Share buyback tax regime to change from October 1: What this means for you

The new share buyback tax rules in India are designed to create a more equitable tax environment. However, the changes will have varying impacts on different stakeholders

There will be significant changes to India's share buyback tax regime from October 1, 2024. The new rules will shift the tax burden from companies to shareholders, fundamentally altering the landscape for buyback strategies.

Key Changes:

• Tax Shift: The current 20% tax on buybacks paid by companies will be eliminated. Instead, shareholders will be taxed on buyback proceeds as dividend income according to their respective tax slabs.
• TDS Implementation: Companies will be required to deduct tax at source (TDS) on buyback proceeds at a rate of 10% for resident individuals and 20% for non-resident individuals.
• Capital Loss Treatment: The cost of shares bought back can be claimed as a capital loss, offsetting gains from other share sales.
• Potential Impact: The increased tax burden on shareholders may deter companies from using buybacks as a primary capital return method.

These changes aim to align the tax treatment of buybacks with dividends and ensure a fairer distribution of the tax burden. However, the impact on corporate behavior and shareholder returns remains to be seen.

 

" Previously, domestic companies engaging in buybacks were subject to a 20% tax (plus applicable surcharge and cess) on the distributed income, while shareholders did not face any additional tax. Under the new rules, the buyback tax will be abolished, and the amounts paid to shareholders during buybacks will be treated as dividends, subject to income tax at the applicable rates. For instance, a resident shareholder in the highest tax bracket could face a tax rate of approximately 35.88%, while a non-resident shareholder may pay around 23.92%, under the domestic laws," said Kunal Savani, Partner, Cyril Amarchand Mangaldas.

 In case of a non-resident, further relief may be claimed under an applicable tax treaty. Additionally, shareholders can recognize the cost of shares sold back to the company as a capital loss, which can be offset against future capital gains and carried forward for up to eight years. 

Companies will still be required to withhold tax on buyback payments—10% for resident shareholders and applicable rates for non-residents. These changes may increase the tax burden on resident shareholders (HNI) compared to non-residents, potentially making buybacks less attractive for companies looking to return capital to their investors. However, for resident shareholders, whose effective tax rate is 20% or below, will be able to save tax in the new regime. 

Savani elaborates on this with the following example: 

To illustrate the changes, let's consider two individuals, Mr. X (Indian resident) and Mr. Y (non-resident), who each receive Rs. 100 from a share buyback.

Under the old system:

The company paid a buyback tax of approximately 20%, reducing the net amount received by shareholders to around Rs. 79 each.

Under the new system:

Mr. X will be taxed on the entire Rs. 100 as dividend income at his applicable income tax slab, which could be around 35.88%, leaving him with approximately Rs. 64.

Mr. Y will be taxed on the entire Rs. 100 as dividend income at a rate of 20% (assuming no tax treaty benefits), leaving him with approximately Rs. 80. Further, Mr. Y, depending on his country of residence, may be able to claim beneficial rates under an applicable tax treaty, which can be as low as 5% in certain cases.

Additional Considerations:

TDS Deduction: Companies will deduct TDS on buyback proceeds at source.

Capital Loss: Shareholders can offset the cost of bought-back shares against capital gains.

Point to note: The buyback gains will be taxed as dividend instead of being treated as a capital gain. 

Further, the cost of acquiring the shares tendered in buybacks will be treated as capital loss either short term or long term for shareholders which can be offset with other capital gains or carried forward upto 8 years.

"The old rule stated that domestic companies undertaking share buybacks are subject to 20% tax on net distributable income. Shareholders therefore receive the proceeds tax free. The buy back tax was earlier similar to dividend distribution tax which was withdrawn in 2020. Since then, dividends have been taxable at the hands of shareholders, in the similar way, from 1st october 2024, any amounts recieved by shareholders in respect to buybacks will be taxable at the hands of the shareholder," said CA Amit Bansal, Partner - Direct Tax, Singhania & Co.

He explains this with the following example: 

XYZ Ltd. decides to buy back shares at Rs 1,000 per share. A shareholder, Mr. A, originally bought 100 shares at Rs 700 per share. After the buyback, he receives Rs 1,00,000 (100 shares x Rs 1,000 per share). Under the new rules effective from October 2024, the entire Rs 1,00,000 is treated as dividend income for Mr. A. Since Mr. A is a resident individual and the amount exceeds Rs 5,000, XYZ Ltd. deducts TDS at 10%, amounting to Rs 10,000. Mr. A receives Rs 90,000 after TDS.

The cost of acquisition of the shares which have been bought back would generate a capital loss in the hands of the shareholder as these assets have been extinguished.

Therefore, when the shareholder has any other capital gain from sale of shares or otherwise subsequently, he would be entitled to claim his original cost of acquisition of all the shares (i.e. the shares earlier bought back plus shares finally sold). 

Winners:

• Tax Authorities: The government will benefit from increased tax revenue due to the taxation of buyback proceeds as dividend income.
• Mutual Funds: Tax-exempt mutual funds may gain an advantage due to their lower tax liability.
• Non-Resident Shareholders: Tax treaties may offer favorable tax rates for non-resident shareholders.

Potential Losers:

• Resident Shareholders: High-income resident shareholders may face a higher tax burden compared to the previous regime.
• Companies: The increased tax burden on shareholders might deter companies from using buybacks as a primary capital return method.