Buy Back of Shares means the purchase by the Company of its own shares. Buy Back of equity shares is an imperative mode of capital restructuring. It is a corporate financial strategy which involves capital restructuring and is prevalent globally with the underlying objectives of increasing Earnings Per Share (EPS), averting hostile takeovers, improving returns to the stakeholders and realigning the capital structure. Buy Back is an alternative way of Reduction of Capital.
Section 68 of the Company’s Act deals with the instance of buy back of its own shares by a company. The most important points to be considered under the Companies’ Act is that the buy back by a company can be made out of :
its free reserves;
the securities premium account; or
the proceeds of the issue of any shares or other specified securities:
No buy-back of any kind of shares or other specified securities can be made out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.
The buy-back should be twenty-five per cent or less of the aggregate of paid-up capital and free reserves of the company. But in case of Equity Shares, the same shall be taken as 25% of paid up equity capital only. Debt equity ratio should be 2:1.
All the shares or other specified securities for buy-back are fully paid-up;
The buy-back in respect of unlisted shares or other specified securities is in accordance with the Share Capital and Debentures Rules, 2014.
No offer of buy-back can be made within a period of one year from the date of the closure of the preceding offer of buy-back.
Income Tax Act
The Companies’ Act as such does not prescribe the rate at which the buy back has to be done. In this context, the provisions of Section 115QA of the Income Tax Act would be relevant, which reads as under:
“115QA. Tax on distributed income to shareholders.- (1) Notwithstanding anything contained in any other provision of this Act, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount of distributed income by the company on buy-back of shares from a shareholder shall be charged to tax and such company shall be liable to pay additional income-tax at the rate of twenty per cent on the distributed income.
Provided that the provisions of this sub-section shall not apply to such buy-back of shares (being the shares listed on a recognised stock exchange), in respect of which public announcement has been made before 5th day of July, 2019 in accordance with the provisions of the Securities and Exchange Board of India (Buy-back of Securities). Regulations, 2018 made under the Securities and Exchange Board of India Act, 1992 (15 of 1992) as amended from time to time.
Explanation.-For the purposes of this section,-
(i) “buy-back” means purchase by a company of its own shares in accordance with the provisions of any law for the time being in force relating to companies;
(ii) “distributed income” means the consideration paid by the company on buy- back of shares as reduced by the amount, which was received by the company for issue of such shares, determined in the manner as may be prescribed .
(2) Notwithstanding that no income-tax is payable by a domestic company on its total income computed in accordance with the provisions of this Act, the tax on the distributed income under sub-section (1) shall be payable by such company.
(3) The principal officer of the domestic company and the company shall be liable to pay the tax to the credit of the Central Government within fourteen days from the date of payment of any consideration to the shareholder on buy-back of shares referred to in sub-section (1).
(4) The tax on the distributed income by the company shall be treated as the final payment of tax in respect of the said income and no further credit therefor shall be claimed by the company or by any other person in respect of the amount of tax so paid.
(5) No deduction under any other provision of this Act shall be allowed to the company or a shareholder in respect of the income which has been charged to tax under sub-section (1) or the tax thereon.”
The government introduced the concept of buyback tax under Sec 115QA vide the Finance Act 2013, wherein tax at the rate of 20 per cent is to be levied on the amount of income distributed by unlisted companies. It is pertinent to note that this tax was earlier applicable to income distribution by unlisted companies and not listed companies. The government was of the view that a similar practice should be adopted for listed companies given that there was also a tax arbitrage and, hence, the buyback tax has now been extended to listed companies as well. This provision was made effective in respect of buyback undertaken from July 5, 2019., by deleting the phrase ‘not being shares listed in a recognized stock exchange’.
Rationale of the provision
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 said amendment was intended to bring 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 may prove to be more expensive. However there have been concerns 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. 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.
However, it is to be noted that w.e.f., Assessment Year 2021-22, a domestic company isn’t required to pay dividend distribution tax on any amount declared, distributed or paid by such company by way of dividend. Dividend received from domestic company is taxable in hands of shareholders.
