Introduction to Buyback:
Buyback of shares is a corporate activity wherein a company repurchases its own shares from existing shareholders. This move is commonly employed to regain ownership by compensating shareholders with the fair market value of their shares. The Income Tax Act of 1961 outlines provisions governing the tax implications of such transactions.
What is Buyback and Why Companies Opt for It?
Buyback involves a company repurchasing shares it previously issued. Typically, companies acquire these shares at market value or higher, intending to return funds to shareholders and regain ownership. Section 115QA of the Income Tax Act, 1961 defines buyback provisions.
Reasons Behind Buyback:
In the fiscal year 2022, approximately 50 companies announced buybacks totaling Rs. 37,519 crore. Common reasons for buybacks include:
- Increasing company ownership.
- Positively affecting share prices.
- Preventing other shareholders from obtaining a controlling stake.
- Enhancing earnings per share.
- Rewarding employees with stock awards.
- Correcting undervaluation.
- Serving as an alternative to dividends for tax efficiency.
Key Terminologies:
Understanding certain terms is crucial:
- Listed Company: Public Limited Company with shares traded on stock exchanges.
- Unlisted Company: Privately Owned Company with shares traded privately.
Processes in Listed and Unlisted Companies:
Listed Company:
- Tender Route: Shareholders surrender shares based on buyback terms.
- Open Market Route: Company announces buyback and purchases shares in the open market.
Unlisted Company:
- Offers buyback directly to shareholders due to absence from stock exchanges.
Taxation on Buyback:
Until 2012, tax on buybacks was levied on investors/shareholders. The capital gain, calculated as (Buyback price x number of shares bought back) – (Amount paid by investor at purchase), was taxed at a lower rate.
Tax Imposed on the Company:
Previously, companies declaring dividends were subject to Dividend Distribution Tax (DDT). However, buyback profits were taxed in shareholders' hands as capital gains. This change aimed to prevent tax avoidance, leading to the introduction of Section 115QA in 2013 for unlisted companies and, later, in 2019 for listed companies.
Calculation of Tax on Buyback:
Tax on buyback is computed as a percentage of distributed income, where Distributed Income = (Consideration paid by the Company) – (Amount received by the company for issuing shares).
Tax Implications for Shareholders:
Investors' gains from buybacks are tax-exempt under Section 10(34A) of the I-T Act, preventing double taxation.
Illustration:
Considering ABC Ltd.'s buyback of 1,000 shares at Rs. 650 each (issued at Rs. 50), the company pays tax on distributed income, while shareholders incur no tax.
Due Date for Buyback Tax:
Tax is due within 14 days from the payment to shareholders, with interest penalties for delayed payment.
Understanding Section 115QA:
This section imposes a flat tax rate of 23.296% on distributed income, comprising a 20% tax rate, 12% surcharge, and 4% Health and education cess.
Implications of Buyback Tax:
While it curbs tax avoidance, it provides companies with options for profit distribution. However, some drawbacks include potential double taxation for listed companies.
Frequently Asked Questions (FAQs):
Limit on Share Buyback:
- Restricted to 25% of the company’s total paid-up capital and free reserves.
Brokerage on Buyback:
- Applicable brokerage, Depository Participants charges, and regulatory charges.
Eligibility for Buyback:
- Only existing shareholders as of the Record Date are eligible.
Withdrawal of Buyback:
- Irrevocable once publicly announced or after filing with SEBI.
Accounting for Share Buyback:
- Reduces cash holdings and total assets, affecting shareholders' equity.
Tax Rate on Buyback:
- A fixed rate of 23.296% on distributed income.
Due Date for Buyback Tax:
- Within 14 days from payment to shareholders.
Conclusion:
Compliance with the Companies Act 2013 is crucial for buybacks. Tax exemptions for shareholders aim to encourage companies to use buybacks for profit distribution, avoiding double taxation.
