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 point 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 shall 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 has to 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. Where: Debt is aggregate of secured and unsecured debts owed by the after buy- back Equity is aggregate of the paid- up capital and its free reserves;
- 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 shall be made within a period of one year from the date of the closure of the preceding offer of buy-back, if any.
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,-
- “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;
- “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 .
- 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
- 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).
- 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.
- 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 ”
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 initially applicable to income distribution by unlisted companies and not listed companies. Since 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 was later extended to listed companies as well. This provision was made effective in respect of buyback undertaken from July 5, 2019. However, by the Finance (No.2) Act, 2019, w.r.e.f. 05.07.2019, by deleting the phrase ‘not being shares listed in a recognized stock exchange’.
The rationale for the introduction of the provision was that the 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, while dividend distribution tax was charged to the company. Therefore the amendment was introduced as an anti-tax avoidance measure.
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 this 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.
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.
Though, there is no restriction on the price of buy back from the Company’s Act point of view, however in order to reduce the Income Tax implications, it is to be taken care of that the buy back is not done at a rate more than the original issue price.
APPLICABILITY OF SECTION 56(2)(x) ON BUY BACK OF SHARES
In my opinion, the shares received by the company pursuant to buyback for cancellation has no value and cannot be regarded as less than fair market value. We draw strength from the supreme Court judgement in the case of CTO v. State Bank of India (Civil Appeal No. 1798 of 2005), 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:
“the replenishment licences or Exim scrips would, therefore, be “goods”, and when they are transferred or assigned by the holder/owner to a third person for consideration, they would attract sale tax. However, the position would be different when replenishment licences or Exim scrips are returned to the grantor or the sovereign authority for cancellation or extinction. In this process, as and when the goods are presented, the replenishment licence or Exim scrip is cancelled and ceases to be a marketable instrument. It Page becomes a scrap of paper without any innate market value. The SBI, when it took the said instruments as an agent of the RBI did not hold or purchase any goods. It was merely acting as per the directions of the RBI, as its agent and as a participant in the process of cancellation, to ensure that the replenishment licences or Exim scrips were no longer transferred. The intent and purpose was not to purchase goods in the form of replenishment licences or Exim scrips, but to nullify them. The said purpose and objective is the admitted position. The object was to mop up and remove the replenishment licences or Exim scrips from the market.
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 Page 41 41 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. the replenishment licences or Exim scrips would, therefore, be “goods”, and when they are transferred or assigned by the holder/owner to a third person for consideration, they would attract sale tax. However, the position would be different when replenishment licences or Exim scrips are returned to the grantor or the sovereign authority for cancellation or extinction. In this process, as and when the goods are presented, the replenishment licence or Exim scrip is cancelled and ceases to be a marketable instrument. It becomes a scrap of paper without any innate market value. The SBI, when it took the said instruments as an agent of the RBI did not hold or purchase any goods. It was merely acting as per the directions of the RBI, as its agent and as a participant in the process of cancellation, to ensure that the replenishment licences or Exim scrips were no longer transferred. The intent and purpose was not to purchase goods in the form of replenishment licences or Exim scrips, but to nullify them. The said purpose and objective is the admitted position. The object was to mop up and remove the replenishment licences or Exim scrips from the market.
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 my 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 my 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.
This proposition has also been held by Mumbai bench of the Tribunal in the case of Vora Financial Services P. Ltd.  171 ITD 646 (Mum). It may also depend on the circumstances under which the shares are bought back, as in the case of Fidelity Business Services India (P.) Ltd.  164 ITD 270 (Bangalore – Trib.), Bangalore Bench of the ITAT 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. Aforementioned judgment of ITAT, Bangalore Bench, has been subsequently affirmed by the Karnataka High Court [ 257 Taxman 266 (Karnataka)]
TAXABILITY IN THE HANDS OF SHAREHOLDERS
Section 115QA provides for taxation of capital gain arising to a company on buy back of its own shares. This provision was inserted in the Act by Finance Act 2013. However taxability of such transactions in the hands of the shareholders was provided in section 46A, which was inserted in the statute by the Finance Act 1999, w.e.f. 01.04.2000. The provisions of section 46A reads as under:
“Capital gains on purchase by company of its own shares or other specified securities.
46A. Where a shareholder or a holder of other specified securities receives any consideration from any company for purchase of its own shares or other specified securities held by such shareholder or holder of other specified securities, then, subject to the provisions of section 48, the difference between the cost of acquisition and the value of consideration received by the shareholder or the holder of other specified securities, as the case may be, shall be deemed to be the capital gains arising to such shareholder or the holder of other specified securities, as the case may be, in the year in which such shares or other specified securities were purchased by the company.
Explanation.—For the purposes of this section, “specified securities” shall have the meaning assigned to it in Explanation to section 77A of the Companies Act, 1956 (1 of 1956).”
However with the insertion of section 115QA, another Clause (34A) was added to section 10 from the Finance Act, 2013, w.e.f. 01.04.2014, giving exemption to such income in the hands of a shareholder. The provision reads as under:
“(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.”
This section thus provides for removal of double taxation both in the hands of the company as well as the shareholders. Incidence of tax in the transaction of buy back now shifts to the company. 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.
REMOVAL OF DIVIDEND DISTRIBUTION TAX
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. However, by the Finance Act 2020 the company is no longer liable to pay tax on dividends. Instead, dividends would be taxable in the hands of the shareholder. From the shareholder’s perspective, this means that income from buybacks is now more tax efficient compared to income from dividend.
In view of the above, a company while buying back its own shares has also to take into consideration the tax component which it may have to bear as provided under section 115QA of the Act, however in the hands of shareholders no tax would be exigible on the same transaction.
(Source: This article is published in souvenir of National Tax Conference which was held on 6th & 7th August, 2022 at New Delhi)