Month: September

1 This Article deals with the amendments made by the Finance (No. 2) Act, 2024 to the provisions of the Income-tax Act, 1961 dealing with reassessment provisions. The Finance (No. 2) Act, 2024 is referred to as “the Amending Act”, the Income-tax Act, 1961 is referred to as “the Act”. The provisions of the Act as they stood immediately before their amendment by the Amending Act are referred to as “the erstwhile provisions”, the amended provisions are referred to as “the amended provisions” / “the present provisions” and the provisions as they stood immediately before their amendment by the Finance Act, 2021 are referred to as “the old provisions”. In this Article, the effect of the amendments carried out by the Amending Act to the provisions of sections 148, 148A, 149, 151 and 152 of the Act have been analysed.

2 Introduction / Background: The Finance Act, 2021 amended the procedure for assessment or reassessment of income escaping assessment w.e.f. 1st April, 2021. The Finance Act, 2021 modified inter alia the provisions of sections 147, 148, 149 and also introduced section 148A. These provisions led to widespread litigation. The Explanatory Memorandum to the Finance (No. 2) Bill, 2024 recognises this and states that “multiple suggestions have been received regarding the considerable litigation at various fora arising from the multiple interpretations of the provisions of aforementioned sections. Further, representations have been received to reduce the time-limit for issuance of notice for the relevant assessment year in proceedings of assessment, reassessment or recomputation.” The Amending Act has amended the reassessment provisions with a view to rationalise the reassessment provisions and with an expectation that the new system would provide ease of doing business to the taxpayers since there is a reduction in time limit by which a notice for assessment or reassessment can be issued.

3 Provisions of the Act dealing with reassessment which have been amended and the effective date from which the amended provisions apply: The Amending Act has amended the provisions of Sections 148, 148A, 149, 151 and 152. Sections 148, 148A, 149 and 151 have been substituted and amendments have been carried out to Section 152. The substituted provisions as also the amendments are effective from 1.9.2024. Section-wise amendments carried out and their impact is explained in subsequent paragraphs.

4 Amendments to Section 148: The Amending Act has substituted a new Section 148 in place of the erstwhile Section 148. The effect of the amended Section 148 is as follows:

4.1 Section 148 requires “issuance of notice” as against “service of notice” earlier: The amended section 148 now provides that the Assessing Officer (AO) shall before making the assessment, reassessment or recomputation under section 147 “issue” a notice to the assessee. The erstwhile section 148 provided for “service” of a notice. Therefore, now the limitation period to file the return of income under section 147 will be with reference to date of “issue” of notice as against the date of “service” of notice under the erstwhile provision. While it is true that in the electronic era, since the notices are generated online the same are dispatched instantly and therefore there would normally be no significant difference between the date of issue of the notice and service thereof. However, at times, it is noticed that due to notices being sent to an incorrect email address, there could be a significant difference between the date of issue of notice and service thereof. In such cases, the time available to the assessee to file return of income will be lower to the extent of time period between the date of issuance of notice and the date of service thereof. To illustrate, if the notice is issued on 25th March, 2025 and it provides that the return be furnished by 30th April, 2025, if such a notice is served on 5th April, 2025, then the time available with the assessee to furnish the return of income is shortened by 10 days, since the assessee will come to know of the notice having been issued only when it is served upon him.

4.2 While Section 148 now provides for “issuance” of notice instead of “service” thereof, the service of notice will still be relevant since, as has been mentioned above, unless the notice is served upon the assessee, the assessee will not be in a position to know about its issuance and comply with the same. Also, since section 153(2) has not been amended the limitation period mentioned in section 153(2) for passing of order of assessment, the time limit for reassessment or re-computation made under section 147 continues to be with reference to date of service of notice under section 148.

4.3 When can notice be said to have been “issued”? Since section 148 provides for issuance of notice by Assessing Officer who is an income-tax authority, in terms of section 282A, it will need to be signed in terms of sub-section (1) of section 282A. Such notice has to be signed and issued in paper form or communicated in electronic form by that authority in accordance with procedure prescribed. Rule 127A prescribes procedure for this purpose.

The Allahabad High Court has, in Daujee Abhushan Bhandar (P.) Ltd. vs. Union of India [(2022) 136 taxmann.com 246 (All. HC)], after considering the various provisions, dictionary meanings and the case laws on the subject, held that the words `issue’ or `issuance of notice’ have not been defined in the Act. However, the point of time of issuance of notice may be gathered from the provisions of the 1961 Act, Income-tax Rules, 1962 and the Information Technology Act, 2000. Similar would be the position if the meaning of the word `issue’ may be gathered in common parlance or as per dictionary meaning. Merely digitally signing the notice is not issuance of notice. Issuance of notice will take place when the email is issued from the designated email address of the concerned income-tax authority.

