From Bye Backs to Buy Backs: how new taxation rules impact equity extraction
– Vinod Kothari and Payal Agarwal | corplaw@vinodkothari.com
Finance Bill, 2026 brings tax relief to investors for share buybacks, by partially restoring the position that existed before the Finance Bill 2024 amendment. The 2024 Finance Bill changed the taxability of buybacks to impose tax on buyback consideration, taxing the entire “receipt” as “dividend”, implying tax at applicable regular tax rates rather than as capital gains.[See our article on the 2024 amendments here.]
The 2026 Bill proposes omission of Section 2(40) (f), [dealing with deemed dividend] and amendments to Section 69, [specifically dealing with tax on buybacks]. The net result of this:
- Buyback consideration not to be treated as deemed dividend;
- Shareholder pays tax on the difference between buyback consideration received and cost of acquisition taxable as capital gains – depending on whether the gain in short term (20%) and long-term (12.5%)
- In case of promoter shareholders, an additional tax, so as to bring the effective tax rate to 22% in case of corporate shareholders, and 30% in case of non corporate shareholders. No difference between short-term and long-term capital gains.
Applicability of the amendments: The amended provisions apply for buybacks done on or after 1st April, 2026. The existing provisions were introduced effective 1st Oct., 2024 and therefore, they would have had a life of only 15 months.
Why buyback?
Buyback is not merely a means of distribution of profits to the shareholders. There may be various reasons or motivations for which buyback may be done by a company, for example:
- Distribution or upstreaming of profits – Buyback is used as a means of distribution of accumulated profits (free reserves as well as securities premium) to the shareholders.
- Scaling down of operations – It is a mode of scaling down the operations of the company, without going through the tedious process of capital reduction through NCLT.
- Selective exit to certain shareholders – Buyback may also be used as a means of providing selective exit to certain shareholders, based on pre-determined arrangements. This may include, for instance, exit to some strategic investor, or a particular promoter, or shareholders not willing to dematerialise their securities etc.
- Put options to strategic or private equity investors – In case of strategic/ private equity investors, the shareholder agreements may include clauses on exit through put options. One of the ways of giving exit to the shareholders exercising the put option may be through buyback of their shares.
- Encashment of stock options granted to employees – It is quite common primarily in case of start-ups, to go for buyback of ESOPs granted to employees, instead of issuing shares upon exercise of options. This helps in providing liquidity to the employees, while also avoiding dilution in the shareholding structure of the company.
Concept of Buyback and Compliances Involved
- Governed by section 68 of the Companies Act read with the rules made thereunder (also see figure 1)
- Out of free reserves, securities premium or proceeds of issue of shares
- Only upto 25% of paid up share capital and free reserves, with shareholders’ special resolution
- Maximum no. of equity shares cannot exceed 25% of total paid-up equity share capital for that financial year
For detailed guidance on the procedure and compliances involved, refer to our FAQs on buyback here.
Figure 1: Buyback process and timelines under Companies Act
Reduction of share capital as an alternative to buyback
For buyback of capital beyond the statutory limits, the provisions of capital reduction u/s 66 apply. With the buyback consideration being taxed as deemed dividends, capital reduction through NCLT route was also being seen as an alternate route for scaling down capital in a relatively tax-efficient manner. There are rulings favouring capital reduction as an alternative to buyback, for instance, the ruling of NCLAT in the matter of Brillio Technologies Pvt. Ltd v. ROC, subsequently also referred to by NCLT Mumbai in the matter of Reliance Retail Ltd. Some of these rulings even permitted selective reduction of capital. See our article on reduction of capital here.
One of the primary deterrents in capital reduction u/s 66 of the Companies Act is the approval requirements – of the shareholders, creditors and even the NCLT.
Buyback of shares vis-a-vis dividend on shares
The scope of dividend distribution is quite narrower as compared to share buybacks. The primary difference between the two is in the source of payment. Dividend distribution can be made only out of surplus; where free reserves are proposed to be utilised for dividend payment, additional conditions are applicable. In no case, can such declaration be made out of securities premium, or proceeds of fresh issuance – which are permissible sources for buyback. Buyback, on the other hand, requires mere liquidity, availability of profits is not mandatory. Therefore, dividends are merely a way to upstream the earned profits; buyback can even be the way to scale down, for example, by releasing the share premium, or using one class of shares to buy back the other.
Once dividend is approved by shareholders with requisite majority, there is no provision for a shareholder to waive off his right to the dividend [see our article on the same here], and unclaimed dividend, if any, are kept in a separate account to be transferred to IEPF. In case of buyback, while the same is also offered to all shareholders, the buyback consideration is paid only to such shareholders who tender their shares for buyback; the question of waiver of rights or unclaimed amounts does not arise.
