Union Budget 2013-14 proposed to levy tax on a share buyback by an unlisted company in the form of an “additional income-tax”, on the lines of dividend distribution tax and not the erstwhile “capital gains or transfer tax”. Finance Minister P. Chidambaram mentioned that unlisted companies have been resorting to share buybacks as an alternative to paying dividends. In certain situations, such share buybacks were claimed to be tax-exempt transactions whereas dividends would be subject to tax. The proposed amendment would ensure that dividend and share buyback are taxed in a similar manner, though the respective tax regimes have been consciously differentiated by the Finance Minister.

A company proposing to buy back its shares would now be liable to pay an “additional income-tax” at 20 per cent, plus surcharges. The tax base would be determined by reducing the sum the company received while issuing the shares, from the consideration paid for buyback. As tax on share buyback is proposed as “additional income-tax”, it will be levied even if the company has no accumulated profits. Also, the initial share issue price may not be adjusted for the inflationary index and would, therefore, result in higher tax liability.

On the flip side, the income earned from share buyback would now be exempt in the hands of the shareholder. The erstwhile regime taxed the resultant capital gains in the hands of the shareholders. Furthermore, if such shareholders were non-residents, the capital gains were taxable under the provisions of Indian Income-tax Act, 1961 or the Double Taxation Avoidance Agreement, whichever was beneficial to the shareholder. As the charge in the new regime is levied on the Indian company itself, the share buyback transaction may not be protected under DTAA. As the proposed tax on share buyback is the “final tax”, the taxable parties cannot claim any credit.

The Finance Minister may need to clarify a few aspects. For instance, where shares are bought back from a shareholder other than the original subscriber, how will the tax base be determined? Also, will the initial cost of subscription be pro-rated if the share buyback involves bonus shares? It may be challenging for the company to map the shares bought back with the respective tranche of issued shares to compute the tax on share buyback. It may be even more challenging if the shares are held in dematerialised form.

The proposed provision essentially puts the onus on the company buying back its shares, and envisages a tested manner of levying and collecting taxes. The new regime certainly increases the worries of CFOs pooling excess capital from companies and deploying them for worldwide operations. It reinforces the need to evaluate the trade-off in repatriating profits through dividend vis-à-vis share buyback.

Hemal Uchat is executive director, Mergers and Acquisitions, PwC India

Abhijeet Shah, Mergers and Acquisitions, contributed to the article.

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