Tax law on buyback comes full circle

In the current global uncertainty, investors, especially foreign ones, look for tax certainty and policy continuity. Buyback taxation qualifies for the same

- MEHUL BHEDA

THE TAXATION OF buyback of shares under the Income Tax Act, 1961, has undergone multiple shifts, reflecting the overall thinking at the government level on how to tax return of capital and distribution of profits as well as the government’s response to tax arbitrage.

Initially, buybacks were taxed as capital gains, which encouraged companies—especially promoter-driven ones—to prefer them over dividends. This was driven by lower tax rates on capital gains vs dividends, and was especially preferred by foreign-owned companies, where the overseas parents could also take benefit of tax treaties. To curb this, the Finance Act, 2013, introduced a buyback distribution tax under Section 115QA for unlisted shares, taxing the company instead of the shareholder.The tax rate was 20% on the buyback proceeds but the amount invested in the company was available as deduction. This seemed to be a balanced way of taxing buybacks, although a basis on the shares was a permanent loss not available for tax purposes if the shares were purchased from other shareholders (secondary purchase). This regime was extended to listed shares in 2019, effectively equating buybacks with dividend distributions. Shareholders were granted exemption, and capital gains provisions were overridden. However, bringing this regime to widely held listed companies led to several practical challenges, especially around the cost deduction.