Important Amendments by The Finance (No. 2) Act, 2024 – Buy-Back of Shares

BACKGROUND

The tax treatment of buy-back of shares has been a focal point of legislative intervention since the concept's inception. In a buy-back, a company purchases its own shares for cancellation and pays consideration to the shareholders. From a shareholder's perspective, this transaction resembles the sale of shares, with the company itself acting as the buyer. However, from the standpoint of the Companies Act, a company purchasing its own shares cannot hold them as treasury stock, and the quantum of the buy-back is partially linked to reserves, aligning its treatment more closely with dividends. This distinction has significantly influenced the legislative framework governing the taxation of buy-backs.

Prior to the Finance Act of 2013, the law provided that any consideration received by a shareholder on a buy-back was not treated as ‘dividend’ due to a specific exemption under section 2(22)(iv). Such buy-back considerations were instead taxed as ‘capital gains’ under section 46A in the hands of shareholders. In the case of shareholders residing in Mauritius or Singapore, India did not have the right to tax capital gains, allowing the entire buy-back proceeds to be repatriated tax-free. Consequently, companies increasingly used buy-backs as an alternative to dividend payments, thereby avoiding the Dividend Distribution Tax (DDT).

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