4.4 Notice under section 148 to be accompanied by copy of order passed under section 148A(3) : Section 148 as amended by the Amending Act provides that the notice shall be issued along with a copy of the order passed under section 148A(3) of the Act. The erstwhile provision required that the notice shall be served along with a copy of the order passed, if required, under section 148A(d). The absence of the words “if required” in the amended provisions makes it mandatory for the notice to be accompanied by an order under section 148A(3). This mandate will not be possible to be complied with in a case where information has been received by the AO under the scheme notified under section 135A. This is because section 148A(4) provides that the provisions of section 148A shall not apply to a case where the AO has received information under the scheme notified under section 135A. If the assessee challenges a notice which has been issued pursuant to information received under the scheme notified under section 135A of the Act on the ground that it is not accompanied by an order under section 148A(3), the court will hold that the provisions of section 148 are subject to the provisions of section 148A and therefore since an order u/s 148A(3) is not required to be passed in a case where information is pursuant to a scheme notified u/s 148 being accompanied by an order u/s 148A(3) would not apply to such a case. Also, the court may invoke the doctrines explained by the maxims Impossibilium Nulla Obligato Est; Lex Non Cogitad Impossiblia; Impossibiliumnulla Obligatio Est and hold that the revenue is not expected to perform the impossible. These maxims have been followed by the courts in several cases e.g. Standard Chartered Bank vs. Directorate of Enforcement [(2005) 275 ITR 81 (SC)]; IFCI vs. The Cannanore Spinning & Weaving Mills Ltd. [(2002) 5 SCC 54 (SC)]; Poona Electric Supply Co. Ltd. vs. State [AIR 1967 Bom 27]; Engineering Analysis Centre of Excellence Pvt. Ltd. vs. CIT [(2021(3) TMI 138 – SC] and Dalmia Power Ltd. vs. ACIT [(2012) 112 taxmann.com 252 (SC)]. However, it would have certainly been advisable that the words “if required” were retained in the amended provisions.

4.5 Time limit for filing return of income now at the discretion of the AO subject to outer limit provided in Section 148: Section 148, as amended by the Amending Act, provides that the notice issued shall specify the period within which the assessee is to furnish a return of income. It is also, however, provided that the time period specified in the notice cannot exceed 3 months from the end of the month in which the notice is issued. The erstwhile provisions of section 148 provided that the notice shall call upon the assessee to furnish a return of income within a period of three months from the end of the month in which such notice is issued or such further period as may be allowed by the AO on the basis of an application made in this regard by the assessee.

The time limit available to furnish the return of income will now be at the discretion of the AO. Failure to furnish the return of income within the period specified in the notice will mean that the return of income so furnished will not be regarded as a return furnished under section 139 and all the consequences thereof will follow e.g. the assessee will not be able to file an updated return under section 139(8A); in terms of the decision of the Supreme Court in Auto & Metal Engineers vs. Union of India [(1998) 229 ITR 399 (SC)] there will be no requirement to issue a notice under section 143(2) and the assessment would commence once return of income is filed.

Earlier, under the erstwhile provisions, when the time period of three months from the end of the month in which the notice is served was provided, an assessee could, if the facts of the case so demanded, file a writ petition and the outcome of the Writ Petition could be known before the date by which the return of income was required to be furnished. Now, possibly, pending the decision in the Writ Petition, an assessee will be required to furnish the return of income, unless a stay is granted by the High Court.

4.6 Express power to the AO to grant extension of time to file return of income on the basis of an application made by the assessee now not there: The erstwhile section 148 empowered the AO to grant, on the basis of an application made by an assessee, an extension of time to furnish return of income in response to notice under section 148. Such a power is not there in section 148 as has been introduced by the Amending Act. Further, in view of the outer limit of the period which may be granted to furnish return of income, it is quite possible to take a view that the AO does not have power to grant an extension of time to furnish the return of income. This view can be supported by the contention that there was an express power to grant extension in the erstwhile provisions, which has not been conferred under the amended provisions. Therefore, legislative intent is not to confer such a power on the AO. Non-furnishing of the return of income by the period specified in the return would render such a return to be a return which has not been furnished under section 139 and all consequences thereof will follow.

4.7 Definition of the expression “the information with the Assessing Officer which suggests that income chargeable to tax has escaped assessment” expanded: A notice under section 148 can be issued only if the AO has information which suggests that the income chargeable to tax has escaped assessment in the case of the assessee for the relevant assessment year. The expression “the information with the Assessing Officer which suggests that income chargeable to tax has escaped assessment” was exhaustively defined in the erstwhile regime in Explanation 1 to the erstwhile section 148 whereas, under the amended provisions, this expression is defined exhaustively in Section 148(3).
On a comparison of the definition of this expression under the erstwhile provisions and under the amended provisions, one finds that earlier the definition had five clauses whereas now it has six clauses. The five clauses which were there in the erstwhile regime and which continue in the present provisions are:

(i) information received in accordance with risk management strategy;

(ii) any audit objection to the effect that assessment has not been made in accordance with the provisions of the Act;

(iii) any information received under agreements referred to in section 90 or 90A;

(iv) any information made available pursuant to a scheme notified under section 135A;

(v) any information which requires action in consequence of the order of a Tribunal or a Court.

Clause (vi) which has now been added in the definition of the said expression reads “any information in the case of an assessee emanating from survey conducted under section 133A, other than under sub-section (2A) of the said section, on or after the 1st day of September, 2024”.

The scope of the expression prima facie appears to have been widened whereas actually it is not so, since the information pursuant to survey conducted on assessee constituted deemed information under the erstwhile regime.

Earlier, under the erstwhile regime, if a survey was conducted under section 133A [other than under section 133A(2A)] and if such a survey was conducted on or after 1.4.2021 and it was conducted on the assessee, then it was deemed that AO had information which suggests that income chargeable to tax has escaped assessment. Therefore, an action of survey on the assessee which, under the erstwhile regime, constituted deemed information, now results into an information suggesting that income chargeable to tax has escaped assessment, with the difference being that the present provisions could even cover a case where information has emanated from a survey under section 133A conducted on some other person and not necessarily on the assessee.

Under the provisions as amended by the Amending Act, what is necessary is that the information in the case of an assessee should emanate from a survey conducted under section 133A [other than under section 133A(2A)]. Based on the language, it is possible to take a view that the survey need not be on the assessee, but the information should emanate as a result of the survey under section 133A [other than under section 133A(2A)].

