its capital. The proposed amendment makes it impossible for companies to reduce their capital base by returning capital not needed, as the only other way is through reduction of share capital, which is subject to shareholders’, creditors’, and NCLT approval. It is surprising that this amendment by the very same Budget which proposes to introduce the novel concept of “variable capital companies”.

• Applicability of the amended provisions
  • For any buyback of shares on or after 1st October, 2024
• Existing tax regime on buyback
  • Section 115QA of IT Act
  • Tax incidence in the hands of company; tax on the “distributed income”, that is, excess of amount paid out over issue price
  • At an effective rate of 23.29% [i.e., 20% (base rate) + 12% (surcharge) + 4% (health & education cess)
  • Was there any foul play? Looking at the flat tax rate of 23.29%, the only possible arbitrage was where the slab tax rate for shareholders was significantly higher. However, on an average, there did not seem much tax gain for buyback. Several large companies have resorted to issue of bonus preference shares, with the obvious intent of redeeming them out. It seems that these schemes have triggered the provision. Open question: the Budget provision explicitly refers to sec. 68 of the Companies Act, whereas redemption of preference shares is not covered by that section.
  • There was a SEBI CP [see below] recommending that the tax on buybacks should be shifted to shareholders; however, SEBI couldn’t have thought of taxing the entire consideration as dividend.
• Amended provisions on taxability of buyback
  • Included u/s 2(22) of IT Act
  • The entire amount paid by the company taxable as “dividend”
  • Tax payable by shareholders
  • Entire buyback consideration taxable as dividend
  • TDS provisions as applicable to dividends apply [section 194 of IT Act]
  • Taxable at slab rates as applicable to respective shareholders, with a flat surcharge @ 15%
  • Entire cost of acquisition in respect of shares bought back to be booked as “capital loss” [section 46A of IT Act]
  • Such capital loss may be set off against capital gains subsequently
    • As per section 74 of IT Act, the set-off is available for a period of 8 AYs immediately after the AY in which loss arises
  • No deductions allowed for any type of expense made in connection therewith [Section 57 of IT Act]
• Example to understand taxability under new regime

• Intent of the amendment
  • The Memorandum to Finance Bill states that “References have been received stating that pay-outs on buy-back of shares should be taxed in hands of recipients, in line with similar regime in place for taxation of dividend.”
  • This is based on the argument that tax incidence on buyback should fall on the recipient shareholders and not on the remaining shareholders.
  • Recommendation was also made by SEBI pursuant to review of the Buyback Regulations applicable on listed entities.
• Consequences of the said amendment
  • The construct of section 2(22) is to cover “distributions” to shareholders from accumulated profits and merely repayment of capital should not be covered under the same. After all, no one can argue that there is any “dividend” unless there is a profit to back it.
  • Buyback may not necessarily entail a distribution of accumulated profits in the hands of shareholders
    • For example, if made at par value. In fact, a company may have accumulated losses, and may do a buyback out of share premium (which is permitted u/s 68 of the CA)
  • However, tax will be charged at the entire consideration received, no matter how much the shareholder paid by the shares. Result: pay tax now, lose your capital, and claim your lost capital as a “capital loss”!  One may argue on constitutionality – as to how what is not “income” by any stretch of argument can be taxed as income, but until then, that is the proposed law.
• Time left under the extant buyback regime
  • Time till 30th September, 2024 (2 months) under the extant tax regime for companies proposing to do buyback
  • Generally, for closely held companies, the entire buyback procedure (except approval of forms from ROC) should be done within a period of 10-15 days
  • Tax incidence will continue to be in the hands of companies as per the current regulations
  • Buy back approved as well as consideration released prior to 1st October 2024 – existing regime will apply
  • Buy back approved prior to 1st October 2024 but consideration released post on or after 1st October, 2024 – new regime should apply.