Complications of the Revised Buy-Back Tax Rules

In her seventh straight budget under the Modi-led Government, following a nail-biting victory in the central elections and amidst the expectations of a populist budget, the Hon'ble Finance Minister Nirmala Sitharaman has flipped the tax position on Buy-Back of shares.

Originally introduced in 2014, the concept of Buy-Back was designed to address the difficulty of taxing individual shareholders by shifting the tax burden to the company at the point of distribution. In contrast and defying that very logic, the Finance (No. 2) Bill, 2024 (Budget 2024) now proposes that the tax on Buy-Backs be levied on shareholders instead, treating the amount as dividends. i.e., on a gross basis, without accounting for the cost of the shares or any associated expenses.

To summarise:

- Buy-Backs are now taxed as dividends.
- The taxing point has shifted from the company to shareholders.
- No cost deductions are available while taxing dividends.
- The cost of the shares for shareholders will be treated as a capital loss, available for future set-off.

Are Buy-Backs the same as Dividends?

The answer is "Nay" even when both entail the distribution of money from the company. The fundamental difference lies in their impact on a company's capital base. Buy-Backs reduce the capital base of the company, as the repurchased shares are "destroyed" or "cancelled" on Buy-Back. Dividends do not affect the company's capital base, they merely represent a yield on investments. Shareholders receiving consideration on Buy-Back experience a reduction in their capital exposure to the said company, making it a capital payback and not a "yield".

What is the Impact?
Due to this fundamental distinction in the corporate action, the Buy-Back taxation might present significant tax issues, such as:

A. Higher tax rates: Dividends are taxed at maximum marginal rates whereas Buy-Backs were previously taxed at a capped rate of 20% (exclusive of surcharge and cess) in the hands of the company.

B. Preponement of taxes: Shareholders will now pay tax as dividends and subsequently face a capital loss that can be set off in the future. With the reduction in capital gains tax rates, this set-off may be applied to income taxed at lower rates in the future, while dividends will be taxed at higher rates.

C. Possibility of non-utilisation of capital loss: Capital losses can be carried forward for up to 8 years, and there is a risk that these losses may not be fully utilised within this timeframe.

D. Increased compliance: There will be heightened compliance requirements related to withholding taxes and remittance for non-resident shareholders.

E. Tax treaty issues: Now that a capital-related income will be taxed as dividends as per Indian tax laws, complications in tax treaties such as characterisation of income, and eligibility to claim foreign tax credit in the host country may arrive.

Conclusion
The intention appears to be aligning the tax treatment of all distributions with that of dividends. However, due consideration should have been given to capital-reducing events such as Buy-Backs. Shareholders are likely to find themselves in a more disadvantageous position when exiting companies, which could trigger greater resistance. In the long run, the adverse effects of the new Buy-Back tax regulations might result in a dead end for Buy-Backs within India Inc.

The views, thoughts and opinions expressed in the article are solely the author's and are not representative of the author's employer/ organisation.

Source:- Taxmann