Income Tax Provisions for the Buy-back of Shares?

If you're a shareholder or involved with a company considering the buy-back of unlisted shares, you might have come across terms like "tax on buy-back" and "income tax provisions for buy-back of shares." While the concept of buy-back can seem straightforward, the tax implications can often be confusing. 

Whether you're a company looking to buy back your shares or an investor involved in such a transaction, understanding the tax rules surrounding it is crucial to avoid surprises.

In this blog, we will simplify the tax provisions that apply to the buyback of shares. We’ll walk you through recent changes in buyback taxation, the specific income tax provisions, and how the buyback tax is calculated. 

Also, we’ll discuss the due date for payment of buyback tax to make it easier for you to understand the entire process. By the end of this blog, you will have a clear idea of what to expect when dealing with the provision of buyback of unlisted shares and how to navigate the tax requirements effectively.

Let’s explore!

Recent Changes in Buyback Taxation

As of October 1, 2024, you should be aware of important updates to the taxation of buybacks in India. These changes will affect how companies and shareholders handle taxes related to share buybacks.

Here is what you need to know:

1. Tax Shift from Company to Shareholder

Previously, when a company bought back its shares, it paid a 20% tax on the buyback amount, which effectively came to around 23.92% after including surcharges and cess. This meant the tax burden was on the company, and shareholders received their proceeds without additional tax implications.

With the new rules, this tax on buybacks is eliminated. Instead, when a company buys back shares, the proceeds you receive as a shareholder will now be treated as dividend income. This means you will be taxed based on your personal income tax slab rate.

For example:

• If you hold shares of Company ABC, and it decides to buy back 100 shares at ₹500 each.

• Total proceeds from the buyback: 100 shares × ₹500 = ₹50,000.

• Under the old system, Company ABC would pay a tax of approximately ₹11,960 (23.92% of ₹50,000), and you would receive ₹50,000.

• Under the new system, you will receive the entire ₹50,000, which will be added to your income for the year and taxed according to your income tax slab.

2. Tax Deducted at Source (TDS)

Along with the changes in taxation, companies are now required to deduct TDS (Tax Deducted at Source) on the buyback proceeds before disbursing the amount to you. The TDS rates are as follows:

• 10% for resident individuals

• 20% for non-resident individuals

For example:

Let's continue with the previous example:

• If you are a resident individual in the 30% tax slab and Company ABC buys back your shares for ₹50,000, the TDS deducted would be 10% of ₹50,000 = ₹5,000

• The amount you receive after the TDS deduction: ₹50,000 - ₹5,000 = ₹45,000.

After this, you must report the entire ₹50,000 as income when filing your tax return, and the ₹5,000 TDS will be adjusted accordingly.

3. Capital Loss Treatment

Another significant change is that shareholders can now treat the cost of shares repurchased as a capital loss. This allows you to offset the loss against any capital gains you may have from other share sales.

For example:

• If you bought 100 shares at ₹300 each (total cost = ₹30,000) and sold them back to Company ABC for ₹50,000, you would have:

• Capital Gain Calculation: ₹50,000 (proceeds from buyback) - ₹30,000 (cost of shares) = ₹20,000 capital gain.

• If you also sold other shares at a gain of ₹15,000 during the same financial year, you could use the ₹20,000 capital gain from the buyback to offset the ₹15,000 gain from the other shares.

4. Impact on Shareholders

The new taxation system may increase the overall tax burden for many shareholders.

For example:

• A shareholder in the highest tax bracket (around 35%) may find that their effective tax rate on buyback proceeds is now higher than what it used to be when companies paid the tax.

With the updated taxation rules in place, you might wonder how this affects the calculation of buyback tax. Let’s break it down next.

Calculation of Buyback Tax

The buyback tax is a specific tax imposed on companies that repurchase their own shares. In India, this tax is governed by Section 115QA of the Income Tax Act, and it has clear implications for both the company carrying out the buyback and the shareholders involved.

1. Tax Rate

The buyback tax rate is set at 23.296%, which includes:

• A base tax rate of 20%.

• A 12% surcharge.

• A 4% health and education cess on the total tax amount.

2. Distributed Income Calculation

The distributed income, which is used to calculate the buyback tax, is determined as follows:

Distributed Income = (Buyback Price × Number of Shares) − (Issue Price × Number of Shares)

For example, if a company buys back 1,000 shares at ₹650 each, which were originally issued at ₹50 each, the distributed income is:

Distributed Income: = (1,000 × ₹650) − (1,000 × ₹50) = ₹600,000

The tax on this distributed income would be calculated as follows:

Tax = ₹600,000 × 23.296% = ₹139,776

After understanding the calculation of the buyback tax, the next step is to be aware of the due date for making the payment. Let’s explore that.

Due Date for Payment of Buyback Tax

When a company purchases unlisted shares, it is obligated to pay tax on the buyback proceeds. Understanding the payment timeline is essential to ensure compliance with the Income Tax Act.

1. Payment Timeline

The tax must be paid within 14 days from the date the company makes any payment to shareholders as part of the buyback. This requirement is outlined under Section 115QA of the Income Tax Act.

2. Interest on Late Payment

If the company does not pay the tax by the due date, it will face a penalty in the form of simple interest at the rate of 1% per month on the unpaid tax amount. The interest will accumulate the day after the due date and continue until the tax is paid.

Conclusion

There have been notable changes in the taxation of buybacks in India, as discussed. This move ensures that companies undertaking a buyback will now be taxed at a rate of 20% on the distribution of profits, making it crucial for companies and investors to stay informed about these provisions related to the provision of buyback of unlisted shares.

When it comes to tax provisions and computation for the buyback of shares, it’s important to note that the buyback tax is applicable on the amount paid by the company to its shareholders, which is subject to tax at the applicable rates. Understanding the provisions, such as the due date for tax payments and how the tax is calculated, is essential to ensure compliance.

To explore potential investment opportunities, you can reserve access to Precize, an alternative investment platform in India. Precize provides access to private equity investments, including unlisted and pre-IPO shares, and offers unique global trade finance opportunities through private credit investment opportunities.