How to compute cost of acquisition
Rule 40BB prescribes the determination of Cost of acquisition to be deducted for computation of Income Tax Liability under Sec. 115QA. The said Rule covers various scenarios of buy back, however in normal scenario to calculate Income Tax of Buy Back of Shares, Amount received by the company is to be deducted from the Buy- Back price. This is because, the intention of Income tax Act is to tax income distributed by the Company. Hence, if a Company buy backs its shares from secondary market, the Income component in the Buy Back price = Buy Back price – Issue price of shares.
Taxability in the hands of shareholders
Section 10(34A) prescribes the taxability in the hands of shareholders.
10(34A) any income arising to an assessee, being a shareholder, on account of buy back of shares by the company as referred to in section 115QA]
Earlier, the declared dividend was chargeable as Dividend Distribution Tax (DDT) to the company and not the shareholder. Whereas the amount distributed as buy-back of shares was chargeable to the shareholder and not the company. The rationale for the introduction of Sec 115 QA was that companies would resort to buyback of shares in order to avoid dividend distribution tax.
As per Section 115QA, read with Section 10(34A), incidence of tax on buy back of shares by the company arises at the company level and thereafter no tax is required to be paid by the shareholder. Thus, shareholder need not calculate any income under the head Capital Gains, in accordance with Section 46A, read with 48, of the ITA. By Finance Act, 2020, DDT on dividends was abolished and the company is no longer liable to pay tax on dividends. Instead, dividends would be taxable in the hands of the shareholder (as per applicable slab rates). From the shareholder’s perspective, this means that income from buybacks is now more tax efficient compared to income from dividend.
Applicability of section 56(2)(x) on buy back of shares
The shares received by the company pursuant to buyback for cancellation has no value and in our view cannot be regarded as less than fair market value. In this regard reading of a the supreme Court judgement in the case of CTO vs State Bank of India (Civil Appeal No. 1798 of 2005) would be beneficial, wherein the issue was replenishment of certain Exim Scrips by the State Bank of India from the original purchaser. The view of the Apex Court was that the SBI is not getting any property in such replenishment. The observation of the Apex Court reads as under:
“34. Be it noted that the initial issue or grant of scrips is not treated as transfer of title or ownership in the goods. Therefore, as a natural corollary, it must follow when the RBI acquires and seeks the return of replenishment licences or Exim scrips with the intention to cancel and destroy them, the replenishment licences or Exim scrips would not be treated as marketable commodity purchased by the grantor. Further, the SBI is an agent of the RBI, the principal. The Exim scrips or replenishment licences were not “goods” which were purchased by them. The intent and purpose was not to purchase the replenishment licences because the scheme was to extinguish the right granted by issue of replenishment licences. The “ownership” in the goods was never transferred or assigned to the SBI.”
From the above, in our understanding, by buying back the shares, the company is not acquiring any ‘property’. The provisions of section 56(2)(x) starts with the terminology ‘where a person receives……. Any property’. In our understanding buy back does not result in company receiving any property. Shares are never “received” by company since they may as one option be deemed to be cancelled without company receiving them. Property is not in existence post the transfer. Section 56(2)(x) is therefore, in our opinion, not applicable.
However, ITAT Bangalore Bench in the case of Fidelity Business Services India (P.) Ltd.  164 ITD 270 (Bang) held that payment in the name of buy back of shares made by the assessee, to its related party, in excess of FMV of the share of the assessee company would fall in the ambit of Section 2(22)(e), i.e. Deemed Dividend. ITAT in the said case held that in case the buy back price is not based on the real valuation and it is artificially inflated by the parties then it is certainly a device for transfer of the reserves and surplus to the holding company by avoiding the payment of tax and therefore it will be treated as a colorable device. This decision of ITAT, Bangalore Bench, has been subsequently affirmed by the Karnataka High Court [ 257 Taxman 266 (Karnataka)]
It is clear that in the wake of section 115QA tax implications arise in the hands of company, be it a private company or a public company, no tax in the hands of shareholder is exigible. However, since now dividend being not taxable in the hands of distributing company but being taxable in the hands of shareholders, it is to be seen how the companies prefer to distribute surplus.
(Source : Article published in Souvenir released at National Tax Conference held at Katra on 2nd & 3rd October, 2021)