4.8 Amended provisions do not provide for any situation / circumstance in which the AO shall be deemed to have information with the Assessing Officer which suggests that income chargeable to tax has escaped assessment:

Explanation 2 to erstwhile Section 148 provided for situations / circumstances in which the AO was deemed to have information which suggests that income chargeable to tax has escaped assessment. These were cases related to search initiated / books of accounts or documents pertaining to the assessee found in the course of search on some other person / any money, bullion, jewellery or other valuable article or thing belonging to the assessee and seized in the course of search of any other person / survey being conducted in the case of an assessee under section 133(A).

Now, under the provisions as amended by the Amending Act, since the assessment in search cases is covered by Chapter XIV-B, this provision is not necessary and therefore is not there. As regards information emanating from survey under section 133A, the same has been included in the definition of the expression “information which suggests that income chargeable to tax has escaped assessment”. This has been analysed in earlier paragraph.

4.9 Requirement to obtain prior approval of Specified Authority before issuing notice under section 148 done away with, except in cases where information is pursuant to scheme notified under section 135A: Under the erstwhile Section 148, up to 31st March, 2022 the AO was required to obtain prior approval of Specified Authority before issuing notice under section 148. This approval was in addition to the approval to be obtained by him for passing an order under section 148A(d) of the Act. The Finance Act, 2022 has w.e.f. 1st April, 2022 done away with this requirement in cases where an order under section 148A(d) was passed with prior approval of Specified Authority that it is a fit case for issuance of notice under section 148.

Under the provisions of Section 148 as amended by the Amending Act, there is no requirement of obtaining prior approval of Specified Authority before issuance of notice under section 148, except in a case where the AO has received information pursuant to a scheme notified under section 135A of the Act [second proviso to section 148].

4.9 Change in Specified Authority: For the purpose of section 148 and 148A, the Specified Authority is as defined in Section 151. Section 151 has been substituted w.e.f. 1st September, 2024. The Specified Authority as defined in present provisions of section 151 is stated hereafter in para 6.2.

4.10 Role of Specified Authority in case information is received pursuant to scheme notified under section 135A: In a case where information is received by the AO pursuant to the scheme notified under section 135A, then the provisions of Section 148A do not apply and a notice under section 148 can be issued by the AO after obtaining prior approval of Specified Authority. In such a case a question arises as to what is the role of Specified Authority? Is the information received under a scheme notified sacrosanct so that no further inquiry / response is to be called for even in a case where assessee challenges the correctness of the information received by the AO? If the information so received is to be regarded as sacrosanct, then the legislature would not have provided the requirement for obtaining prior approval of Specified Authority before issuing a notice under section 148, as that would then be a mere empty formality.

Under the erstwhile provisions as well, the provisions of section 148A did not apply to information received pursuant to scheme notified under section 135A. In that context, in Benaifer Vispi Patel vs. ITO [(2024) 165 taxmann.com 5 (Bombay)], an assessee in whose case there was a discrepancy in the information received pursuant to the scheme notified under section 135A, challenged the notice issued to her under section 148 before the Bombay High Court. The court held:

i) it cannot be conceived that at all material times, the information available in the electronic mechanism / system, would be free from errors and defects, in as much as the basic information which is being fed into the system would certainly be filed by the manual method and thereafter such information is converted and disseminated as an electronic data.

ii) since assessee had informed Assessing Officer that interest income disclosed in return was correct, such remarks or explanation as offered by assessee necessarily was required to be considered before Assessing Officer could proceed with issuance of notice under section 148.

Amendments to Section 148A: The Amending Act has substituted a new Section 148A in place of the erstwhile Section 148A. The effect of the amended Section 148A is as follows:

4.10 Conducting an enquiry before issuance of notice under section 148A done away with: Section 148A(a) of the erstwhile provisions empowered the AO to conduct an enquiry, if required, with respect to the information which suggests that income chargeable to tax has escaped assessment. This enquiry could be conducted with prior approval of Specified Authority. Results of the enquiry were to be shared with the assessee. As a result of this power, the AO was reasonably assured of the correctness of the information before he could issue a show cause notice under section 148A(b) of the Act.

Under the amended section 148A, there is no express power to the AO to conduct an enquiry before issuance of show cause notice. This will result in notices being issued without verification of the correctness of the information, and in cases where enquiry is conducted after issuance of the show cause notice under section 148A(1), to verify the correctness of the contentions of the assessee, then the AO will be under pressure of time to pass an order under section 148A(4).

4.11 Prior approval of Specified Authority not required for issuing notice under section 148A(1): Section 148A(1) of the amended provisions is akin to section 148A(b) of the erstwhile provisions. Like in the erstwhile regime, there is no requirement to obtain prior approval of Specified Authority for issuing notice under section 148A(1). Where AO has information suggesting that income chargeable to tax has escaped assessment, the AO is mandated to serve upon the assessee a notice under section 148A(1), before issuing a notice under section 148, asking him to show cause why a notice under section 148 should not be issued in his case for the relevant assessment year. An opportunity of hearing has to be provided to the assessee.

4.12 Statutory mandate to provide information which suggests that income chargeable to tax has escaped assessment along with the notice under section 148A: Under the amended provisions of section 148A(2), it is mandatory for the AO to give information which suggests that income chargeable to tax has escaped assessment in his case for the relevant assessment year along with the show cause notice. It is the entire information and material which the AO has, which should accompany the notice issued under section 148A(2). Not giving information along with the notice will be a jurisdictional defect rendering the notice bad in law and liable to be quashed. Furnishing the information subsequently upon the assessee asking for the same, may not meet the requirements of the provision. Opportunity of being heard has to be necessarily provided to the assessee. Not granting opportunity of being heard, apart from being a violation of the principles of natural justice, will be contrary to the statutory mandate of section 148A(1) of the Act. Furnishing / giving partial information or portions of information considered relevant by the AO will not be compliance of the mandate of this provision.

