Share Buy-Backs: Tax Aspects

Source: The Hitavada      Date: 13 Aug 2018 12:47:20



A buy-back is a corporate action in which a company buys some of its shares from the existing shareholders. The reasons for such an action may be many --- 1. The company has a large amount of cash on hand even after paying hefty dividends in the past. Idle cash in hand is very costly and there are no opportunities to deploy the cash for organic or inorganic growth. 2. If the cash is distributed as dividend the company may not be able to cater to recession and therefore, it desires to hold on to the cash. 3. The company feels that the market has undervalued its stock substantially and therefore it makes sense to use the funds to buy its own shares. 4. By reducing the number of outstanding shares, its Earnings per shares (E/P ratio) increases substantially thereby sending strong signals to the marker about its health etc. To achieve this goal, some of the companies may finance the purchases through buying some debt.

Unlisted Companies
Normally, proceeds for the buy-back come out of the profits earned in the past years and retained by the company after paying dividends over the years. So a buy-back becomes an indirect way of paying dividend without attracting Dividend Distribution Tax (DDT).

Some ‘creative’ companies indulged in paying less or nil dividend and rewarded the shareholders through buy-back to avoid DDT and replace it with LTCG which was more efficient. In the case of a non-resident shareholder, for the capital gain emanating out of buy-back, the tax treaty provisions would apply, to the extent they are more favourable. Typically, under the tax treaties India has entered into with Mauritius, Cyprus and Singapore, capital gains is not taxable in India under their domestic tax laws. Consequently, buyback of shares by unlisted companies were not subject to tax either in India or in the foreign country. This route was commonly being used by NRIs to mitigate the DDT which is otherwise payable when profits are distributed as dividends.

FA13 inserted Sec. 115QA to plug this loop hole by levying an ‘additional income tax’ on distribution of income by way of buyback of shares by unlisted companies. Accordingly, besides the standard corporate tax, an additional income tax will be charged @20 per cent (+ Surcharge + Cess) on the difference between considerations received by the shareholder on buyback as reduced by the amount received by the company for issue of such shares. Since the tax will be levied on the Indian company making the share buy-back, a non-resident shareholder will not be able to reduce the impact of the tax by claiming treaty protection. This additional tax is applicable even if the normal tax payable by the company is nil! This additional tax is applicable even if an Indian company buys back its shares from a Resident. To avoid double taxation of same transaction, Sec. (10)(34A) is inserted to exempt the gain, if any, arising in the hands of shareholders. Consequently, loss arising on such transaction, if any, cannot be set off or carried forward.
Moreover, no deduction under any other provisions shall be allowed to the company or shareholders on the amount which has been charged to this tax.

Listed Companies
Listed securities, not sold on a recognised stock exchange in India such as private transactions between two individuals as also buy-back of its own shares directly (not through broker) from its shareholders do not suffer STT. In such cases, LTCG is charged to tax @20 per cent on CG (with indexation) or @10 per cent of the profit (without indexation), whichever is lower. STCG is payable at normal rate applicable to the assessee. Individuals had an option of adopting whichever route was beneficial to them. In most cases, the option of 20 per cent with indexation resulted in a loss and therefore no tax was payable. Unfortunately, SEBI has made this direct route unavailable through Circulars dt 24.3.2015 followed up by dt 13.4.2015 and 9.12.16. Investors do not have an option anymore and have to mandatorily route the transaction through the exchange.

The buy-back transaction, if routed through a recognised stock exchange in India, STT is payable at as low a rate of 0.1 per cent on the gross receipts. Once the STT is paid, the entire long-term capital gains (holding period of more than one year), irrespective of its size, becomes exempt. Let us examine the taxability through a live example.

On 20.5.2004 Ramesh had purchased 300 shares of Infosys @ Rs 628.13/share. Over the years thereafter, Ramesh continued buying Infosys. He had also received a 1:1 bonus on 15.6.15. He accepted the recent buy-back offer of Infosys @ Rs 1,150/share. He was entitled to 90 buy-backs. Since he was aware of the fact that there are many investors who would not accept this offer, either because of their lethargy or non-availability or any other reasons, Ramesh offered all his holdings for the buy-back and was surprised to find that Infosys bought back as many as 209 shares from him. The amount paid by Infosys was per cent 2,40,350 (= 209*1150) on which STT applicable was per cent 240 (=0.1 per cent of 240350). This STT enabled him to claim exemption on the LTCG Ramesh had earned.

How much LTCG Ramesh had earned? The index for FY 04-05 is 113 and that for the current FY 17-18 is 272. Consequently, his indexed cost of acquisition per share was Rs 1,531 (=(628.13*272/113)). The LTCG per share = 1150 – 1531 = a long term loss of Rs 381/share resulting in total long-term loss = Rs 79,629. Since for transactions which suffer STT, the LTCG is tax-free, the loss is also tax-free. In other words this loss is lost to him. He cannot set it off against any long or short term gain earned during the year.

Had Ramesh not sold the shares directly through the R&T agents of Infosys, this loss of Rs 79,629 could be setoff against any other capital gains earned during the year and thereafter it could be carried forward for 8 successive years for similar setoffs. This is no longer possible.
To SumAll said and done, we strongly feel that the investor should be given the option to go directly to the company or through his broker, whatever is more advantageous to him. It is difficult to fathom the wisdom behind the broker being brought into the picture in any buy-back transaction. This is strictly a transaction between the company and the investor. The broker is a third party who has no role to play in this. The investor is unnecessarily getting penalised by forcing him to pay the brokerage, STT, SEBI Turnover Fee, Transaction Tax, and Stamp Duty, CM Charges. Over and above this, GST @18 per cent is applicable on brokerage, SEBI Turnover Fee, Transaction Tax and CM Charges.

Note that GST was supposed to replace all other related taxes to simplify and streamline the system but in actual practice, it appears that some of these continue to be applicable. We sincerely entreat the regulating authority to reinstate the earlier provisions.
(The authors may be contacted at
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