Income Tax impact on buy back of shares due to changes in Finance Bill, 2024

Buy back of shares was introduced under Section 77A of Companies act, 1956 w.e.f 31-10-1998. Many Companies were bought back their shares complying with the provisions of section 77A. The same buy back of shares is continued under section 68 of the Companies act, 2013.
Success of any corporate action depends upon its income tax treatment. initially the buy back of shares was considered as tax efficient way of rewarding shareholders.
However, finance bill 2024 has brought significant changes to buy back consideration paid to shareholders. This article analyses tax impact pre and post amendment.
1. Background
The Finance Bill, 2024 has proposed certain changes relating to levy of income tax on buy back of shares. The changes are effective from 1.10.2024. This change has significant impact on income tax liability to shareholders.
2. Buy back
Pursuant to provisions of Section 68 of Companies Act, 2013 and rules made thereunder, companies can buy back its shares
a. With approval of board of Directors – up to 10%
b. With approval of Shareholders – up to 25%
3. Income tax liability before budget changes
a. As per Section 115QA of income tax act, 1961 buy back consideration paid to shareholders for buy back of its shares attracts income tax liability @20%. Effective tax rate with surcharge and cess is 23.30 %.
b. This amount was exempted in the hands of shareholders.
c. Companies used to prefer Buy-back as tax planning measure instead of declaring dividend.
To neutralize tax impact between dividend declaration and buy back, Finance Bill, 2024 has made significant changes to Buy-back tax.
4. Budget Changes
a. Section 115QA of Income Tax, 1961 has been withdrawn and Section 2(22)(f)
b. As per the amended section, “any payment by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 68 of the Companies Act, 2013 is treated as deemed dividend
c. Accordingly, amount received by shareholders on offering shares for buy back will be added to the total income of recipient (shareholder) as other income. Accordingly, it will attract income tax at applicable rates.
d. The cost of investment is not allowed as deduction whereas entire amount received on buy back is taxable. The cost of investment is treated as Capital loss which can be set off against Long-Term Capital Gain during next 8 years.
e. This provision is applicable from 1st October, 2024.
The Impact analysis is as follows
Illustration-1
M/s. ABC Private Limited issued 1,00,000 equity shares at Rs. 300 in the year 2013. Nominal value of the share is Rs. 100/-. (Share premium Rs. 200)
The Company announced Buy-back of 10,000 equity shares at a price of Rs.500 per share. Mr. X, shareholder offered 10,000 shares for the buy-back offer.
The Company paid buy back consideration of Rs.50,00,000 (10,000*500) to Mr. A and he has to pay income tax of Rs. 19,50,000 (i.e., 39% maximum rate). The balance money available to Mr. ‘A’ is Rs. 30,50,000/-
The cost of investment Rs. 30,00,000 (10,000*300), is treated as capital loss and this long term capital loss is available for set off during next 8 years against long term capital gain.
Illustration-2
In the illustration 1, assuming that the buy back price is also Rs. 300/- (issue price and buy back price is same), then tax liability is as follows
Tax liability before and after amendment are as follows:

Particulars
Before Amendment (Rs.)
After Amendment (Rs.)

Buy-back Consideration
30,00,000
30,00,000

Cost of Investment
30,00,000
30,00,000

Tax paid by:
Company
Shareholder

Tax Rate
23.3%
39% (Maximum Rate)

Amount on which tax is payable
NIL
(Rs. 30 Lakh – Rs. 30 Lakh)
30,00,000

Tax amount
NIL
11,70,000
(30,00,000*39%)

Capital Loss
NIL
30,00,000 (To be set off within next 8 years)

The Buy-back consideration received Rs.30,00,000 (10,000*300) is taxable @ 39% (maximum rate). Tax liability is Rs. 11,70,000
Tax outgo before amendment
Company used to pay Rs. NIL as buy back tax pursuant to section 115QA. However due to amendment, shareholder need to pay Rs. 11,70,000 as income tax
Budget impact
Additional tax outgo due to amendment is Rs.11,70,000
Income tax saving on Capital loss
When a shareholder offers shares for buy-back, then consideration received is taxable as a deemed dividend under Section 2(22)(f) without considering cost of investment. The cost of investment is treated as capital loss and this can be set off against any other capital gain during 8 years.
Tax implications are as follows:
a. This capital loss is available for set off for only 8 years.
b. Even if we set off capital loss against other capital gain, the tax saved on account of set off is 12.5% (if the capital gain is long term)
In view of the above, buy-back will have a huge tax impact after 1st October, 2024. Unless amended, buy back deals will come down heavily.