Buy Back of Shares Pendulum - TRANSITION OVER A PERIOD!

Since introduction of section 77A in the Companies Act 1956 (CA’56), the landscape of Buy-Back Tax has been introduced and later been a rollercoaster ride of tax reforms under the Income Tax Act, 1961 (I.T. Act, 1961) in different time zones. Over the decade, the tax liability pendulum on share buy-backs has swung back and forth, shifting from shareholders to companies and back again. Now, with the latest twist in the Finance Bill 2024 proposing new amendments, the saga continues. Below summarized tabular chart (Appendix -A) and verbatim will show the transition journey of taxability on buy back of shares and its related controversies since inception till the amendments proposed vide Finance Bill 2024.

hronological sequence of series of amendments brought in:

► Phase-1 Earlier to Finance Act 2013

Initially as per Section 77 of CA’56 (now Section 67 of the Companies Act 2013 (CA’13)), the companies were restricted from the purchase of its own share either directly or indirectly to ensure that the company's capital remains intact and is not reduced by the company using its funds to buy back its own shares. However, exception was provided for Reduction of capital in accordance with the provisions of CA’56 u/s 100-105 (now 68 of CA’13) and pursuant to a scheme of compromise or arrangement approved by the court.

The said restriction on buy-back of shares was lifted vide Companies (Amendment) Ordinance, 1998 wherein section 77A of the CA’56 was for the very first time introduced. Upon insertion of section 77A; the companies were allowed to purchase their own securities (i.e. buy-back of shares) and thereafter cancel the securities as bought-back. As such buy back of shares would lead to gain/loss in the hands of shareholders; correspondingly this raised queries with respect to taxability as a dividend or capital gains. Therefore, Vide Finance Act, 1999- Section 46A was inserted in the I.T. Act 1961 whereby on the event of buy back of own shares by the company as per section 77A of CA’56, capital gain was required to be determined in the hands of shareholders. Simultaneously section 2(22) was amended through insertion of sub-clause (iv) as to provide exception for not considering buy–back as any kind of dividend distribution as stipulated u/s 2(22). Amendment to section 2(22), reads as under:-

“(22) "dividend" includes—

………

but "dividend" does not include—

 ………

(iv) any payment made by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 77A of the Companies Act, 1956 (1 of 1956);”

However, the tax drafters made a differentiation while amending section 2(22) that the buy-back of shares should be in accordance with he provisions of section 77A of CA’56. Therefore, vide such amendment a bifurcation that can be drawn upon the taxability of purchase of own shares when the shares are purchased:-

a. In accordance with the provisions of section 77A of the CA’56- Buyback through automatic route, &

b. In accordance with the provisions of CA’56 u/s 77 (now 67) r.w.s. 100-105 (now 66) r.w.s. 391-393 (now 230-231)- Buyback through approval route.

So, if buy back of shares whether listed or unlisted is in accordance with the provisions of section 77A of CA’56 then the same is taxed in the hands of Shareholders as capital gain u/s 46A & there’s no liability in the hands of company.

► Phase-2- Finance Act 2013

However, later vide Finance Act 2013 Chapter XII-DA (section 115QA) was inserted in the I.T. Act 1961 to address tax avoidance schemes employed by unlisted companies through share buybacks instead of dividend distributions. Section 2(22)- dividends are defined, and Section 115-O levies Dividend Distribution Tax (DDT) on companies distributing dividends, ensuring that such income remains exempt in the hands of shareholders. In contrast, buybacks of unlisted shares result in shareholders being taxed on capital gains u/s 46A. Unlisted companies exploit this distinction to avoid DDT, especially where resulting capital gains arising to the shareholders are either non-taxable or taxed at a lower rate. To counteract this practice, the amendment mandates an additional income-tax at 20% on the excess consideration paid by a company for buybacks made in accordance with the provisions of section 77A of CA’56 over the sum received during the shares' issuance (termed distributed income). This tax, akin to DDT, will be final and borne by the company. Concurrently, shareholders will enjoy an exemption on the capital gains arising from such buybacks, provided the company pays the additional income-tax.

