New share buyback rules from October 1, 2024: A higher tax for many, but these people will gain The new laws announced in July will be effective from October 1, 2024. The new laws tax the share buybacks in a similar fashion as dividends are taxed now. The new income tax laws will impact most taxpayers negatively. However, certain taxpayers will gain as well
Bijal Ajinkya
Partner, Khaitan & Co, LLM (International Law)
Viraj Doshi
Principal Associate at Khaitan & Co.
Set to take effect from October 1, 2024, the new buyback tax rules aim to shift the income tax liability from companies to shareholders. This will fundamentally transform the approach companies adopt for capital distribution and investment strategies.
#sr_widget.onDemand p, #stock_pro.onDemand p{font-size: 14px;line-height: 1.28;} .onDemand .live_stock{left:17px;padding:1px 3px 1px 5px;font-size:12px;font-weight:600;line-height:18px;top:9px} #sr_widget.onDemand .sr_desc{margin:0 auto 0;} #sr_widget.onDemand .sr_desc{color: #024d99;margin-top:10px;} #sr_widget.onDemand .crypto .live_stock .lb-icon{8px 6px 5px 3px !important} #sr_widget.crypto.onDemand a.text{border-bottom:1px solid #ccc;padding-bottom:5px;display:block;width:100%} #sr_widget.onDemand .sr_desc .text p, #stock_pro.onDemand .sr_desc .text p{font-size:12px;font-weight:400;} According to the existing rules, domestic companies undertaking share buybacks are subject to a 20% tax on net distributable income; shareholders receive the buyback proceeds tax-free. The buyback tax is similar to the now-withdrawn dividend distribution tax (DDT), which was applicable until March 2020. Since April 2020, dividends have been taxable in the hands of shareholders. Going forward, the money received from buyback will be completely taxable in the hands of a shareholder.
New buyback tax rules from October 1, 2024
From October 2024, the entire amount received by shareholders from buybacks will be treated as dividend income and taxed according to their respective income tax slabs, with the responsibility for withholding tax (TDS) on the company. The tax will be deducted by the company at the rate of 10%, in case of payment to resident individuals (provided the buyback proceeds are equal to or exceed Rs 5,000) and at the rate of 20% in case of payment to non-resident individuals (subject to tax treaty benefit, if any).The buyback proceeds, which are now taxed as "dividend", will not be taxable as "capital gains" under the income tax laws. However, the cost of acquiring shares tendered in a buyback will be treated as a capital loss (either short term or long term) for shareholders, which can be offset against other capital gains or carried forward for up to eight years.
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The shift in income tax liability may deter companies from using buybacks as a preferred method of returning capital to shareholders, particularly if the tax burden on shareholders outweighs the benefits.
Who gains from the new buyback tax rules?
The new buyback taxation in India offers several positive outcomes. Firstly, the new regime aims to reduce tax arbitrage between dividends and buybacks, promoting a level playing field and fairness in the taxation of corporate payouts. Treating buyback proceeds as dividend income brings enhanced clarity and uniformity to the tax landscape. Additionally, the new tax rules would encourage companies to undertake buybacks only when they believe their shares are genuinely undervalued and not merely to take advantage of a lower tax rate. This focus on long-term shareholder value creation could lead to more prudent and strategically sound buyback decisions.Mutual funds, which pay no or minimal taxes on account of the exemptions available to them under the income tax laws, stand to benefit from such a shift in buyback taxation.
Non-resident shareholders are poised to benefit from the changes. The ability to leverage lower tax rates under tax treaties for "dividend income", typically ranging from 5% to 15%, along with the option to claim credits for Indian taxes in their home jurisdictions (which was not available under the current regime as buyback tax is a tax on Indian companies and not the shareholders) provide a significant relief. However, the benefit may differ based on the jurisdiction of such non-resident shareholders and the peculiar interplay of the article on "dividend", "capital gains" and "other income" under the respective tax treaties.
For instance, a UK shareholder in an Indian company would benefit from the India-UK tax treaty, where any income classified as a dividend under Indian law is also treated as such for treaty purposes. Further, the ambit of capital gains as per the India-UK tax treaty is also based on the respective domestic tax laws. In such cases, a lower tax rate of 10% or 15% on dividend income (as under the India-UK tax treaty) should be available, given that the buyback proceeds are set to be treated as dividend. Conversely, under the India-Mauritius tax treaty, while the dividend article is similarly drafted, buyback results in an "extinguishment of rights" in the shares as well, which is specifically covered under the capital gains article. Hence, the applicability of treaty benefits should be carefully examined. Notably, capital gains are exempt for shares acquired before April 1, 2017, while dividends are taxable at a reduced rate of 5% or 15% under the India-Mauritius tax treaty.
Even when leveraging treaty benefits, non-resident shareholders must demonstrate eligibility for treaty entitlement and "beneficial ownership" of income, necessitating a detailed analysis.
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Who loses from new buyback tax rules?
Despite these positive aspects, there are notable drawbacks to the new buyback tax rules. The most immediate concern is the increased tax burden on resident shareholders. By shifting the tax liability to shareholders, particularly those in higher tax brackets, the overall attractiveness of buybacks has been diminished. This can be understood by an illustration:Particulars
Individual A: Dividend income includible in the highest tax bracket (above Rs 15 lakh)
Individual B: Dividend income includible in the lower tax bracket (for example in the bracket of Rs 10 lakh to Rs 12 lakh)
Position prior to amendment
Position after amendment
Position prior to amendment
Position after amendment
Amount of buyback proceeds
100
100
100
100
Buyback tax on the company
23.3
-
23.3
-
Additional tax on individual on account of buyback proceeds considered as dividend
-
35.88
-
15
Impact on absolute income-tax rates
Increase in tax rate by 12.58%
Decrease in tax rate of 8.3%
All income tax rates above are assuming the new tax regime for both individuals and the highest level of surcharge for Individual A. Further, the cost of investment for both individuals is considered negligible. Note: Figures in Rs
While the individuals taxable in a lower tax bracket stand to benefit from this proposal, high-net worth individuals could stare at a sizeable tax cost on such buybacks. This increased tax burden could make buybacks less appealing. In certain cases, even if the companies do not have potential deployment areas, they may prefer to retain cash at the company level rather than undertaking a buyback and decreasing the effective return for the shareholders.
Typically, dividends are taxable only to the extent the company has accumulated reserves. However, according to the new rules, shareholders now face taxation on the entire buyback amount, rather than just the net gain, which can significantly reduce their return on equity investment.
The recognition of capital losses also presents a challenge. While it allows for future tax relief, this tax benefit is deferred, and shareholders must generate sufficient capital gains in subsequent periods to utilise these losses completely. This deferral may not provide immediate financial relief, particularly for those who do not have substantial capital gains in the near term.
Impact on financial markets due to new buyback tax rules
The changes in buyback taxation could have broader implications for the financial markets. By making buybacks less attractive, companies may need to reassess their capital distribution strategies. This shift could influence market dynamics, potentially leading to a reduction in buyback activities and affecting overall market liquidity. Companies will face increased compliance and reporting requirements as they adhere to new tax provisions and ensure accurate tax withholdings.While the changes aim to reduce tax arbitrage between dividends and buybacks and promote fairness, the increased tax burden on shareholders and the deferred benefits pose substantial challenges. Companies and investors will need to navigate these changes carefully, reassessing their strategies to optimise returns and comply with the new provisions.
(Bijal Ajinkya is Partner and Viraj Doshi is Principal Associate at Khaitan & Co. The views expressed are personal.)
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This story originally appeared on: India Times - Author:Faqs of Insurances