It is not necessary that the AO must merely have information but the ‘information’ must prima facie, satisfy the requirement of enabling a suggestion of escapement from tax – Divya Capital One (P) LTD. vs. Assistant Commissioner of Income Tax & Anr [(2022) 445 ITR 436 (Del)]; Dr. Mathew Cherian & Ors. vs. ACIT [(2022) 329 CTR 809 (Mad.)] and Excel Commodity & Derivative (P) Ltd. vs. UOI [(2022) 328 CTR 710 (Cal.)].

4.13 No statutory time limit for furnishing response to show cause notice issued under section 148A(1): Section 148A(2) of the amended provisions provides that an assessee, on receiving the notice under section148A(1), may furnish his reply within such period as is mentioned in the notice.

Under the erstwhile provisions, it was provided that the AO had to grant a minimum time period of seven days and a maximum time period of 30 days to the assessee to furnish his reply. Also, it was provided that the AO may, on an application made by the assessee, extend the time granted for furnishing a reply. However, the amended provisions do not provide for any minimum or maximum period which needs to be granted. Therefore, the time to be granted to furnish a response to the show cause notice will now be at the discretion of the AO. However, principles of natural justice will demand that a reasonable time be granted to the assessee to furnish his response. There could be a debate as to what constitutes reasonable time. One may contend that a time period of two weeks would be reasonable time period and for this one may place reliance on the circulars of CBDT in the form of SOPs for Assessment Unit under Faceless Assessment Scheme, 2019 being Circular dated 19th November, 2020 and also SOP for Assessment Unit dated 3rd August, 2022, where for the purposes of furnishing response to notices under faceless assessment schemes it is stated that a time period of 15 days be granted. The courts in various contexts have held a time period of 15 days to be reasonable time period. At the worst, the time period of seven days provided in erstwhile provisions could be taken to be a reasonable yardstick.

4.14 Section 148A does not apply to cases where information is received pursuant to scheme notified under section 135A: Like in the erstwhile regime, even the amended provisions provide that where information is received pursuant to the scheme notified under section 135A of the Act, then the provisions of section 148A are not applicable to such information. In such a case, the AO can directly issue a notice under section 148 with prior approval of Specified Authority [Section 148A(4)]

4.15 Express power not available to grant extension of time for furnishing reply to the show cause notice issued under section 148A(1) : The erstwhile provisions of section 148A(b) clearly empowered the AO to grant on the basis of an application by the assessee, further time to furnish response to show cause notice issued by the AO. Such an express power is now missing in the amended provisions of section 148A(1) of the Act. Consequently, the AO having granted time (which he considers to be reasonable) mentioned in the notice issued by him, may refuse to grant extension of time on the ground that the section does not provide so. However, it is possible to contend that the AO has an inherent power to grant extension. In the event, the AO issues notice under section 148A(1) when the issuance of notice under section 148 is getting time barred soon, then the AO will be reluctant to grant extension of time and this may result in avoidable litigation.

4.16 Statutory obligation to provide opportunity of being heard continues: Like in the erstwhile regime, even the amended provisions provide for granting an opportunity of being heard. Opportunity of being heard would mean an opportunity of a personal hearing as well. Not granting an opportunity of being heard would be a fatal defect which may lead to the proceedings being quashed.

4.17 Order under section 148A(3) is to be passed on the basis of material available on record and taking into account reply of the assessee. Does material available on record mean only information available with the AO on the basis of which a notice under section 148A(1) has been issued? The amended provisions in Section 148A(3) provide that an order shall be passed by the AO determining whether or not it is a fit case to issue notice under section 148. This order shall be passed on the basis of material available on record and taking into account the reply of the assessee furnished under section 148A(2).

A question which arises for consideration is as to whether, when the provision refers to material available on record, is it merely the information which the AO has which suggests that income chargeable to tax has escaped assessment in the case of an assessee or is it any other material as well. The AO, on the basis of information which he has, issues a show cause notice, and the assessee furnishes the response thereto. To verify the correctness of the response furnished by the assessee, the AO may make enquiry by exercising powers vested in him under the Act and the results of such enquiry may also be the basis of determining whether or not it is a fit case for issuance of notice under section 148. However, the results of such enquiry will need to be shared with the assessee and the assessee granted an opportunity of furnishing his response thereto.

This view also gets support from the provisions of section 149, which provide that if three years but not more than five years have elapsed from the end of relevant assessment year, then a notice under section 148A can be issued only if, as per information with the AO, the income chargeable to tax which has escaped assessment amounts to or is likely to amount to ₹50 lakh or more. However, when it comes to issuance of notice under section 148, the requisite condition inter alia is that the AO has in his possession books of account or other documents or evidence related to any asset or expenditure or transaction or entries which show that the income chargeable to tax which has escaped assessment amounts to or is likely to amount to ₹50 lakh or more.

On a comparison of the two, it is clear that at the stage of issuance of notice under section 148A, what the legislature envisages is merely information with the AO whereas when it comes to issuance of notice under section 148, the requisite condition is AO having in his possession books of account, documents or evidence. It appears that these books of accounts, documents or evidence can come into possession of the AO in the course of proceedings under section 148A as a result of enquiries or otherwise.

4.18 Passing of an order under section 148A(3) requires prior approval of Specified Authority: The amended provisions of section 148A(3) provide that an order can be passed under section 148A(3), determining whether or not it is a fit case for issuance of notice under section 148, only with the prior approval of Specified Authority. For this purpose, Specified Authority is defined in section 151 to mean Additional Commissioner or Additional Director or Joint Commissioner or the Joint Director, as the case may be. Under the erstwhile provisions as well prior sanction of the Specified Authority was necessary. However, the Specified Authority under the erstwhile provisions was as stated in Para 6.2.

