Taxing buybacks

Dividends are taxed and so are capital gains. But here’s a new one. The Finance Bill 2013 has seen the introduction of a tax on buyback offers where sums paid by the company to the shareholder, over and above the issue price of the shares, are to be taxed.

Why buyback

A company may choose to buy back its own shares for various reasons. These could include attaining a target capital structure, returning value to shareholders, facilitating exit to shareholders or even stabilising the share price.

The buyback of shares has however been at the receiving end of a lot of flak too. Where companies have overseas shareholders, the strategy has been maligned as a tax avoidance scheme to repatriate profits outside India without suffering tax.

Under the new provisions, the consideration paid by the company for the buy-back of shares, which is in excess of the amount received by the company during issue of shares, will be charged to tax at a flat 20 per cent (plus applicable surcharge and cess). This tax will be levied at the hands of the company making the buyback.

This would essentially mean that what would have normally been a gain in the hands of the shareholder would now be subject to tax in the hands of the company. This tax is envisaged to be a final levy, with no further tax liability (capital gains liability) in the hands of the shareholders. Interestingly, consideration from buyback was hitherto regarded as capital gains under the Act and the shareholder taxed accordingly (subject to tax treaty benefits for non-resident shareholders). But it would now be regarded as akin to dividends.

Arbitrary judgment

This perhaps takes a leaf out of the Otis case, where the Authority for Advance Ruling (AAR), adjudicating in favour of the Revenue held that the transaction of buyback was a ‘colourable transaction’, and characterised a buyback as a means to distribute dividends, rather than return of capital to shareholders.

The AAR judgment was widely trounced as arbitrary. There was slight relief when the Shome committee in its report expressed the opinion that buybacks should not be regarded as ‘colourable transaction’ warranting the attraction of GAAR.

However, the Government, though it has ostensibly accepted large portions of the Shome Committee report, seems to have held on to its own opinion on the ‘colourability’ of buyback transactions. The new buyback distribution tax clause could hence appear to have a dual impact, resulting in a change in income characterisation as well as tax liability.

Under the capital gains characterisation, a non-resident shareholder in Singapore or Mauritius, does not pay any tax since India’s treaties with these countries allows taxing rights on capital gains to the country of residence.

Given that these countries would characterise the income as tax exempt, no credit on the new tax would be available under the respective treaties, thereby increasing the cost of investment.

These new proposals for taxation of capital transactions give rise to questions on equity of the principles of taxation being followed in India.

An entrepreneur could be taxed for making investments as well as exiting the investments. Though this may have been a ruse to garner more revenues, what if companies choose to forego the buyback route completely? Other repatriation strategies, including dividend distribution, may be preferred to take advantage of the tax arbitrage. This leaves us with the biggest question — contrary to revenue authorities’ expectations, would both the share premium tax and buyback tax be reduced to sections in the Act which never get applied? We will have to wait and see!

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