The Finance (No.2) Bill, 2024, introduces a significant change to how buy-back of shares is taxed in India. Any payment made by a company to repurchase its shares will be treated as dividends and taxed in the hands of shareholders at applicable rates. This marks a departure from the earlier system, where companies paid a flat buy-back tax. The change aligns buy-back tax treatment with dividend tax rules but comes with new implications for companies and shareholders.

What Changes with the New Rule?

Under the current system, companies pay a buy-back tax of 23.3% on distributed income, leaving shareholders with net proceeds. After the amendment, the tax burden shifts to shareholders, and rates could go as high as 42.7% for individuals in the highest tax bracket. Companies must withhold tax on the entire distributed amount, while shareholders can claim the cost of repurchased shares as a capital loss to offset future gains.

Impact on Non-Resident Shareholders

For non-resident shareholders, the new rules require careful tax planning. Buy-back proceeds may qualify as dividends under tax treaties, potentially benefiting from lower withholding tax rates (typically 5-15%). However, eligibility depends on whether the buy-back is funded by securities premium or accumulated profits.

For example, if a shareholder receives ₹100 as buy-back proceeds under the new system:

• A withholding tax of 10% applies, leaving the shareholder with ₹90.
• Shareholders can claim the ₹10 capital loss (assuming the cost of the shares is ₹10), which can offset future taxable gains, further improving the final outcome.

  Under the current regime, the shareholder would only receive ₹76.7 after the 23.3% buy-back tax, showing a clear cash flow improvement for investors using tax treaties.

Challenges with Section 80M and Tax Computation

The proposed amendment includes buy-back proceeds as deemed dividends under Section 2(22) of the Income Tax Act, 1961. However, it is unclear whether they qualify for deductions under Section 80M, which applies to distributed dividends. The difference in terminology between "payment" (used for buy-back) and "distribution" (used in Section 80M) creates ambiguity.

Clarifications on Sections 50CA and 56(2)(x)

While Section 50CA, dealing with capital gains, may no longer apply to buy-back transactions, there is debate over whether Section 56(2)(x), which governs property transactions, could still be relevant. However, treating buy-back proceeds as dividends under the new rule likely overrides such concerns, focusing tax treatment under the dividends category.

Implications and Next Steps

The abolishment of buy-back tax changes the financial strategies of companies and the tax impact on shareholders, especially those in higher brackets. Companies are accelerating buy-backs before the new rule takes effect to benefit from the existing tax regime. Post-implementation, they will need to align with the revised framework, considering the higher tax burden on shareholders.

This shift encourages businesses and investors to revisit their tax strategies, especially regarding repatriation of funds and financial structuring. While the new system simplifies compliance, it increases the tax liability for shareholders, reshaping how companies plan buy-backs moving forward.