Buy-back of shares, in simple terms, means purchase by a Company of its own shares in accordance with the provisions of law.

There are two modes of buy-back:

a. Direct buy-back- i.e. directly from the shareholders (Off-Market deals)

b. Buy back through stock exchange (On-Market deals)

Let us understand the various tax implications involved in the buy-back of shares by Companies. For the purpose of our analysis, let us split the tax implications for buy-back of shares for:

1. Listed Companies and;

2. Unlisted Companies.


Buy back by Listed Companies

The tax implications for buy-back by Listed Companies can be broadly classified into two categories, as mentioned earlier:

Direct buy-back i.e. directly from the shareholders: In cases where shares are bought back directly from the shareholders, long term capital gains on transfer of shares would attract tax for the shareholders, by virtue of Section 112 of the Income Tax Act, at the rate of lower of the following:

  • 20% of capital gains after indexation and;
  • 10% of capital gains without indexation.

The shareholder is not entitled to the exemption on long-term capital gains on sale of listed securities under Section 10(38) of the Income Tax Act, since STT (Securities transaction tax) is not paid on such direct transfers.

Gains are considered to be in the nature of ‘long-term capital gains’, when the shares (listed) transferred by the shareholder are held by him for a period of more than 12 months. On the other hand, if the shares are held for a period of up to 12 months by the shareholder before the transfer, then the gains would be in the nature of ‘Short-term capital gains’.

Short-term capital gains shall be taxed at the slab rate applicable to the individual shareholder. If the individual is in the 5% bracket, short term gains would be taxed at 5%. If he is in the 20% or 30% bracket, then the short-term gains would be taxed at the rate of 20% or 30% respectively.

Buy back through stock exchange: If shares of a listed Company are bought back through a recognised stock exchange, the tax implications are as under:

For the purpose of understanding, let us classify the transactions into two categories as under:

  • Buy-back of shares acquired by the shareholder before 1st October, 2004 and;
  • Buy-back of shares acquired by the shareholder on or after 1st October, 2004

As far as category ‘i.’ is concerned, the shareholders would be entitled to the benefit of exemption under Section 10(38) of the Income Tax Act on long-term capital gains arising on account of buy-back, provided STT (securities transaction tax) is paid on the transaction. However, for the purpose of exemption, the condition of payment of STT need not be satisfied in cases where the transaction is undertaken on a recognised stock exchange located in any International Financial Services Centre and where the consideration for such transaction is paid or payable in foreign currency.

So far as category ‘ii’ is concerned, the benefit of exemption under Section 10(38) would be available to the shareholder only on the fulfilment of either of the following additional conditions:

  • STT has been paid by the shareholder on the acquisition of such shares or;
  • The shares have been acquired by the shareholder in one of the modes notified by the Government. [Notification NO. SO 1789(E) [NO. 43/2017 (F.NO.370142/09/2017-TPL)] dated 5-6-2017]- The Government has, by virtue of this notification, bestowed relaxation in cases of certain genuine transactions where the STT could not have been paid, such as acquisition of shares pursuant to IPO, FPO, bonus or rights issue, etc.

If the criteria for exemption, as aforesaid, are not satisfied, then long term capital gains on transfer of shares would attract tax for the shareholders, by virtue of Section 112 of the Income Tax Act, at the rate of lower of the following:

  • 20% of capital gains after indexation and;
  • 10% of capital gains without indexation.

On the other hand, Short-term capital gains arising from transfer of listed shares through a recognised stock exchange (with STT) would be taxed at the rate of 15% by virtue of Section 111A of the Income Tax Act.

 

Buy back by Unlisted Companies:

In the event of a buy-back by Unlisted Companies, as per Section 115QA of the Income Tax Act, the unlisted company shall pay an additional tax (i.e. over and above the tax chargeable in respect of the total income of the Unlisted company for any assessment year) at the rate of 20% on the ‘distributed income’. The term ‘distributed income’ has been defined to mean ‘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’.

The mode of computation of amount received by the Company in respect of the shares issued by it has been laid down in Rule 40BB of the Income Tax Rules. In the hands of the shareholder of the afore-mentioned Unlisted Company, the income (i.e. the excess of buy back price over his cost of acquisition) is exempt by virtue of Section 10(34A) of the Income Tax Act. This exemption holds goods regardless of whether the gain is short-term or long-term.


Image: https://legallogik.com/wp-content/uploads/2016/10/Do-You-Need-A-Shareholders-Agreement.jpg and https://www.ft.com/__origami/service/image/v2/images/raw/http://prod-upp-image-read.ft.com/40d43e5a-7eb3-11e7-ab01-a13271d1ee9c?source=next&fit=scale-down&quality=highest&width=1440