4.19 No outer time limit to pass an order under section 148A(3): Section 148A(d) of the erstwhile provisions provided that an order under section 148A(d) was required to be passed within one month from the end of the month in which the reply of the assessee was received and, where no reply was furnished, within one month from the end of the month in which the time or extended time allowed to furnish a reply expired.

Under the amended provisions, there is no outer limit for passing an order under section 148A(3), but the time limit provided in section 149 for issuance of notice under section 148 will indirectly work as an outer time limit for passing an order under section 148A. The AO will need to ensure that he has sufficient time to issue notice under section 148, which has to be accompanied by an order passed under section 148A(3).

5 Amendments to Section 149: The Amending Act, with effect from 1st September, 2024, has substituted a new Section 149 in place of the erstwhile Section 149. Section 149 provides for limitation period beyond which notice under section 148 / 148A cannot be issued.

5.1 Under the erstwhile provisions of section 149 it was only time limit for issuance of notice under section 148 which was provided. The amended provisions of section 149 provide for separate time limits for issuance of notice under section 148A and also for section 148. The time limits and the conditions for issuance of notice are as under:

BCAJ Admin

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).

This tax arbitrage was addressed by the Finance Act of 2013 through the introduction of section 115QA, which shifted the tax liability to the company executing the buy-back. The Memorandum to the Finance Bill 2013 highlighted the issue:

“Unlisted Companies, as part of tax avoidance schemes, are resorting to buy-backs of shares instead of paying dividends to avoid the payment of tax by way of DDT, particularly where the capital gains arising to the shareholders are either not chargeable to tax or are taxable at a lower rate.”

Following the amendment, the regime for buy-backs became analogous to that of dividends, with the company paying the tax, and the income being exempt in the hands of shareholders under section 10(34A). The Finance Act 2020 abolished DDT (i.e., section 115-O) and reverted to the classical method of taxation, wherein dividends are taxed in the hands of the shareholders. This change led to a shift from a flat DDT rate to variable tax rates for shareholders — 36 per cent for residents and 20 per cent for non-residents (potentially reduced under DTAA rates). However, section 115QA remained intact, with companies continuing to pay tax at a flat rate of 23.296 per cent (inclusive of surcharge and cess), while the shareholders’ income remained exempt under section 10(34A). This discrepancy once again created an opportunity for tax arbitrage. For resident individual shareholders, dividends were taxed at 36 per cent, whereas buy-backs were taxed at 23.296 per cent. Moreover, since the tax was borne by the company, a larger distributable amount remained with the shareholders, prompting unlisted companies to favour buy-backs over dividend declarations to exploit the tax advantage.

This practice was curtailed by the Finance Act (No. 2) of 2024, which introduced a classical, albeit unconventional, split in the tax treatment. The new law proposes to treat the consideration received on a buy-back as a dividend, while the extinguishment of shares by shareholders is treated as a capital gain. This hybrid treatment is the focus of the article’s analysis.

LAW PRIOR TO AMENDMENT

Section 115QA mandated a flat rate of taxation at 23.296 per cent on the company executing the buy-back, while the consideration received by the shareholder was exempt under section 10(34A). The law, as it stood, had several unique features:

• Tax Liability on the Company: The obligation to pay tax was placed on the company, allowing it to distribute the entire amount computed under section 68 of the Companies Act, 2013, to shareholders. The tax paid on the buy-back did not count towards the limits set by the law, enabling a higher payout to shareholders. Consequently, the effective tax rate, on a derivative basis, reduced to 18.89 per cent (calculated as 23.296/123.926*100).
• Tax on Distributed Income (DI): The tax was levied on the distributed income, which was defined as the amount received by the company upon the issuance of shares, minus the consideration paid on the buy-back. This definition excluded the cost to the shareholder in cases where shares were purchased through secondary transfers, resulting in tax being paid on a higher amount than the actual income generated.
• Challenges for Non-Resident Shareholders: Since the tax was paid by the company in addition to the corporate tax, non-resident shareholders faced difficulties in claiming tax credits in their home countries. This scenario often led to the possibility of double taxation.
• Exemption for Shareholders: With the income being exempt in the hands of shareholders and the tax borne by the company, listed companies frequently offered buy-back prices above market value to incentivize participation. Shareholders, seeing significant value appreciation, were thus motivated to tender their shares in the buy-back.

This tax arbitrage was addressed by the Finance Act (No. 2) of 2024, which introduced significant changes to the tax regime governing buy-backs.

AMENDMENT BY FINANCE (NO. 2) ACT 2024

Finance (No. 2) Act 2024 introduced series of amendment introducing novel method to tax buy back. Following are list of amendments:

i) Introduction of section 2(22)(f) in the ‘Act’ to state that 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 taxable as dividend. (Clause 3 of the Bill)

ii) Insertion of proviso to section 10(34A) of the Act to provide that this clause shall not apply with respect to any buy-back of shares by a company on or after the 1st October, 2024. (Clause 4 of the Bill).

iii) Insertion of a proviso to section 46A of the Act w.e.f. 1st October, 2024 to provide that where a shareholder receives any consideration of the nature referred to in sub-clause (f) of section 2(22) from any company, in respect of any buy-back of shares, then the value of consideration received by the shareholder shall be deemed to be “nil’. (Clause 18 of the Bill)

iv) Insertion of a new proviso to section 57 to provide that that no deduction shall be allowed in case of dividend income of the nature referred to in sub-clause (f) of clause (22) of section 2. (Clause 24 of the Bill)

v) Insertion of a further proviso to sub-section 115QA(1) of the Act whereby it would not apply in respect of any buy-back of shares that takes place on or after 1st October, 2024. (Clause 39 of the Bill)

vi) Amendment to section 194 of the Act on deduction of taxes at source @10 percent on payments of dividend, to make it applicable to sub-clause (f) of clause (22) of section 2. (Clause 52 of the Bill)

Provisions are effective from 1st October, 2024. In other words, buy back before cut-off date will be governed by section 115QA. It is advisable that buy back scheme is complete in all respects (including filing with ROC), to avoid transitionary issues.

