Section 115QA: Tax on Buyback of Shares

Companies undertake share buybacks to repurchase their outstanding shares from the market, aiming to boost shareholder value, signal confidence in their future, or use excess cash efficiently. Both companies and investors need to understand the tax on buybacks of shares. Navigating the complex tax landscape helps stakeholders make informed decisions about participating in share buyback programs.

Buyback of Shares: Meaning

A share buyback occurs when a company repurchases its own issued shares from existing shareholders. The company typically buys back shares at market value or higher. This method is used to return cash to shareholders and regain ownership. In India, the tax implications of share buybacks are governed by Section 115QA of the Income Tax Act, 1961.

Why do Companies Buyback shares?

As per recent trends, one can observe an increasing use of buyback as a means of capital restructuring by Indian companies. The following are certain objectives a company aims to achieve when it undertakes a buyback:

• Share buybacks reduce the number of shareholders of the company, thus enhancing the EPS (Earnings per share) to shareholders in the long run. 
• Management may feel the market has undervalued its share price too sharply, hence a buyback may result in a fairer valuation of the company’s stock price.
• Helps improve key financial ratios like return on net worth, return on assets etc. over a period of time.
• Serves as a positive sign for investors about the confidence of the management in the business. 
• Provide exit to investors in times of volatility.

Tax on Buyback of Shares

Until 2012, investors/shareholders paid taxes on the profits they earned when the company bought its shares. As a result, to avoid tax companies started resorting to the buyback of shares as an attractive way to distribute surplus income amongst stakeholders. The government introduced Section 115QA under the Income Tax Act vide the Finance Act, 2013 an anti-tax avoidance measure.

Initially, section 115QA applied only to unlisted companies. However, the Union Budget 2019 announced the said section to apply to the listed companies as well. The amendment is effective for all buybacks post July 5, 2019, vide Finance Act (No.2) 2019.

Tax for Company

• Both listed and unlisted companies are liable to pay income tax on the amount of distributed income on the buyback of shares from shareholders. 
• The tax on distributed income i.e. buyback is payable by the company even if such a company is not liable to pay income tax.
• The tax rate is 20% plus a surcharge of 12% and applicable cess.
• The company is liable to pay the tax within 14 days from the date of payment to the shareholders on the buyback.

Tax for Shareholder

As per Section 10(34A) of the Income Tax Act, any resulting income in the hands of shareholders from the buyback of shares by the company is exempt from taxation.
Gains from buyback should be reported as exempt income under Schedule EI of the ITR.

Illustration

Bajaj Auto buyback: Bajaj Auto Limited is a multinational automobile manufacturer based in Pune, India. Bajaj Auto share buyback for raising up to ₹4,000 crore was opened on March 6, 2024 and closed on March 13, 2024. In terms of taxation, the Buyback Tax is applicable at the company level. This means that Bajaj Auto would be required to pay tax on the amount of buyback.

As for the shareholders of Bajaj Auto, any capital gains they realize from selling their shares back to the company through the buyback process are exempt from taxation under Section 10(34A) of the Income Tax Act.

Implications to individual shareholders

Generally, a company that has a distributable surplus has two options to return cash to its shareholders: 

• Declare dividend
• Buyback its shares

Earlier, the declared dividend was chargeable as Dividend Distribution Tax (DDT) to the company and not the shareholder. Whereas the amount distributed as buy-back of shares was chargeable to the shareholder and not the company. The rationale for the introduction of Section 115QA was that companies would resort to buyback of shares in order to avoid dividend distribution tax. However, under Budget 2020, the finance minister abolished DDT i.e. Dividend Distribution Tax and the company is no longer liable to pay tax on dividends. Instead, the shareholder needs to pay tax on dividends at applicable slab rates. From the shareholder’s perspective, this means that income from buybacks is now more tax-efficient than income from dividends.

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