Therefore as per section 115QA; the domestic unlisted companies on purchase of its own shares as per 77A of CA’56 had an obligation of paying addition buy back tax (BBT) @20% (plus surcharge & cess) on the distributed income as defined in the act. And simultaneous in Finance Act 2013 w.e.f. 01.04.2014 a new clause was inserted section 10(34A) which laid down that any income arising to the shareholders on account of buy back of shares by the company as referred to in section 115QA is exempted from tax.

So, if the company makes buy back of unlisted shares then the company would be subject to BBT u/s 115QA & the same would be exempt u/s 10(34A) in the hands of shareholders. However, the treatment for buyback of listed shares will still continue to remain the same.

• Controversy since introduction of section 115-O:- the consideration received upon buy back would be taxed as capital gain u/s 46A or dividend income subject to DDT u/s115-O?

• Introduction of Dividend Distribution Tax (‘DDT’) u/s 115-O of the Act was w.e.f. 01.04.2003 till 31.05.2013 and the provisions of 115QA were being interpreted in a conflicting manner, thereby giving rise to disputes on the issue. It had been contended that subsequent to introduction of section 115QA in the Act and placing reliance on a decision of the Authority for Advance Ruling (AAR No. P of 2010), income-tax authorities, in some cases have sought to re-characterize the purchase consideration received on account of buy-back of shares, undertaken prior to 01.06,2013, as dividend and accordingly, subjecting the amounts so distributed by the companies to DDT.

• To provide clarification on such matter CBDT issued circular 3/2016 dated 26^th February 2016 serving clarification regarding “nature of buy-back of transactions” under the I.T. Act 1961, wherein CBDT clarified that consideration received on share buyback by the shareholders between the period April 1, 2000 till May 31, 2013 shall not be treated as 'dividend' in view of specific provisions of Sec 2(22)(iv); such gains would be treated as 'capital gains' in the hands of the recipient in accordance with Sec 46A of the Act.

► Phase-3 Finance Act 2016

The first amendment in section 115QA was made in 2016 wherein initially buy back of shares were in accordance with the provisions of “section 77A of the Companies Act 1956”, the same was substituted for “any law for the time being in force relating to companies”. Such amendment was made in response to recent uncertainties regarding the applicability of section 115QA to buybacks conducted under various provisions of the Companies Act, 1956 or the Companies Act, 2013, the amendment expands its scope to encompass buybacks conducted under any relevant provisions of Companies Act.

• Question- Whether the provision of section 115QA of the Act will get triggered in case of any capital reduction scheme issued by National Company Law Tribunal ('NCLT')?

In the CA’56 provisions of capital reduction has been laid down u/s 100-105 (now 66). The Companies Act allows a company to reduce its capital under the two routes– Automatic and Approval. As long as the company fulfils the requirements of Section 77A of the CA’56, it can buy back its shares without approval from NCLT. In the approval route, the company must prepare a scheme of compromise and arrangement and get it approved by the NCLT under Sections 391 to 393, r.w.s. 77 and Sections 100 to 105. The distribution made to the shareholders upon Capital reduction by the company is considered to be as deemed dividend as per Section 2(22)(d) of the I.T. Act 1961. The same proceeds are subject to DDT u/s 115-O in the hands of company & exempt u/s 10(34) in the hands of the shareholders.

Therefore, before the amendment purchase of own shares whether listed or unlisted in accordance with section 100-105 (now 66)r.w.s. 77 (now 67) r.w.s. 391-393 (now 230- 231) would be taxed u/s 2(22)(d) r.w.s. 115-O DDT Liability in the hands of the company & exempt u/s 10(34) in the hands of the shareholder.

*Section 115-O & 10(34): Sunset clause vide Finance Act 2020

However, vide amendment in section 115QA in 2016, the bifurcation once created above with regards to taxability of purchase of own shares when the shares are purchased:-

a. In accordance with the provisions of section 77A of the CA’56- Buyback through automatic route, &

b. In accordance with the provisions of CA’56 u/s 77 (now 67) r.w.s. 100-105 (now 66) r.w.s. 391-393 (now 230-231)- Buyback through approval route;

has been rendered to be at par.

