Buyback of shares ordinarily means repurchasing of shares by the company that issued them. The company pays the shareholders the market value of the shares and reclaims the ownership that was previously distributed.
Reasons for Buyback
A company raises share capital by distributing shares and raising capital. Therefore it may seem contradictory for companies to buy back the shares and pay money to shareholders. The reasons for the same can be as follows:
- Compact Ownership: Substantial shareholding implies widespread ownership and higher costs to the company. So in order to serve both the motives that is to bring compactness in ownership and reduce the cost of capital, buyback of shares comes into the picture.
- Share Price Correction: The market price of the shares can be highly undervalued due to various reasons. Hence a buyback supports the correction of the market price.
- Attractive Financials: The buyback of shares can also make a company’s financials look more attractive. With a reduced number of shares, the Earning per Share of the company looks more attractive.
- Increased Shareholding of Promoters: Buyback is often used if the promoters of a company are planning to increase their shareholding.
Income Tax Provisions For Buyback of Shares
The provisions of Income Tax with regard to buyback of shares are covered under Sec 115 QA of the Finance Act, 2013 which applied to only unlisted companies which warranted a tax of 20% on the distributed income.
The rationale for the introduction of the provision was that unlisted companies resorted to buyback of shares in order to avoid dividend distribution tax.
As the buyback was charged as capital gains in the hands of the shareholder and dividend distribution tax was charged to the company. Therefore the amendment was introduced as an anti-tax avoidance measure.
The Union Budget 2019 announced the said section to be applicable to the listed companies as well. The amendment is effective for all buybacks post-July 5, 2019, vide Finance Act (No.2) 2019.
| Provisions | Listed Companies | Unlisted Companies |
| Buyback Tax | Applicable to all Listed Companies resorting to buyback of shares post July 5, 2019 as per Finance (No 2) Act 2019 | Applicable since the Finance Act 2013 |
| Capital Gains Tax | No longer applicable to the investor | Not applicable to the investor since the Finance Act 2013 |
Illustration
The following illustration will bring clarity to the changes effected by the amendment.
A listed company Delta Ltd repurchased 1,000 shares in May 2019 (prior to amendment) at the current market price of Rs. 500. The issue price for the same is Rs 50.
- No tax liability for Delta Ltd.
- Individual shareholders must pay capital gains tax (Long term or short term) depending on the holding period of shares on the difference amount (Market price – Issue Price) that is Rs. 500 – Rs. 50 = Rs. 450.
Delta Ltd repurchases 500 shares in August 2019 (post amendment), with a market price of Rs. 650 with an issue price of Rs. 50.
- The company is now liable for a buyback tax of 20% on the distributed income that is Rs. 600, the difference between market price and issue price (650-50).
- The individual shareholders are no longer liable to pay taxes.
Implications of the Amendment
The said amendment now brings at par both the methods of income distribution that is dividend payout and buyback of shares.
In fact, companies will now show a greater preference for the dividend payout as the buyback rules are more relatable to unlisted companies.
The computation of “amount received by the company for the issue of shares” will lead to absurd results for listed companies.
Another concern that the amendment raises is that the shares of listed companies being tradeable pass through many hands. Every time a shareholder sells his shares, he 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.
The company that has surplus funds and no viable investment opportunity to invest in will look to distribute the surplus.
While dividend payout and buyback both result in payouts, buyback warrants a smaller shareholding and higher Earnings Per Share also compact ownership.
With the recent amendment, the tax implications under both methods stand at par and hence companies will have to consider all the factors before distributing its surplus either through buyback or dividend payout.
Tax Rate Under Section 115QA
Under Section 115QA of the Income Tax Act, any domestic company that buys back its own shares is liable to pay additional income tax on the distributed income at an effective tax rate of 23.296% of distributed income [Rate of tax - 20% (plus surcharge @ 12% plus Health and education cess @ 4%)]. This tax is known as ‘Buy-Back Tax’ or ‘Buy-Back Distribution Tax’ (BDT).
How is Tax Computed on the Buyback of Shares?
In the case of listed and unlisted companies, tax is levied on buyback income or distributed income.
Distributed Income = Consideration paid by the company on account of buyback – amount received by the company for the issue of such shares.
When the buyback is through the open market, the shares are traded through many hands. Thus, the company cannot determine the purchase price at which individual investors would have bought shares from the open market. 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 had bought it).
Due Date of Buyback Tax
The tax should be paid within 14 days from the date of payment of any amount to the shareholders on the buyback of shares. In the case the tax is not paid within the due date, the company is liable to pay simple interest at the rate of 1% per month on the amount of the tax for the period starting from the last date on which such tax should have been paid.
Tax Implications for Shareholders
The company purchasing its own shares is liable to pay BDT. The receipt of the buyback price by the shareholders is exempt from tax under Section 10(34A) of the Act. Since income is exempt, implication under Section 14A should be considered by the shareholders.
Disclaimer: The materials provided herein are solely for information purposes. No attorney-client relationship is created when you access or use the site or the materials. The information presented on this site does not constitute legal or professional advice and should not be relied upon for such purposes or used as a substitute for legal advice from an attorney licensed in your state.
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