Buyback taxation: existing scenario vs new scenario
| Particulars | Finance Bill, 2024 | Finance Bill, 2026 |
| Applicability for buybacks done | w.e.f. 1st October, 2024 | w.e.f. 1st April, 2026 |
| Taxable as | Deemed dividend. The holding cost of the bought back shares allowed as short term capital loss | Capital gains |
| Tax incidence on | Recipient shareholder | Recipient shareholder |
| Amount taxable | Entire buyback consideration | Gains on buyback, that is, Buyback consideration minus, cost of acquisition |
| Rate of tax | Applicable income tax slab rate | LTCG – 12.5%, subject to exemption upto Rs. 1.25 lacs STCG: 20% In case of promoters: 22%/ 30% (depending on whether domestic company/ otherwise) |
| Differential treatment for promoter shareholders | No | Yes, additional tax rates apply |
Under the erstwhile regime, the entire buyback consideration was taxable as deemed dividend, with the cost of acquisition claimable as capital loss. In such a case, the higher the cost of acquisition on such shares, higher would have been disincentive in the form of taxing the cost component as dividends. The benefits of capital loss depend on the existence of capital gains, and hence, the effective tax rates on buyback could not be ascertained.
In the amended tax regime, buyback consideration, minus, cost of acquisition, is taxed at flat rates of capital gains – 12.5%/ 20%, depending on whether the capital gains are long-term or short-term in nature.
Disincentives under the extant regime and market reaction
The disincentives were two-fold:
- Higher tax slabs: The treatment as “deemed dividend” resulted in higher tax rates for top bracket individuals, as compared to capital gains, chargeable @ 12.5%/ 20% – depending on long-term/ short-term capital gains.
- Taxing entire consideration: The entire “receipt” was taxable, instead of the actual gains, that is, excess of the receipts over the cost of acquisition.
- Cost of acquisition as capital loss: The cost of acquisition was to be treated as short term capital loss. As a result, there is an advantage to those shareholders who have short-term capital gains to offset the short term capital loss created as a result of the buyback. Note that the deemed dividend, in case of corporate shareholders, may be claimed as a deduction u/s 80M.
Resultant market reaction: a sharp decrease in buyback offers during FY 24-25 as compared to previous financial years. As per the publicly available data in case of listed companies, the total buyback size for 2024-25 was ₹7,897 Crores when compared to 2023-24 with a buyback offer size of Rs. 49,836 crores, indicating a decrease of 84.2 per cent.
The number of buyback offers sharply declined, with only 17 instances of buyback offer by listed entities between 1st October 2024 till date (3rd February, 2026) as compared to about 36-40 instances in each of FY 22-23 and FY 23-24.
How Finance Bill 2026 rationalises the tax treatment?
Pursuant to the Finance Bill, 2026, the buyback taxation appears to be rationalised in the following manner:
- Buyback consideration not to be treated as deemed dividend [omission of clause (f) to Sec 2(40)]
- Difference between consideration received and cost of acquisition taxable as capital gains [S. 69(1)]
- In the hands of the recipient shareholder
- In case of promoter shareholders, tax payable at higher rates depending on whether promoter is a domestic company or not
- Effective rate of 22% in case of domestic company and 30% in case of persons other than domestic company
With this, while the tax incentive remains in the hands of the recipient shareholders, the tax treatment is rationalised in the form of value that is to be taxed and the manner in which tax is levied. However, the provision differentiates between a promoter and non-promoter shareholder.
Meaning of promoter: moving beyond the statutory definition
In case of listed company
- Refers to the definition of promoter under Reg 2(1)(k) of SEBI Buyback Regulations
- SEBI Buyback Regulations, in turn, refers to Reg 2(1)(s) of SAST Regulations
- Under SAST Regulations, promoters include “promoter group”
| Promoter | Promoter group |
| Person having control over the affairs of the company, or Named as promoter in annual return, prospectus etc. | Includes immediate relatives of promoters Entities in which >20% is held by promoters Entities that hold >20% in promoters etc. Persons identified as such under “shareholding of the promoter group” in relevant exchange filings |
The scope of “promoter group” thus, is much broader than “promoter”.
In case of an unlisted company
- Refers to the definition of promoter under Sec 2(69) of the Companies Act
- Concept of promoter group is not there under Companies Act
- To broaden the scope, a person holding > 10% shares in the company, either directly or indirectly, has also been covered.
Question may arise on what does “indirect” shareholding mean? Does it include shareholding through relatives, or through other entities as well? The word “indirect” is not the same as “together with” or “persons acting in concert”. Indirect shareholding should usually mean shares held through controlled entities.
Why additional tax for promoters?
The amendments bring higher tax rates for promoters, in view of the distinct position and influence of promoters in corporate decision-making including in relation to buyback transactions. Promoters may want to influence buyback decisions for various reasons, for example:
- Providing exit to an existing promoter/ strategic shareholder in accordance with any existing arrangement
- Creation of capital losses (assuming buyback consideration is lower than the cost of acquisition) thus setting off the capital gains earned from other sources
- Encashing securities premium or accumulated profits in the company etc.
In view of the promoter’s ability to influence buyback decisions to meet own objectives, additional tax is levied on buyback consideration received by the promoters, thus addressing any tax-arbitrage that could have been created through buybacks.
See our Quick Bytes on Budget, 2026 at here
Our other resources on buyback at here