So, as per the above discussion and after the amendment made in section 115QA, buyback of unlisted shares whether in accordance with the provisions of section 77A or or 100-105 or NCLT scheme i.e. approval rote; all such buy back would be subject to tax u/s 115QA in the hands of the domestic unlisted company & will be exempt u/s 10(34A) in the hands of shareholder. And buyback of listed shares will still continue to be tax as they were before in their respective form/ section of buyback.

• Question:- Whether Amendment to Section 115QA w.e. 01.06.2016 was also to include 'redemption of Redemption of the preference shares' as buy back of shares?

If one contends referring to the case of Anarkali Sarabhai [(224 ITR 422)] = [TS-1-SC-1997-O], Apex Court has held that Redemption of Preference share is a transfer u/s 2(47) as there is a relinquishment of rights in the preference shares and hence taxability arises u/s 45 r.w.s 48 in the hands of shareholder; and thereby correspondingly it would be read as Purchase of shares in the hands of company to trigger Section 115QA. However, one may note that the question limited before Apex court whether redemption of preference share is taxable to capital gain or not in the hands of investor and it was not the case for determination of whether such redemption of preference share would be considered to be ‘purchase of own securities’ as defined u/s 77A or 77 of CA'56.

~ Section 77A (Buy back through automatic route), Section 77 (Buy back through Approval Route), Section 80 (Redemption of preference shares) of companies Act, all are separate and distinct set of procedures and with different purposes under Companies Act.

~ Redemption of preference share capital was subjected to Taxation in the hands of share holders only u/s 45 r.w.s. 48 of IT Act, since beginning.

~ As Section 77A was introduced in Co. Act,1956, simultaneously Buy Back Tax Regime was introduced in IT Act on Buy back of shares as per section 77A of Co. Act through multiple chronological amendments viz. Section 46A , 10(34A) , 115QA.

~ Capital reduction as defined u/s 77 of CA'56 was intended to be covered u/s 2(22)(d) r.w.s. 115-O, and hence seeing Taxable event by virtue of DDT coverage. However, it was being contended that Purchase of own share u/s 100-105 (now 66) r.w.s. 77 (now 67) r.w.s. 391-393 (now 230- 231) cannot be a Dividend as defined u/s 2(22)(d) and also not a buyback as defined u/s 77A and hence DDT and BBT both were contended to be not applicable.

Also, the above discussed chronological amendments were not in statute at the relevant time while matter was before Apex court. Revenue has contended that tax leakage was happening for buy back through approval route mechanism; and as such earlier also redemption of preference share was getting taxed under section 45 r.w.s. 48 (which also get enforced by Apex court ruling). Apex court ruling is in the limited context redemption of preference share was to be held to be transfer of shares and it was not in the context of ‘ purchase of own shares as per the provisions of any law’ as later covered under 115QA; and such redemption of preference share was as such taxable under section 45 in the hands of investor, and hence referring to the Apex court ruling in the case of Anarkali Sarabhai would be a stretched contention.

~ As to bring 'HC/NCLT sanction Scheme of arrangement' under tax ambit explicitly (which was being contended as not exigible to tax), a wide worded amendment was introduced u/s 115QA (without explicit mentioning of coverage of new amendment) w.e.f. 01.06.2016; however, it was not intended to cover Redemption of preference share capital. This even gets established as Section 77 & 77A is inter-alia connected and providing different route to buy-back the securities i.e. automatic and approval one; whereas Redemption of share capital is payment to the shareholder which was committed for at the time of issuance of instrument to them, there is no intention to purchase of security under Section 80 of CA'56. If law maker would have wished to include even redemption of Preference share capital to 115QA, then corresponding amendment would also have been brought to Section 45 r.w.s. 48 and specifically at Section 46A, Section 10(34A).

~ NOW, EVEN THE AMENDMENT PROPOSED VIDE FINANCE BILL 2024 FOR INSERSATION OF CLAUSE f) to SECTION 2(22) refers to 68 of CA'13 (earlier 77A), STRENGHTHENS ABOVE POSITION EVEN FOR EARLIER YEARS ALSO that Redemption of Preference Shares were NEVER INTENDED TO BE COVERED u/s 115QA.

