Detailed Analysis of Tax Implications on Share Buybacks Under the Finance Bill, 2024

The Finance (No. 2) Bill, 2024, introduces significant changes in the tax treatment of share buybacks, particularly in the classification of buyback proceeds as "deemed dividends" and the treatment of the purchase cost. This article provides a comprehensive breakdown of these changes, explaining the impact on shareholders and how the recognition of capital losses plays a role in this new tax regime.

Previous Tax Regime (Before October 1, 2024)

Before the amendments, under Section 115QA of the Income Tax Act, 1961, companies conducting share buybacks were required to pay a 20% tax on the distributed income, which was calculated as the difference between the buyback price and the amount originally received by the company for issuing the shares. The tax was borne by the company, and the shareholders received the buyback proceeds tax-free, irrespective of their tax brackets.

Example:

• Purchase Price per Share: Rs.400

• Buyback Price per Share: Rs.600

• Number of Shares: 1,000

• Total Buyback Amount: Rs.600,000

• Original Issuance Price per Share: Rs.300

• Taxable Distributed Income: Rs.600,000 - Rs.300,000 = Rs.300,000

• Tax Payable by Company (20%): Rs.300,000 × 20% = Rs.60,000

• Net Proceeds to Shareholder: Rs.600,000 (Tax-Free)

This regime ensured that shareholders were not directly taxed on the buyback proceeds, making buybacks an attractive option for companies and shareholders alike.

Amendments Introduced in the Finance Bill, 2024

The Finance (No. 2) Bill, 2024, effective from October 1, 2024, which fundamentally alters the taxation of buyback proceeds. Under the new regime, buyback proceeds are reclassified as "deemed dividends" and are taxable in the hands of the shareholders at their applicable slab rates. This change has significant implications for the treatment of the purchase cost and the recognition of capital losses. Treating the proceeds from Buybacks as deemed dividend has been done by way of inserting Sub-Clause (f) after Section 2(22)(e) which is reproduced as under-

“(f) any payment by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 68 of the Companies Act, 2013;”;

Treatment of Purchase Cost and Capital Losses

1. No Deduction of Purchase Cost: Under the new regime, shareholders cannot deduct the purchase cost of the shares from the buyback proceeds when calculating taxable income. The entire buyback amount is treated as taxable income, which can significantly increase the tax liability for shareholders.

2. Recognition of Capital Loss: Although the purchase cost cannot be deducted from the buyback proceeds for immediate tax calculations, the difference between the buyback price and the original purchase price can be recognized as a capital loss. This loss can be set off against capital gains in future years.

Carry Forward of Capital Losses

Capital losses are classified into short-term and long-term losses. These losses can be set off against future capital gains as follows:

• Short-Term Capital Losses: Can be set off against both short-term and long-term capital gains.

• Long-Term Capital Losses: Can only be set off against long-term capital gains.

• Carry Forward Period: Capital losses can be carried forward for up to eight assessment years following the year in which the loss was incurred. This provision allows shareholders to reduce their tax liability by offsetting these losses against future capital gains.

Illustrative Example of New Regime:

• Purchase Price per Share: Rs.500

• Buyback Price per Share: Rs.600

• Number of Shares: 1,000

• Total Buyback Amount: Rs.600,000

• Taxable Income (Deemed Dividend): Rs.600,000

• Applicable Tax Rate (Assumed 30%): Rs.600,000 × 30% = Rs.180,000

• Net Proceeds to Shareholder (After Tax): Rs.600,000 - Rs.180,000 = Rs.420,000

• Recognized Capital Loss: (Rs.500 - Rs.600) × 1,000 = Rs.(100,000)

• Set Off Against Future Gains: Can be carried forward for up to eight years.

Comparative Table: Old vs. New Regime

Strategic Implications for Shareholders

The new regime`s treatment of buyback proceeds and purchase costs introduces complexity for shareholders, particularly in managing capital losses. The inability to deduct the purchase cost from taxable income means that shareholders must rely on carrying forward capital losses to offset future gains, making strategic tax planning more critical. The rationale given in Memorandum explaining Finance (No. 2) Bill, 2024 is as under-

“Tax on distributed income of domestic company for buy-back of shares

Special provisions relating to tax on distributed income of a domestic company from buy-back of shares were introduced by Finance Act, 2013, in line with the then schema of dividend distribution tax. Prior to the amendments made by the Finance Act, 2020, a company had to pay dividend distribution tax (DDT), on the distributed profits by way of dividends in addition to the income-tax chargeable in respect of the total income for any assessment year. DDT was done away with by the Finance Act, 2020.

2. References have been received stating that pay-outs on buy-back of shares should be taxed in hands of recipients, in line with similar regime in place for taxation of dividend.

3. Both dividend as well as buy-back are methods for the company to distribute accumulated reserves and thus ought to be treated similarly. In addition, there is extinguishment of rights for the shareholders who are tendering their shares in the buy-back by domestic company, to the extent of shares bought back by such company from shareholders. The cost of acquisition of such shares also needs to be accounted for in some manner.

4. It is therefore, proposed that, the sum paid by a domestic company for purchase of its own shares shall be treated as dividend in the hands of shareholders, who received payment from such buy-back of shares and shall be charged to income-tax at applicable rates. No deduction for expenses shall be available against such dividend income while determining the income from other sources. The cost of acquisition of the shares which have been bought back would generate a capital loss in the hands of the shareholder as these assets have been extinguished. Therefore when the shareholder has any other capital gain from sale of shares or otherwise subsequently, he would be entitled to claim his original cost of acquisition of all the shares (i.e. the shares earlier bought back plus shares finally sold). It shall be computed as follows:

(i) deeming value of consideration of shares under buy-back (for purposes of computing capital loss) as nil;

(ii) allowing capital loss on buy-back, computed as value of consideration (nil) less cost of acquisition;

(iii) allowing the carry forward of this as capital loss, which may subsequently be set-off against consideration received on sale and thereby reduce the capital gains to this extent.

Example :

5. These amendments will take effect from the 1st day of October, 2024, and will accordingly apply to any buy-back of shares that takes place on or after this date.”

Conclusion

The Finance Bill, 2024, significantly changes the tax landscape for share buybacks, particularly for unlisted companies. Shareholders now face a direct tax liability on buyback proceeds, with the purchase cost recognized as a capital loss that can be carried forward for up to eight years. Understanding these changes and their implications is essential for both companies and investors to make informed financial decisions. It’s important to note that for simplicity and ease of understanding, the impact of surcharge and cess has been ignored in the examples provided.