Buy back tax bites

In June 2013, India introduced a new levy on unlisted companies that purchased back its own shares. The levy is called buy back tax or BBT.

The BBT was introduced to plug tax planning that was possible under certain double tax treaties wherein a tax exemption could have been claimed for repatriation of profits to overseas shareholders through buy-back of existing shares, instead of dividend distribution.

The BBT is a liability of the Indian company which is not mitigated through tax treaties and is in addition to the corporate tax paid by the corporates. It is about 23 per cent of the “distributed income”, which is essentially the difference between the amount of consideration paid by the company on buy-back less the amount that the company actually received when it issued the shares.

The law, however, created ambiguity on the interpretation of the amount received by the company (i.e. issue price).

Specifically in situations such as the issue of shares pursuant to merger, demerger, shares issued post conversion of bonds, debentures, etc, wherein in no specific amounts were actually received by the company on these events as such opened up different interpretations.

To bring more clarity on these, the Government has now released draft rules for public comments. The rules seek to clarify the following in relation to the determination of what constitutes the amount received by the company for calculating BBT pursuant to issue of shares:

1. By subscription: Amount received by the company including premium less any amount returned;

2. Pursuant to amalgamation: Amount received by the amalgamating company for such shares;

3. Pursuant to demerger: Amount received by the demerged company in the proportion of net book value of assets transferred pursuant to the demerger to the net worth of the demerged company immediately before demerger

4. Bonus issue: Considered as nil;

5. Conversion of bonds, debentures, debenture-stock or deposit certificate: Amount received by the company for the instrument that was converted;

6. In any other case: Face value of shares.

This is a welcome move to reduce ambiguity for calculation of BBT and is in line with the Government’s philosophy to simplify tax rules.

However, some additional scenarios need to be addressed. They are: what would be the amount received for issuance of shares by the company, where the shares are issued pursuant to conversion of a proprietorship concern, partnership firm or LLP into a company, and where shares were issued for consideration other than cash.

It may also be worthwhile to consider the actual cost of acquisition in the hands of the shareholder instead of the issue price received by the company. This aspect is critical to ensure that overall shareholder value is not diluted.

In other words, the shareholder could lose out in the event he bought shares at a price higher than its issue price as he will not be in a position to claim losses on sale through buy-back.

Goenka is Partner, Direct Tax, and Ramaswamy is Partner, M&A Tax, at PwC, India. With inputs from Lakshmisha S. The views are personal.

COMMENT NOW