Sitharaman’s new tax may make share buyback a thing of the past, and how!
Govt introduced the concept of buyback tax under Sec 115QA vide the Finance Act 2013.
Post a thumping victory in the Lok Sabha elections, the Narendra Modi-led government announced the Union Budget on July 5, 2019. Amid concerns over an economic slowdown and lack of employment opportunities, Finance Minister Nirmala Sitharaman announced some key tax amendments. One of the most important tax amendments was the levy of buyback tax on listed companies.
Buyback Tax – Existing Provisions
The government introduced the concept of buyback tax under Sec 115QA vide the Finance Act 2013, wherein tax at the rate of 20 per cent was levied on the amount of income distributed by unlisted companies. The term ‘distributed income’ means the difference between considerations paid by the company on buyback less the amount received by the company on issue of such shares.
It is pertinent to note that this tax was applicable to income distribution by unlisted companies, and not listed companies. In other words, income distributed by listed companies were not covered under the purview of buyback tax. Instead, shareholders were liable to capital gains tax on the same.
This 2013 amendment was brought in as the government believed companies were avoiding dividend distribution, but distributing profits through the buyback mechanism, as it provided some arbitration for domestic investors and significant arbitration for international investors, especially those from treaty countries like Mauritius and Singapore.
Buyback Tax – The Amendment
The government was of the view that a similar practice should be adopted for listed companies given that there was also a tax arbitrage and, hence, the buyback tax has now been extended to listed companies as well.
Correspondingly, investors will not have to pay any tax on capital gains on buyback as this is now exempted.
The proposed provisions would be effective in respect of buyback undertaken from July 5, 2019.
How will this work?
If an individual has subscribed to a company in IPO stage at Rs 100 and subsequently the company announced a buyback a Rs 500, the company would pay the buyback tax at 20 per cent on Rs 400 (i.e. buyback price less issue price). In the earlier scenario, the individual would have paid long-term capital gains tax at 10 per cent or short-term capital gains tax at 15 per cent on the Rs 400 in the case listed companies.
Unintended Double Taxation?
The buyback tax for listed companies may result in indirect double taxation, as the computation mechanism provided considers buyback price less issue price. This does not consider the fact that the shareholder may have purchased the shares at rates higher than the issue price. Also, the previous transfers would have already been taxed. So, this may ultimately lead to double taxation.
For example, if Mr A purchased shares of ABC on stock exchange at Rs 500 from Mr B. Mr B had originally subscribed to the shares of the company under IPO. ABC announced buyback at Rs 900. Here the original issue price of the shares was Rs 100.
In this scenario, ABC would be paying 20 per cent buyback tax on Rs 800 (i.e. Rs 900 – Rs 100). It would be pertinent to note that Mr B would have already paid a long-term/short-term capital tax (@10%/15%) when he sold the shares to Mr A on the difference between Rs 500 less Rs 100. Total tax to the government kitty in this case would be Rs 200 (i.e. 20 per cent tax on 800 paid by ABC and 10 per cent tax on Rs 400 paid by Mr B). This would result in double taxation. The question is whether this is unintended or intentional?
By extending the provisions of buyback tax to listed companies, the government may discourage listed companies from going through the buyback route. With this amendment, even genuine cases would be impacted.
On one hand, the government introduced the buyback tax for listed companies and on the other hand they have recommended Sebi to increase public shareholding in listed companies from 25 per cent to 35 per cent. If this suggestion is accepted by Sebi, then there may be a situation where many MNCs having higher promoter shareholding may be forced to dilute their holdings or look to delist. Delisting would trigger an open offer and companies would have to pay buyback tax.
The government should also amend the buyback rules, as the current rules provide for situations which are more relatable to unlisted companies and not listed companies. The computation of the “amount received by the company for issue of shares” may lead to absurd results, which would deter listed companies from buying back shares. Accordingly, the provisions for buyback may not be practically implemented, thus rendering them redundant over time.
(Moulik Doshi is Senior Executive Director - Transfer Pricing and Transaction Advisory Services at SKP Business Consulting. Views are his own.)