IMPLICATIONS IN HANDS OF COMPANY

Previously, companies were required to pay buy-back tax under section 115QA. With the recent legislative changes, the law now treats the payment of consideration by the company as a dividend, making it taxable in the hands of the shareholder. Consequently, the company assumes the role of a tax deductor. It will be required to deduct tax under section 194 or section 195 of the Income Tax Act, depending on the specific circumstances. Following the deduction, the company must remit the tax and comply with the filing requirements for TDS (Tax Deducted at Source) and SFT (Statement of Financial Transactions) returns.

The treatment of buy-back proceeds as dividends remains consistent even in scenarios where the company does not have accumulated profits. The deliberate omission of the phrase “to the extent of accumulated profits,” which is present in other provisions of Section 2(22), underscores the intent to classify buy-back transactions as dividends irrespective of the company’s profit status. This is particularly relevant in cases where the buy-back is funded from the securities premium account. However, from an equity perspective, securities premium fundamentally represents a repayment of capital, and therefore, its characterization as a dividend raises questions. The underlying principle is that securities premium should not be treated as a dividend, as it does not constitute income in the traditional sense but rather a return of capital to shareholders.

An intriguing question arises regarding buy-backs conducted under sections 230 to 232 of the Companies Act, which require approval from the National Company Law Tribunal (NCLT). The query is whether such buy-backs will be treated as dividends. This ambiguity exists because section 2(22)(f) of the Income Tax Act specifically refers to the purchase of shares in accordance with the provisions of section 68 of the Companies Act, 2013. A similar situation emerged concerning section 115QA, where the definition of buy-back initially referred only to section 77A of the Companies Act, 1956. This definition was subsequently broadened by the Finance Act of 2016 to include the purchase of shares in accordance with the provisions of any law in force relating to companies. However, this amendment was applied prospectively.

In the absence of a similar broadening of the language in the current context, it can be argued that only buy-backs conducted in accordance with section 68 of the Companies Act, 2013, fall within the scope of the new definition of dividend. At the same time, care and caution needs to be exercised as Court / Tribunal in undernoted decision1 have recharacterised buy back as dividend.

On similar lines, redemption of preference shares is governed by section 55 of Companies Act 2013 and should be outside the purview of provisions.

TAX IMPLICATIONS IN THE HANDS OF RESIDENT SHAREHOLDERS

CHARACTERISATION OF BUY-BACK CONSIDERATION

Section 2(22) of the Income-tax Act defines “dividend,” and clause (f) within this section specifically includes payments made by a company for purchasing its own shares as dividends. This definition of dividend is applied consistently across the entire Act, meaning that the consideration received by shareholders during a buy-back transaction will be treated as dividend income. Consequently, this income must be reported under the head “Income from Other Sources” and taxed accordingly.

1 Cognizant Technology-Solutions India Pvt. Ltd., vs. ACIT [2023] 154 taxmann.com 309 (Chennai - Trib.); Capgemini India (P.) Ltd., In re [2016] 67 taxmann.com 1 (Bombay HC)

Section 57 of the Act prohibits any deductions against this income, implying that the entire buy-back consideration will be taxed on a gross basis, without allowing any deduction for the original cost of the shares. Shareholders must also account for this dividend income when calculating their advance tax obligations. However, interest obligations under Section 234C will only commence from the quarter in which the dividend is actually received.

The Act allows this dividend income to be set off only against losses under the heads “House Property” or “Business Loss.” The fiction of treating buy-back consideration as dividend is intended to be applied uniformly throughout the provisions of the Act. For shareholders that are domestic companies, the benefit of Section 80M should be available. In essence, buy-back consideration deemed as dividend can be considered by the company if it further declares dividends to its shareholders or engages in additional buy-backs, allowing the company to claim a deduction under Section 80M. As a result, tax will only be paid on the income exceeding the relief available under Section 80M. Additionally, an Indian company can claim a capital loss for the shares bought back and set it off against future capital gains, effectively allowing for a double benefit under the new regime.

TAX RATE ON DIVIDEND INCOME

Dividend income, classified as “Income from Other Sources,” is taxed according to the applicable income tax slab rates. The highest tax rate for a resident individual taxpayer is 36 per cent. It’s important to note that the surcharge on Buy-Back Tax (BBT) is capped at 12 per cent, compared to a 15 per cent surcharge on dividend income, potentially resulting in a higher overall tax burden on dividend income. On the other hand, if a shareholder’s income falls below the taxable slab limits, the entire dividend income may be tax-free, allowing the shareholder to carry forward the cost of acquisition as a capital loss.

SHARES HELD AS STOCK IN TRADE

The new scheme of taxation primarily addresses cases where shares are held as capital assets. However, an important issue arises when shares are held as stock-in-trade, which is particularly relevant because dividend income is generally required to be offered for tax under the head “Income from Other Sources” without any deductions.

In the author’s view, since these shares are held as business assets, the appropriate head of income for dividend income should be “Business Income” under Section 28 of the Income-tax Act². This approach would allow for a more accurate reflection of the economic reality of holding shares as part of the business inventory. Accordingly, the cost of shares should be allowed as a deduction when computing the business income, ensuring that the income is taxed in a manner consistent with its treatment as part of the business operations³. This interpretation aligns with the principle of matching income with related expenses, thereby providing a fair and logical tax outcome for shares held as stock-in-trade.

