Union Budget may shift Buyback tax back to the investors

Budget may shift Buyback tax back to shareholders
Budget may shift Buyback tax back to shareholders

by 5paisa Research Team Last Updated: Feb 01, 2023 - 11:33 am 5.5k Views
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As the demands of the Union Budget are still being collated, there are some broad expectations that have started to emerge. One of the contentious areas has been the calculation methodology for buyback tax. Buyback is when the company uses its surplus funds to buyback its own shares either from the open market or through a tender offer to existing shareholders. That raises the issue of how buyback gains will be taxed. Till 2018, the buyback gains were taxed in the hands of the investor as capital gains. However, it emerged that many companies were using buybacks as a proxy for dividend payout for the lower tax. At that time, the company had to pay dividend distribution tax.

To avoid this anomaly, the Income Tax Act decided to tax buybacks also as dividends by imposing dividend distribution tax (DDT). The disconnect arose when in 2020 Union Budget the government scrapped the concept of DDT on dividends altogether and decided that dividends paid by companies and by equity mutual funds would be taxed as other income and taxed at the peak rate of tax applicable to individual shareholders. However, at that point of time, the tax incidence on buybacks was not changed and it continued at the same rate. Even today, the buyback tax is paid by the company and the gains over the original issue price attract a dividend distribution tax of 20%, in form of dividend distribution tax.

However, in the last few years, there have been several objections to the existing method of taxing buyback of shares. For instance, the buyback tax was introduced in the form of a dividend distribution tax (DDT). However, when the DDT on cash dividends and the incidence shifted to the shareholder, a similar change was not done for the buyback. There is also an issue of fairness. When the company pays tax on a buyback, the burden also falls on the shareholders not opting for the buyback, which is prima facie unfair. Above all, today if investors opt to pay long term capital gains tax or even short term capital gains tax on the buyback profits, it would still be lower than the current tax burden that company bears.

Change proposed in Union Budget 2023

In this background, as explained above, the Finance Ministry is considering a proposal to shift the tax liability on buyback of shares from companies back to the individual shareholders who participate in the share repurchase process. This is like going back to the old system of taxing buybacks. At the end of the day, the idea is treat buybacks as a proxy for dividends and tax it in a similar manner. It remains to be seen if buyback profits would be treated as capital gains and taxed at a concessional rate or whether it would be treated as other income and taxed by the Union Budget at the peak applicable rate. That decision could determine the attractiveness of buybacks in future.

While there is no confirmation on this front, reports suggest that the government could be serious looking at this option of shifting the taxation of buybacks back to the shareholders who participate in the buyback exercise. The whole idea of the exercise is to ensure that the liability of the tax falls only on the participating shareholders and not on the continuing shareholders of the company, which is unfair. To a large extent this would also address the issue of double taxation, which is a real problem now. It maybe recollected that while the existing rule was implemented for unlisted companies from 2013 itself, it was extended to listed companies only in the Union Budget 2020.

The global practice is to tax share buybacks in the hands of the investors. One option that has also been suggesting is to pay the exiting shareholders the net amount so that the burden does not fall on the non-participating shareholders at all. However, the feasibility of such a move would have to be closely examined. Actually, the expert view is that if the buyback tax is shifted from the company to individual shareholders, then a much larger number of companies may opt for buyback over dividends, assuming that the concessional tax rate for capital gains continues to apply to buyback of shares. Even procedurally, the shifting of the tax burden to shareholders would be a better move.

Till date, it is the cash rich IT companies that have been active in doing the back of shares. In the first nine months of FY23, India saw 44 buyback issues amount to Rs. 18,703 crore. There is the controversial buyback proposal of One97 Communications, but the key would be the taxation aspect. Hopefully, the budget will address the twin needs of reducing the burden on the continuing shareholders and also encouraging buybacks as a capital returning model.

Also Read: Who will present Union Budget 2023 and How is it prepared?
 

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