Tax analysts are in favour of changes to the current framework of taxation on buybacks — a mechanism for distributing surplus cash where a company purchases its own outstanding shares from existing shareholders.
According to analysts, Infosys promoters opting out of a ₹18,000-crore share buyback is unlikely to be a one-off, as buybacks have lost their relevance as a tax-efficient mechanism following changes in 2024.
What has changed?
Before October 1, 2024, a company buying back its shares was liable to pay a buyback distribution tax (BDT) of approximately 23.3 per cent (including surcharge and cess) on the distributed income — the difference between the buyback price and the issue price of the shares.
Moreover, the proceeds received by shareholders were exempt from tax in their hands. For promoters, whose original issue price was very low, this arrangement was highly tax-efficient, especially compared with dividends, where the tax burden fell on their hands.
Effective October 1, 2024, the BDT applicable to the company was abolished, and tax liability was shifted to the shareholders who tendered their shares in a buyback. The entire buyback amount received by the shareholder is treated as deemed dividend and is taxable under the head ‘Income from other sources’.
For resident individual promoters, who are typically high net-worth individuals, the entire deemed dividend is taxable at their marginal slab rate, which can be as high as 35.88 per cent (30 per cent tax + 15 per cent surcharge + 4 per cent cess). Crucially, no deduction is allowed for the original cost of acquiring the shares against the deemed dividend income, and the entire consideration is taxed, making it an inefficient transaction.
“From October 1, 2024, any amount received by a shareholder from selling back to the company is taxable as dividend income and taxed at the marginal rate of tax (often 30 per cent or more). The entire cost of the shares brought back cannot be adjusted but can only be carried forward as long-term capital loss, which can at best be adjusted against future gain on sale of shares,” said Vivek Jalan, founder, Tax Connect Advisory Services.
“For a high-income promoter, the tax on buyback proceeds has jumped from effectively zero to over 35 per cent. This makes the buyback financially unviable compared with other options,” said Arvind Agarwal, chairman, Council of Direct Taxes, MCCI
Open market sale
Capital gains on the sale of shares directly in the open market have become more efficient than paying higher tax on proceeds from buybacks.
“Promoters who held their shares for a long time can sell them on the stock market and receive long-term capital gains (LTCG) treatment, which is more tax-efficient. LTCG is taxed at a much lower rate of 12.5 per cent, plus surcharge and cess. Moreover, LTCG is calculated on the actual gain (selling price minus cost), not the entire proceeds,” said Agarwal.
“Buybacks have become less attractive for both companies and specifically for shareholders. Unless the tax framework is rationalised to align income taxation with corresponding loss relief, buybacks risk losing their relevance as an effective capital distribution mechanism,” said Deepesh Chheda, partner, Dhruva Advisors.
“This led to scenarios where promoters intentionally do not participate. Non-residents can still benefit from lower tax rates on dividends under the Double Taxation Avoidance Agreements,” he said.
Changes required
To restore the attractiveness of buybacks, tax analysts feel that there is a need to allow the deduction of acquisition costs or introduce a concessional rate of tax on buybacks.
The tax on deemed dividend income should be levied on the gain (buyback price minus acquisition cost), not the entire proceeds. This would align the tax treatment with how capital gains are calculated.