~ If it is at stretch contended that redemption of preference shares is also buyback of own securities as per Anarkali Sarabhai (224 ITR 422), then the tax implications for earlier phases and pursuant to budget proposal in Finance Bill 2024, is summarised in the below chart.

► Phase-4 Finance (No.2) Act 2019

Effective from July 5, 2019, amendments were introduced in section 115QA of the I.T. Act, 1961, marking a significant shift in its scope. Specifically, the amendment removed the exclusionary clause "not being shares listed on recognized stock exchange," thereby extending the provisions of this section to encompass all shares, whether listed or unlisted. Concurrently, a similar amendment was enacted in section 10(34A), granting shareholders exemption from income arising from the buy-back of both listed and unlisted shares.

The rationale behind these amendments stemmed from the disparity in tax rates between Buy-Back Tax (BBT) and Dividend Distribution Tax (DDT). With BBT being lower than DDT, companies increasingly favoured buy-back of shares over dividend declarations. This trend was initially observed among unlisted companies but subsequently permeated to listed entities, prompting the need for uniform regulation u/s 115QA.

Thus, the amendments sought to address tax avoidance strategies adopted by companies, ensuring equitable treatment irrespective of a company's listing status. The introduction of section 115QA originally targeted unlisted companies making buy back in accordance with the provisions of section 77A of the CA’56 but was expanded via various amendment to include listed companies as well as buy in accordance with any law at force, aligning tax implications with the overarching goal of fair and balanced taxation practices in corporate finance.

Therefore, vide the above amendment all buy back of listed as well as unlisted shares would be subject to BBT u/s 115QA in the hands of the company & will be exempt u/s 10(34A) in the hands of shareholder.

► Phase-5 Amendment proposed in Finance Bill 2024

Following amendments has been proposed in the Finance Bill 2024 in relation to buy back of shares which all would be effective from 01.10.2024:-

The tax implication of above referred proposed amendments will be made as under:-

As in the proposed amendment section 2(22)(f), only buyback made in accordance with the provisions of section 68 of CA’13 is covered; bifurcation is once again crept in for buy back of shares:

a. In accordance with the provisions of section 68 of the CA’13- Buyback through automatic route, &

b. In accordance with the provisions of CA’56 u/s 77 (now 67) r.w.s. 100-105 (now 66) r.w.s. 391-393 (230-231)- Buyback through approval route.

Proposed amendment also suggest that the income derived by the shareholders would be characterised u/s  2(22)(f) r.w.s. 56 will see taxability at High Tax rate (Normal Tax rate 25.17 to 34%) and whereas 46A r.w.s 74 LTCL/ STCG (as per the holding period) arising would be allowed to be set-off against LTCG/ other capital gain which is proposed to be exigible to tax at 12.5%/20% only. And as per the budget proposal the benefit of indexation would not be given on the shares which or bought back or sold in general. This apparently gives Tax Leakage to the tax payer. Share-holders receiving their value in form of buy back of shares been proposed to characterised as dividend on which higher tax would be paid and later there would be Tax Leakage arising on account of proposal to allow only against capital gain income, this may be tested in times to come.

Above referred proposed amendments introduced vide Finance Bill 2024 are to be effective from 01.10.2024 and hence looking to the delta available companies would prefer to carry the buy-back of shares as per the existing applicable regime. Also, Capital loss arising due to higher cost of acquisition then value proposed under buy back or loss arising on account of Indexation on the shares which were to be bought back; One can still argue that such Loss arising would be eligible to claim even though it is Exempt u/s 10(34A). Pursuant to above referred amendments as proposed vide Finance Bill 2024 effective date, if one wants to test for claiming such Loss due to higher cost of acquisition / due to index cost of acquisition even though correspondingly being covered u/s 10(34A); would not be possible to knock to that proposition. Execution timing would be the key in such scenarios!.

* what is stated above is the author’s personal view.