2 Refer CIT v Coconada Radhaswami Bank Ltd (1965) 57 ITR 306 (SC)
3 Badridas Daga v CIT (1958) 34 ITR 10 (SC); Dr TA Quereshi v CIT (2006) 287 ITR 547 (SC)

COST OF ACQUISITION OF SHARES

From the shareholder’s perspective, the buy-back results in the extinguishment of shares. Under the law, the cost of acquisition of these shares is treated as a capital loss, which can then be set off against other capital gains. This treatment is facilitated by an amendment to Section 46A, a special provision introduced by the Finance Act of 1999. This section states that, subject to the provisions of Section 48, the difference between the consideration received on buy-back and the cost of acquisition is deemed to be capital gains for the shareholder.

The Finance Act (No. 2) 2024 adds a proviso to Section 46A, deeming the value of the consideration received by the shareholder as Nil. Since the consideration is deemed Nil, the cost of acquisition becomes a capital loss, which can be carried forward according to the provisions of the capital gains chapter. The law’s intention is to allow shareholders to offset this loss against future gains, thereby economically maintaining the status quo. The Memorandum to the Finance Bill provides detailed numerical examples illustrating this tax neutrality.

Because the consideration is deemed Nil, this treatment applies uniformly across all provisions of the Act. Notably, the provisions of Section 50D or Section 50CA cannot be used to notionally increase the consideration. This fiction of Nil consideration will also hold true in the context of transfer pricing provisions involving non-resident Associated Enterprises (AEs).

An interesting question arises regarding the determination of the cost of acquisition for the purposes of Section 46A. Shareholders may acquire shares through direct purchase, various modes specified in Section 47 read with Section 49, or by acquiring shares before 31st January, 2018, which would qualify for the grandfathering benefit under Section 55(2)(ac). Section 46A references the cost of acquisition and explicitly makes its provisions subject to Section 48, which outlines the mode of computation but does not define the cost of acquisition itself.

While Section 49 provides the cost of acquisition for specific modes of acquisition, Section 46A does not directly reference this section, nor does it explicitly refer to Section 55, which defines the cost of acquisition for the purposes of Sections 48 and 49. This creates ambiguity, as Section 46A does not provide a clear fallback to Sections 49 and 55 for determining the cost of acquisition.

There are two possible interpretations of this issue:

1. Strict Interpretation (Recourse Not Permissible): Some may argue that Section 46A, being a special provision, is intended to override the general provisions of Sections 45 and 47. If this interpretation is followed, it would imply that recourse to other provisions, such as those allowing for a step-up in cost under Sections 49 and 55, may not be permissible. This view treats Section 46A as a self-contained code, limiting the ability to refer to other sections for determining the cost of acquisition.

2. Contextual Interpretation (Recourse Permissible): On the other hand, it can be argued that this interpretation is too extreme. Section 46A is explicitly made subject to Section 48, and Section 55 provides the cost of acquisition for the purposes of Section 48. Therefore, it stands to reason that the cost step-up provisions, including those under the grandfathering rules in Section 55(2)(ac), should be available to shareholders. Additionally, the headnotes of Section 49 state that it pertains to the “cost with reference to certain modes of acquisition,” which suggests that it should be interpreted in a manner similar to Section 55. This interpretation aligns with the legislative intent to preserve the cost base for shareholders, ensuring that they are not disadvantaged by the lack of explicit reference in Section 46A.

In conclusion, while there is room for debate, the contextual interpretation that allows recourse to Sections 49 and 55 seems more consistent with the broader legislative intent and the structure of the Income-tax Act. This approach ensures that shareholders can benefit from the cost step-up provisions, thereby maintaining their cost base and achieving a fairer tax outcome.

The grandfathering provisions under Section 55(2)(ac) require a comparison of three key values: the cost of acquisition, the fair market value of the asset as on 31st January, 2018, and the full value of consideration received or accruing as a result of the transfer. Among these, the lowest value must be adopted as the cost base for computing capital gains.

However, the proviso to Section 46A introduces a significant twist by deeming the third limb—the full value of consideration received — to be Nil in the context of buy-back transactions. As a result, the benefit of the grandfathering provisions effectively becomes unavailable in these cases. Since the deemed consideration is Nil, the computed capital gains could potentially be much higher, negating the protective intent of the grandfathering rules.

Given this scenario, shareholders might find themselves better off by selling their shares in the open market and paying tax on the resultant long-term capital gains, rather than opting for a buy-back. This approach would allow them to fully utilise the grandfathering benefit, thereby reducing their tax liability. Consequently, this provision makes buy-back transactions less attractive compared to a straightforward market sale, especially for shares that have appreciated significantly since 31st January, 2018.

TREATMENT OF CAPITAL LOSS

The cost of acquisition treated as a capital loss in the hands of the shareholder falls under the head “Capital Gains” and is governed by Section 74. A short-term capital loss can be set off against either short-term or long-term capital gains, while a long-term capital loss can only be set off against long-term gains. Overall, capital losses can be carried forward for a period of eight years.

Capital loss from a buy-back may arise from both listed and unlisted shares and can be set off against capital gains from the sale of shares, immovable property, or any other capital asset. This broad spectrum of gains available for set-off provides flexibility to shareholders. There may be instances where capital loss may not be available for set off:

• If no future gains arise within the eight-year period, the capital loss becomes a dead cost.
• In cases where the transfer is exempt under the Income-tax Act, such as transfers between a holding company and its subsidiary, the capital loss from a buy-back may not be allowable for set-off. Although the buy-back would be fully taxed, the exemption on the transfer prevents the recognition of the capital loss, leading to double jeopardy for the holding company, which faces taxation without the benefit of loss offset.
• If shares were converted into stock-in-trade prior to 1st October, 2024, and the buy-back occurs after this date, the entire proceeds would be taxed as dividend income. Simultaneously, the suspended capital gains tax on the conversion would become taxable under Section 45(2) of the Income-tax Act. This situation again results in double jeopardy, as the shareholder faces dual taxation. However, in such cases, the fair market value of the stock-in-trade as on the date of conversion should be allowed as a business loss at the time of the buy-back, providing some relief to the tax payer. From an equity perspective, the consideration is taxed as a dividend at a rate of 36 per cent, while the set-off of capital loss is available against long-term gains taxed at 12.5 per cent or short-term gains at 20 per cent. This discrepancy results in higher taxable income, reducing the real gain in the hands of the shareholder. Additionally, shareholders must file a return of income to carry forward the loss in accordance with Section 80, even if they have no other income chargeable to tax.

