Income Tax on Buyback of Shares

Buyback is the activity wherein the Company repurchases its shares from the existing shareholders. The companies usually take this step to regain ownership from shareholders by paying them the fair market value of the shares owned by them. The Income-tax Act 1961(I-T Act) lays down certain provisions on the taxability of such transactions. 

In this article, we will learn about the buyback of shares, the reason, and the tax implications of buyback in the hands of shareholders and the company.

​What is the Buy-back of Shares?

Buyback of shares refers to repurchasing the shares by a company that they issued. The company usually buys the shares at the market price or higher. This is generally done by the companies to give the money back to the shareholders and regain their ownership. Section 115QA of the Income Tax Act, 1961 defines the buyback provisions.

Reasons for Buy-back

In FY 2022, around 50 companies announced a buyback of their shares worth Rs.37,519 crore. The most common reasons for buybacks are listed below:

1. Buyback enables companies to increase the proportion of shares owned by the company’s investors/promoters.
2. Under regular market conditions, the portion of profits that a company uses to buy back shares has a positive effect on the share price.
3. The company takes the decision of buyback to prevent other shareholders from taking a controlling stake.
4. To boost the proportion of earnings that is allocated per share, thereby making Financials more attractive. This is done when the company is bullish on its current operations.
5. Some company also buys back shares to issue those shares as a form of award to their employees and management with stock rewards and options.
6. If the company thinks that its shares are undervalued, then it may do a buyback to provide investors with a return. This also allows the company to make price corrections.
7. Companies do buybacks as a replacement for dividends due to lower taxation.

However, on the other side, a share buyback can give investors the impression that the corporation does not have other profitable opportunities for growth, which is a restraining point for growth investors looking forward to revenue and profit increases.

Key Terminologies

Before understanding the taxability of share buyback, it is important to understand some key terminologies and how the buyback process works.

• Listed Company – Also known as a Public Limited Company that issues shares that are traded on the stock exchange wherein the purchase and sale of shares happen through the open market. 

• Unlisted Company – Also known as Privately Owned Company, as they are not listed on the stock exchange, they are privately owned. For such a company, the trading of shares happens over the counter as per company specifications and the agreement between the concerned parties.

Process of Buyback in listed and unlisted companies

Listed Company

The buyback is carried out in 2 different ways:

• Tender route: In this case, the Company puts an offer to the shareholder to surrender the company’s shares held by them in exchange for the proceeds distributed by the Company based on the terms of buyback.

• Open Market route: The company makes an announcement and buys its shares in the open market at a particular price.

Unlisted Company

As the shares of the unlisted company are not listed on the stock exchange, the only way to buy back shares is by placing the offer in front of the shareholders and re-purchasing shares from them.

Taxation on buyback of shares

Until 2012, when the company bought its shares, the tax was levied in the hands of investors/ shareholders on the profits (also called capital gains) earned by them.

Capital gain, in this case, is the total proceeds that the investor receives as a part of the company’s buyback as reduced by the price at which the shares were purchased by the investor. The formula for calculating Capital gain in the case of the buyback is as follows:

Capital Gain = (Buyback price x number of shares bought back by the Company) – Amount paid by the investor at the time of purchase of those shares

Why is the Buyback Tax levied on the Company?

Earlier, when a company used to declare dividends, they were liable to pay Dividend Distribution Tax (DDT). But when the amount was distributed to the shareholders as a buy-back, then the taxability was in the hands of shareholders (in the form of capital gains). There was no taxability in the hands of the company for the buyback of shares.

Being treated as capital gains, the income tax was paid at a lower rate on the buyback of shares as the percentage of Capital gain tax was lower. Also, not all the shareholders have income more than the basic exemption limit. To avoid tax, the unlisted companies started using the buyback route to distribute money to their shareholders rather than declaring dividends.

Some foreign companies claimed tax treaty benefits on capital gains, whereby the investee companies would not declare dividends but buy back shares, resulting in tax-free capital gains for the foreign companies.

Therefore, as an anti-tax avoidance measure, the government introduced section 115QA under the I-T Act vide the Finance Act, 2013, for unlisted companies, and in July 2019, the provisions became applicable for the buyback of shares by listed companies as well.

How is Tax computed on the buyback of shares?

In the case of both Listed and Unlisted Companies, the tax is levied on buyback income / distributed income.

Distributed Income = Consideration paid by the Company on account of buyback – the amount which was received by the company for the issue of such shares.

If a Buyback is through the open market, in such cases, the shares are traded through many hands. The company cannot make out the purchase price at which individual investors would have bought shares from the open market. So, even in such cases, the tax is levied in the hands of the company on the difference between the buyback price and the price at which the Company issued its shares, irrespective of the market price at which the buyer would have bought it.

Taxability in the hands of shareholders

The income or gain earned by investors and shareholders in case of buyback is exempted from tax to avoid double taxation as per section 10(34A) of the I-T Act, 1961. Since this income is tax-free, shareholders need to consider the implications of Section 14A.

Illustration

Let’s understand it with an illustration:

ABC Ltd. is a steel manufacturer and announces a buyback of 1,000 shares with a market price of Rs. 650. The shares were issued by the Company 10 years back at Rs. 50.

Here, the Tax levied in the hands of the Company is as follows:

Net Distributed Income = (1000 shares x Rs 650 per share) – (1000 shares x Rs 50 per share) = Rs 6,00,000.

Tax on buyback = (Rs 6,00,000 x 23.296%) = Rs 1,39,776.

Therefore, the company will have to pay a taxation amount of Rs.1,39,776.

However, the taxation in the hands of investors or shareholders is Nil.

Due Date for payment of buyback tax

The tax is payable within 14 days from the date of payment of any amount to the shareholders on the buy-back of shares as per section 115QA(3) of the I-T Act. 

In case the tax is not paid within the due date, it shall be liable to pay simple interest at the rate of 1% per month or part thereof on the amount of such tax for the period beginning on the date immediately after the last date on which such tax was payable as per section 115QB of the I-T Act.

What is section 115QA?

Section 115QA of the Income Tax Act lays down the provision for Buyback tax (also known as Buy-back distribution tax – BDT).

It states that if a company does the buyback, then, in that case, it is liable to pay tax at a flat rate of 23.296% [where the rate of tax is 20% (a surcharge at 12%, and Health and education cess of 4%) on distributed income].

Implications of introducing buyback tax

With the introduction of amendments, the companies now have the option to share profits through dividends and buybacks. Both the options are now at par.

Moreover, the companies now offer dividends over buybacks due to fewer formalities. The buyback process is easier for unlisted companies.

However, there are a few drawbacks to the new rules, which are as follows:

• The computation of the “amount received by the company for the issue of shares” will lead to absurd results for listed companies.
• The shares of listed companies being tradeable pass through many hands. Every time a shareholder sells their shares, they will incur short-term or long-term capital gains on the differential price (Market price – Purchase price). Now, when the company buys back the shares, it again incurs tax on the differential price (Market Price – Issue Price). Therefore, there is a possibility of double taxation. The same occurrence is less likely in the case of Unlisted Companies.
• Reduces the company’s financial flow.

Final Words

The buyback of shares needs to comply with the provisions of the Companies Act 2013, wherein the company needs to match the buyback provision to become eligible for the same. The Company is liable to pay tax once the buyback procedure is completed and the money is distributed to the shareholders. To avoid double taxation, the Government of India provides tax exemption in the hands of the shareholders or the investors for the income that they receive on account of buyback.

Frequently asked questions