Understanding Income Tax on Buyback of Shares
Regaining ownership of the company's shares through the purchase of previously issued shares is a crucial component of any organization's financial plan. Companies used to evade taxes in the past because share buybacks were tax-free. Section 115QA, which placed a tax on share buybacks, was later added to the tax code. Everything you need to know regarding taxes on the repurchase of listed shares is covered in this article.
Table of Contents:
What is a Buyback of Shares?
Repurchasing the company's shares that were issued by them is known as a buyback of shares. In most cases, the business purchases the shares at market value or above. Regaining possession of the company's shares and paying back the shareholders' money are the goals of this action. Section 115QA of the Income Tax Act of 1961 lays forth the rules for share buybacks.
Process of Buyback of Shares by Listed and Unlisted Companies
You must comprehend the share buyback procedure before you can comprehend the tax associated with it. For both listed and unlisted businesses, it is different.
Listed Companies: A public limited business, also known as a listed firm, issues shares that are bought and sold on the open market on the stock exchange. There are two methods used to execute a buyback for a publicly traded company:
Through the tender procedure, the business gives shareholders the chance to give up their shares in exchange for the current market price (CMP) or a higher market price.
The open market approach, in which the business declares and purchases its shares at a specific price on the open market.
Unlisted Companies: A privately held company or one that is unlisted is not on the stock exchange. The buyback process is carried out by presenting the offer to the shareholders and repurchasing shares from them, as shares of an unlisted firm are traded over the counter.
Reasons for Buyback of Shares
By issuing shares and raising money, a business can increase its share capital. As a result, firms' decisions to compensate shareholders and purchase back their shares may appear incongruous. The following are some possible explanations for the same:
Widespread ownership and increased expenses for the business are implied by substantial shareholding. Buybacks of shares are therefore necessary to fulfil the dual goals of lowering the cost of capital and bringing compactness to ownership.
For a number of reasons, the market price of the shares may be significantly undervalued. Therefore, a buyback encourages the market price to adjust.
Repurchasing shares can also improve a company's financials. When there are fewer shares, the company's earnings per share appear more appealing.
When a company's promoters intend to raise their stake in the company, buyback is frequently used.
Why Are Companies Required to Pay Tax on Buyback
Companies used to have to pay Dividend Distribution Tax (DDT) when they paid dividends. However, the tax burden was transferred to the shareholders in the form of capital gains when they paid out money to them through share buybacks. For the buyback, the business itself was exempt from paying taxes. Companies, particularly unlisted ones, began favouring share buybacks over dividend payouts in order to minimise taxes because capital gains tax rates are often lower and not all shareholders generate income beyond the standard exemption limit. A few international businesses used tax treaties to evade capital gains taxes. By encouraging investee companies to repurchase shares rather than pay dividends, they allowed the foreign entities to benefit from tax-free capital gains.
Latest Tax Updates on Buyback of Shares
The finance minister declared that the buyback tax would be completely redesigned. As explained in more detail in the paragraphs that follow, the company is currently required to pay tax on the difference between the buyback price and the issue price of the shares. It was first implemented in 2013 in accordance with the dividend distribution tax that was in effect at the time. DDT has been eliminated by the Finance Act of 2020, and the receiver is now subject to dividend tax. In order to align the repurchase tax with the dividend distribution tax, it is suggested that the company eliminate the buyback tax through this July 2024 budget.
Therefore, in accordance with the Budget 2024 amendment, the company will not be subject to tax on any buybacks undertaken after October 1, 2024. However, under the recently added clause of Section 2(22)(f), the receiving shareholder will be required to pay tax on the entire amount received from the buyback as a considered dividend. You must be asking if the cost of purchasing the shares that were offered for repurchase will be deductible from the amount of money considered dividend income. No, the cost of purchasing shares will not be deducted from dividend income received through buybacks. The aforementioned expense, however, will be carried forward as a capital loss and may be offset by future profits from the sale of any remaining shares.
Income Tax Provisions for Buyback of Shares
Only unlisted businesses that qualified for a 20% tax on distributed income were subject to the income tax regulations pertaining to share buybacks under Section 115 QA of the Finance Act of 2013. The regulation was introduced on the grounds that unlisted corporations were using share buybacks as a way to evade the dividend distribution tax. Dividend distribution tax was imposed on the business, and the buyback was taxed as capital gains in the hands of the shareholders. As a result, the modification was proposed as a way to combat tax evasion. The aforementioned section will also apply to listed enterprises, according to the 2019 Union Budget. According to the Finance Act, the modification is applicable to all buybacks made after July 5, 2019.
