The buy-back of shares has long been a strategic financial tool for Indian companies. It allows businesses to return excess capital to shareholders, reduce the number of outstanding shares, and potentially boost Earnings Per Share (EPS). Governed under Section 68 of the Companies Act, 2013, share buy-backs are widely used for corporate restructuring and shareholder value enhancement.
However, with significant amendments in the taxation structure of buy-backs effective from 1st October 2024, companies and shareholders alike must be mindful of the changing tax landscape. This guide explores the updated procedural, legal, and taxation frameworks for share buy-backs, highlighting the transition from company-level taxation to shareholder-level taxation.
Legal Framework and Objective of Share Buy-Backs
Under Section 68 of the Companies Act, 2013, a buy-back involves a company repurchasing its own shares, which are subsequently extinguished. This reduces the company's equity base and can serve multiple strategic purposes:
- Return surplus cash to shareholders.
- Increase EPS by reducing the share count.
- Improve financial ratios, especially the debt-equity ratio.
- Offer exit routes for shareholders, particularly institutional investors.
- Thwart hostile takeovers by reducing available equity in the market.
In addition to the Companies Act, the SEBI (Buy-back of Securities) Regulations, 2018 govern buy-backs by listed companies, providing further procedural clarity.
Types of Buy-Backs
- Tender Offer Buy-Back: The company makes an offer to repurchase shares at a fixed price.
- Open Market Buy-Back: Shares are bought from the open market at prevailing prices, subject to a maximum price limit.
Eligibility Criteria and Conditions for Buy-Back
A company must adhere to several key criteria before initiating a buy-back:
- Articles of Association (AoA) Authorization: The company's AoA must authorize the buy-back.
- Fully Paid-Up Shares: Only fully paid-up shares can be bought back.
- Limit on Buy-Back: The buy-back in any financial year cannot exceed 25% of the company’s paid-up capital and free reserves.
- Debt-Equity Ratio: After the buy-back, the company’s debt-equity ratio must not exceed 2:1.
- Time Gap: No buy-back can be made within 12 months of the completion of a previous buy-back.
Procedure for Buy-Back
- Board Resolution: The company’s Board must pass a resolution approving the buy-back. If the buy-back exceeds 10% of the company’s paid-up capital, a special resolution is required at a general meeting.
- Filing of Form MGT-14: The resolution must be filed with the Registrar of Companies (ROC) within 30 days.
- Letter of Offer (Form SH-8): Sent to shareholders, informing them of the buy-back offer.
- Declaration of Solvency (Form SH-9): The company must declare that it is solvent and can meet all liabilities post buy-back.
- Buy-Back Offer Period: The offer must remain open for a minimum of 15 days and a maximum of 30 days.
- Extinguishment of Shares (Form SH-11): Shares bought back must be extinguished within 7 days of the completion of the buy-back.
Taxation of Buy-Backs: Pre and Post 1st October 2024
One of the most notable changes in recent times is the shift in the taxation regime for buy-back transactions.
Taxation Before 1st October 2024:
Section 115QA of the Income Tax Act imposed a 20% tax on the company conducting the buy-back. This buy-back tax was calculated on the difference between the buy-back price and the issue price of the shares. The company was liable to pay this tax, making the proceeds received by shareholders tax-free.
Section 10(34A) exempted any income arising from the buy-back in the hands of the shareholders. Thus, shareholders were not taxed on the buy-back proceeds, as the company already bore the tax burden.
Taxation Post 1st October 2024: Major Changes
Abolition of Section 115QA: From 1st October 2024, companies are no longer required to pay buy-back tax under Section 115QA. The liability now shifts from the company to the shareholders.
Taxation at Shareholder Level (Deemed Dividend under Section 2(22)(f)):
Post-1st October 2024, the buy-back proceeds will be considered deemed dividends in the hands of shareholders, and taxable at their respective income tax slab rates. This is a substantial shift as it alters the cost-benefit analysis for shareholders.For example:
- Shareholders in higher tax brackets (30%) will now face significant tax implications compared to the earlier tax-free status.
Capital Gains: Buy-back transactions will no longer trigger capital gains tax since the entire consideration received will be taxable as deemed dividend. However, capital loss can be generated and carried forward under Section 74.
Illustrative Example: Buy-Back Pre and Post 1st October 2024
| Particulars | Pre-1st October 2024 | Post-1st October 2024 |
|---|---|---|
| Buy-Back Price (per share) | Rs. 100 | Rs. 100 |
| Issue Price (per share) | Rs. 50 | Rs. 50 |
| Buy-Back Amount (100 shares) | Rs. 10,000 | Rs. 10,000 |
| Tax Payable by Company | 20% of (100-50) = Rs. 1,000 | None |
| Tax Liability of Shareholder | Nil | Taxable as deemed dividend at slab rate |
| Shareholder Tax Rate (assumed 30%) | Nil | Rs. 3,000 (30% of Rs. 10,000) |
| Net Proceeds to Shareholder | Rs. 10,000 (tax-free) | Rs. 7,000 after tax |
Impact of the New Taxation Regime on Share Buy-Backs
Impact on Companies:
Reduction in Tax Burden: Companies benefit from the removal of Section 115QA. Previously, they were liable to pay a 20% buy-back tax. With the new regime, companies are relieved of this tax, thereby reducing the cost of conducting buy-backs.
Enhanced Liquidity and Financial Flexibility: Since companies no longer need to factor in the buy-back tax, they have greater financial flexibility to manage surplus funds and optimize their capital structure.
Impact on Shareholders:
Higher Tax Liability for Shareholders: The transition from tax-free buy-back proceeds to taxable deemed dividends increases the tax burden for shareholders. Shareholders in higher tax brackets will face significantly higher tax liabilities, reducing the attractiveness of buy-back offers.
Strategic Considerations: Shareholders will need to carefully evaluate whether participating in a buy-back is financially beneficial, especially if they fall under higher income tax slabs.
Conclusion: Navigating the Post 1st October 2024 Buy-Back Regime
The abolition of Section 115QA and the introduction of deemed dividend taxation for shareholders fundamentally changes the landscape of buy-backs in India. While companies gain from reduced tax liabilities, shareholders now face the brunt of the tax burden.
For shareholders, careful tax planning is essential to navigate this new regime effectively. For companies, buy-backs remain a potent tool for capital structure optimization, albeit with an altered tax dynamic.
Understanding the procedural, legal, and taxation aspects of share buy-backs is crucial for both corporates and investors to make informed decisions in this evolving regulatory environment.
