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All You Need to Know About Tax Liability on Buyback of Shares

Tax Liability on Buyback of Shares
Karan Singh
| Updated: Apr 07, 2021 | Category: SEBI Advisory

In India, Buyback of Shares is not a new idea to the Capital Market. Currently, achievement in the corporate world has observed a huge amount of Buyback of Shares by cash-rich entities, mostly in IT Sectors such as Wipro, TCS, and others. In common phrasing, Buyback of Shares means the company purchases their shares from the present shareholders at a price decided by the Management or Board as the case may be. Coming to the aspect of Income Tax, tax liabilities on Buyback of Shares is governed by Section 115QA and 46 A of the Income Tax Act, 1961.

Buyback of Shares generally means repurchasing of shares by a company that issues them. The company pays the stakeholders the market value of the shares and reclaims the proprietorship that was formerly distributed. Scroll down to check more information regarding Tax liability on Buyback of Shares.

What are the different reasons for Buyback?

A company increase the share capital by distributing shares & raising capital. Hence, it might seem differing for companies to Buyback the shares and pay money to stakeholders. Following are the reasons for the same:

  1. Compact Ownership: Significant shareholding indicates widespread ownership and higher company costs. So, to serve both the motives, that is, to bring solidity in ownership and reduce the capital cost, Buyback of Shares comes into the depiction.
  2. Attractive Financials: Buyback of Shares can also make the financials of the company more attractive. With a decreased number of shares, the company’s Earning per Share looks more attractive.
  3. Share Price Correction: The price of the shares in the market can be extremely underrated due to different reasons. So, a buyback backings the correction of the market price.
  4. Improved Shareholding of Promoters: Buyback is used if the company’s promoters are planning to increase their shareholding.

Tax Liability on Buyback of Shares as per the Provisions of Income Tax

The Income Tax provision with regard to tax liability on Buyback of shares is covered under Section 115 QA of the Finance Act, 2013[1], which applied to unlisted entities only, which assured a tax of 20 per cent on the distributed income.

The reasoning for the introduction of the provision was that unlisted entities resorted to Buyback of Shares in order to escape the Dividend Distribution Tax. As the Buy Back was charged as capital gains in the hands of the member, and Dividend Distribution Tax was imposed on the company. Therefore the modification was introduced as an anti-tax avoidance measure.

The Union Budget 2019 stated the said section to be applicable to the listed companies as well. The amendment is effective for all buybacks post-July 05, 2019, vide Finance Act (No. 2) 2019.

Provisions

Listed Companies

Unlisted Companies

Buyback tax

As per Finance (No 2) Act 2019, this tax is applicable to all Listed Companies or entities resorting to Buyback of Shares post-July 5, 2019.

Applicable after the Finance Act, 2013.

Capital Gains Tax

No longer valid for the investor.

Since the Finance Act, 2013, it is no longer applicable to the investor.

Illustration of Tax Liability on Buyback of Shares

The below-mentioned illustration will bring clearness to the modifications effected by the amendments.

  1. A listed entity called Delta Ltd repurchased 1000 shares in the month of May 2019 (before amendment) at the existing market price of Rs. 500. The issue price for the shares is Rs. 50.
  2. No tax liability on Buyback of Shares for Delta Ltd. Company;
  3. Separate shareholders should pay capital gains tax (Short or Long Term) depending on the holding price of shared on the difference amount (Issue Market Price), i.e. Rs. 500 – Rs. 50 = Rs. 450.
  4. In August 2019, Delta Ltd. Company again purchased 500 shares (post amendment), with a market price of Rs. 650 with an issue price of Rs. 50.
  5. Now, the company’s tax liability on Buyback of shares is 20% on the distributed income, i.e., Rs. 600, the difference between issue and market prices, i.e. (650-50).
  6. The separate shareholders are no longer liable to pay taxes.

Effects of Amendments – Tax Liability on Buyback of Shares

The proposed amendment brings at par both the ways of distribution of income, that is, Buyback of Shares and dividend payout. Actually, companies will now represent a better preference for the dividend payout as the rules of the Buyback is more relevant to the unlisted entities. The calculation of the amount received by the company for the issue of the shares will lead to illogical outcomes for listed companies.

Another anxiety that the amendment raises the shares of listed entities being tradeable pass through various hands. Every time a member sells their shares, they will experience long or short term capital gains on the disparity price (Market Price-Purchase Price). When a company buys back the shares, it again suffers tax on different price (Market Price – issue Price). Hence, there is an opportunity for double taxation. A similar happening is less likely in the case of unlisted entities. The company with extra funds and no feasible investment chance to invest in will distribute the excess. While buyback and dividend payout both outcome in payouts, Buyback permits a minor shareholding and greater Earnings Per Share also compact ownership. With the current amendment, the tax consequences will have to consider all the aspects prior to distributing its excess either by dividend payout or Buyback.

Conclusion

Buyback of shares is not a new concept to the capital market in India. In India, income tax on Buyback of shares is governed under Section 46A and Section 115 QA of the Income Tax Act, 1961. I hope that this article brings clarity on Income tax implications in the buyback transactions.

Read our article:Process for Buyback of Shares in India: A Guide

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Karan Singh

A legal writing enthusiast, a wanderer, and a zealous reader. After gaining a lot of knowledge about the diverse legal topics and developing research skills, Karan joined the league of legal content writers to deliver quality-rich blogs.

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