Provisions | Listed Companies | Unlisted Companies |
Buyback Tax | Applicable to all Listed Companies for buyback of shares post July 5, 2019 under Finance (No 2) Act 2019 up to 1st October 2024 | Applicable since the Finance Act 2013 up to 1st October 2024 |
Capital Gains Tax | No longer applicable to investors | Not applicable to the investor since the Finance Act 2013 |
Illustration
In August 2024 (before to amendment), X Ltd. repurchases 500 shares at a market price of Rs. 650 and an issue price of Rs. 50. A 20% repurchase tax on the dispersed income, or Rs. 600, the difference between the market price and the issue price (650-50), is now due from the corporation.Taxes are no longer due from individual stockholders.
In November 2024 (after modification), X Ltd. buys back 500 shares at a market price of Rs. 650 and an issue price of Rs. 50. The business is no longer required to pay taxes on buybacks. However, under the recently added clause of Section 2(22)(f), the recipient shareholder will pay tax on the entire amount received from the buyback as a considered dividend according to their income tax bracket.
Tax Rate under Section 115QA
Any domestic business that repurchases its own stock is subject to additional income tax on the distributed income under Section 115QA of the Income Tax Act, with an effective tax rate of 23.296% of distributed income [tax rate - 20% (plus surcharge @ 12% + health and education cess @ 4%). "Buy-Back Tax" or "Buy-Back Distribution Tax" (BDT) are the names given to this tax.
Due Date for Tax on Buyback of Shares
According to section 115QA(3) of the IT Act, income tax on share buybacks must be paid within 14 days of the date that any sum is paid to shareholders. Let's say the business fails to pay the tax on the share repurchase before the deadline. According to section 115QB of the IT Act, it will thereafter be required to pay simple interest at the rate of 1% per month, or a portion of it, on the amount of the tax for the period starting on the day immediately following the final date on which the tax was due.
Calculation of Tax on Buyback of Shares
Both listed and unlisted businesses must pay taxes on their dispersed or buyback income.
Distributed Income= Amount the corporation received for issuing such shares - Consideration it paid for the buyback.
Shares are exchanged among numerous hands when the repurchase occurs on the open market. As a result, the business is unable to ascertain the price at which private investors would have purchased shares on the open market. The difference between the buyback price and the price at which the firm issued its shares is subject to taxation in these situations, regardless of the market price at which the buyer purchased the shares. It should be noted that, in compliance with Budget 2024, the company will not be subject to tax on any buybacks done after October 1, 2024. However, under the recently added clause of Section 2(22)(f), the receiving shareholder will be required to pay tax on the entire amount received from the buyback as a considered dividend.
Conclusion
Unlike in the past, businesses cannot choose to forego taxes by paying dividends in favour of buybacks. Companies can now distribute dividends more tax-efficiently because they are exempt from paying dividend taxes according to changes made to the Finance Act 2020.
FAQ
Q1. Is buyback income taxable?
The buyback was taxable in the company's hands until October 2024. However, as per Budget 2024, the buyback will be taxable in the recipient's hands as a dividend at their corresponding slab rate beginning of October 1st.
Q2. Do companies prefer to give dividends over share buyback?
While the buyback process is simpler for unlisted companies, listed corporations prefer to provide dividends because there are fewer formalities involved.
Q3. What is the limit on share buyback?
The repurchase cannot be greater than 25% of the company's total paid-up capital and free reserves, according to the Companies Act of 2013.
Q4. Will cost of acquisition of shares be permitted against deduction against deemed dividend income as buyback?
No, the cost of purchasing shares will not be deducted from dividend income received through buybacks. The aforementioned expense, however, will be carried forward as a capital loss and may be offset by future profits from the sale of any remaining shares.
Q5. What is the new tax treatment for share buybacks?
The tax treatment of share buybacks will change on October 1, 2024. Share buyback proceeds will now be counted as dividend income. This implies that, depending on their applicable tax slab, shareholders will pay income tax on the amount they receive from the buyback. Crucially, the cost of purchasing the repurchased shares will not be eligible for a tax deduction.
Q6. How does the new tax treatment vary from the previous tax treatment?
Companies were required to pay a special tax on share buybacks under Section 115QA of the Income Tax Act 1961 under the old tax system. Section 10(34A) exempted the revenue obtained by shareholders from such buybacks from taxation in order to avoid double taxation. The new rule, however, transfers the tax burden from corporations to shareholders.
Q7. What are the tax implications for shareholders after 1st October?
The revenues from share buybacks must be reported by shareholders as part of their overall income under the new rule. The relevant income tax slab rate will subsequently be applied to this income. The goal of this modification is to align the tax treatment of share buybacks with that of dividends.
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