By Kunal Savani, Bipluv Jhingan and Lakshya Gupta
Buyback tax was first introduced in 2013 to align tax treatment of buy-back of shares with the then-existing dividend taxation regime, wherein a company was liable to pay a Dividend Distribution Tax’ (DDT) on the amount of dividends distributed, in addition to the regular corporate taxes. Additionally, shifting the tax incidence in case of buy-back from the shareholders to the companies also acted as an anti-avoidance mechanism, whereby the shareholders who were liable to capital gains tax on account of buy-back were prevented from avoiding taxes by claiming various exemptions under the domestic laws and tax treaties.
Now, with the Finance Act, 2020 abolishing the DDT regime and sun-setting on the capital gains exemption available under various tax treaties, the finance minister has yet again sought to re-align the taxation of buy-back of shares with that of dividends. Starting October 1, 2024, buyback proceeds are proposed to be treated as dividend income in hands of the shareholders.
While this proposed amendment may appear portentous, at least at a first glance, in our view the impact of this proposal vis-à-vis each stakeholder warrants a closer look.
Higher Taxes, But Really?
Under the new regime, proceeds received from a buy-back will be subject to tax as dividend. This means that these proceeds will be added to the shareholder's total income and taxed at their applicable slab rate (in case of resident shareholders), which can be as high as 35.88 percent for those in the highest tax bracket. This move is expected to hit resident promoters and large shareholders the hardest, as buy-backs have been frequently used as a tax-efficient way to reward them, especially after the abolition of DDT.
However, unlike residents, non-residents are subject to tax at the rate of 20 percent (plus applicable surcharge and cess) on dividend income. Further, with the tax burden shifting on the shareholder, such non-resident may not only claim the beneficial dividend taxation rates under applicable tax treaties (i.e., depending on the provisions of the applicable tax treaty) but also claim foreign tax credit for such taxes paid in India.
This should, consequently, reduce their overall tax cost. It may be relevant to note that while typically India’s tax treaties tax dividend income at a rate of 10-15 percent, in some cases this rate may be as low as 5 percent.
Let us understand the impact of these proposed amendments with an illustration:
Capital loss recognition: delayed but greater relief
While the proposed regime also provides that no deduction shall be available against the dividend income received pursuant to a buy-back, the Budget proposes to deem the cost of acquisition of the shares bought back as a ‘capital losses’, as such shares would be extinguished. Thus, whenever the shareholder has any other capital gains, he/she would be able to set-off his original cost of acquisition of shares.
No doubt that this mechanism would postpone the relief available to the shareholder vis-à-vis their cost of acquisition. However, unlike the buy-back tax regime, where typically the initial subscription amount is deducted while computing the buy-back tax, secondary acquirers would be able to claim set-off for the entire cost of acquisition. Say in the aforementioned illustration, a shareholder had acquired the shares from the original investor for Rs 30, who had previously subscribed to the said shares for Rs 10. Now, in the said scenario, buy-back tax would be computed on Rs 90 (i.e., Rs 100- Rs 10), even though the cost of acquisition in the hands of the shareholder was Rs 30. However, under the proposed regime the entire Rs 30 would be deemed to be a capital loss, which can be set-off against future incomes.
Deduction available to corporate shareholders?
Under extant laws, domestic companies can claim deductions for dividends received from other companies to the extent such income is distributed as dividends to their shareholders before a specified date. With buyback proceeds proposed to be treated as dividends, it would be crucial to assess whether domestic companies can avail themselves of this deduction upon receipt of buyback proceeds.
Conclusion
The proposed changes to the buyback tax regime are poised to impact both resident and non-resident investors in India. Further, with companies being obligated to withhold tax on distributions made on account buy-back, the compliance burden of such companies would also increase significantly, especially considering the different kinds of withholding tax rates which may be applicable to different investors.
However, despite the proposed abolition of buy-back tax regime, buy-backs may still be a tax efficient mode of exit/repatriation for investors, in certain scenarios.
Importantly, these provisions are proposed to take effect from October 1, 2024. Thus, there is a limited window for companies to undertake buy-backs under the existing tax structure. Many companies have been reported to have announced their buyback plans in anticipation of these changes and are moving quickly to approve share buy-backs before the new rules come into effect.
(Kunal Savani is Partner, Bipluv Jhingan is Principal Associate and Lakshya Gupta is Associate at Cyril Amarchand Mangaldas.)
Views are personal and do not represent the stand of this publication.
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