For the company, capital loss is attached to the company itself. In cases of merger or demerger, there are no transitional provisions since Section 72A only addresses the transfer of business loss. Furthermore, shareholders of unlisted companies cannot carry forward and set off capital losses if there is a change in shareholding that triggers Section 79.

TAX IMPLICATIONS IN HANDS OF NON-RESIDENT SHAREHOLDER

TAX RATE

For non-resident shareholders, dividend income is taxed under Section 115A of the Income-tax Act at a flat rate of 20 per cent (plus applicable cess and surcharge). However, this rate can be reduced under the provisions of the Double Taxation Avoidance Agreement (DTAA) between India and the shareholder’s country of residence. Depending on the specific treaty, the tax rate may be reduced to 5 per cent⁴ or 10 per cent⁵ or 15 per cent⁶, provided the non-resident shareholder meets the treaty eligibility criteria, such as the Principal Purpose Test (PPT) or the Limitation of Benefits (LOB) clause.

4 Hongkong, Malaysia, Mauritius if shareholding in India Company is at least 15%
5 UK, Norway, Ireland, France
6 USA, Singapore

Regarding the cost of shares, it will be treated as a capital loss, which can be set off in the manner prescribed earlier. However, this brings into focus a potential tax disadvantage for Foreign Direct Investment (FDI) shareholders who do not have any other investments in India. The capital loss arising from the buy-back of shares can typically only be set off against capital gains from the sale of shares in the FDI company. In such cases, the conventional route of declaring dividends might be more tax-efficient for the non-resident shareholder, as it would allow for a more immediate and potentially beneficial tax treatment compared to the deferral and potential loss of the capital loss offset in the buy-back scenario.

DIVIDEND CHARACTERISATION UNDER DTAA

Shareholders have the option to choose between the provisions of the Double Taxation Avoidance Agreement (DTAA) and domestic law, depending on which is more beneficial to them. The Dividend Article under most DTAAs offers a concessional rate of taxation. However, an important consideration is whether the dividend defined under Section 2(22)(f) of the Income-tax Act qualifies as a dividend under the DTAA.

One approach is the “pick and choose” method, where the shareholder adopts the domestic law definition of “dividend” for characterisation purposes and then opts for the concessional DTAA rate. This approach has been supported by courts and tribunals in various cases⁷, allowing shareholders to leverage the more favourable aspects of both the domestic and treaty provisions.

7 ACIT vs. J. P. Morgan India Investment Company Mauritius Ltd [2022] 143 taxmann.com 82 (Mumbai - Trib.)

Alternatively, one might argue that the dividend under Section 2(22)(f) does not fall within the Dividend Article of the DTAA. If successful, this argument would imply that the consideration received during the buy-back is not taxable as a dividend under the DTAA. Instead, it would fall under the Capital Gains Article, with its computation governed by domestic law. Under Section 46A, the consideration is deemed to be Nil, and this fiction remains absolute, irrespective of the taxability of the consideration in the hands of the shareholder. The “Other Income” Article in the DTAA would only apply if the income is not addressed by any other specific Article.

For this discussion, let’s consider the Dividend Article as defined in the OECD Model Convention (MC) and the UN Model Convention (MC). The definition of “dividend” under these conventions comprises three parts:

1. Income from shares;

2. Income from other rights, not being debt-claims, participating in profits; and

3. Income from other corporate rights which is subjected to the same taxation treatment as income from shares by the laws of the Contracting State of which the company making the distribution is a resident.

These parts are interconnected, particularly through the use of “other” in the second and third parts, which serves as a linking element. While the first two parts are intended to be autonomous, the third part is complementary, including income from other corporate rights, provided it is subject to the same tax treatment as income from shares under the laws of the source State. However, this does not automatically imply that all income treated domestically as dividend would fall within this definition.

Arguments Supporting that Dividend under Section 2(22)(f) Does Not Fall Within the Definition of Dividend under the DTAA:

• For income to fall under any of the three limbs of the Dividend definition, it must originate “from” shares, other rights, participation in profits, or corporate rights. The term “from” implies a direct relationship between the income and the asset. The asset must exist at the time the income arises, which is a crucial aspect of the definition.
• All three limbs require the asset to continue existing after the income is realised. This is consistent with the Supreme Court’s decision in Vania Silk Mills, where it was held that the charge under the capital gains article fails if the asset no longer exists after the transaction.
• The Dividend Article should be interpreted from the shareholder’s perspective, not the company’s. Section 2(22)(f) is specific to the company, as indicated by the words “any payment by a company on purchase of its own shares from a shareholder.” From the shareholder’s perspective, this payment is the consideration received for selling shares, and the tax consequences should not differ merely because the shares are purchased by the company itself.
• In cases involving buy-backs, there is a conflict between the Capital Gains Article and the Dividend Article. From the shareholder’s perspective, the transaction results in the extinguishment of rights in the company. This is acknowledged by the Memorandum to the Finance Bill, and the amendment to Section 46A, which deems the consideration to be Nil, indicates that the transaction is governed by capital gains provisions. The characterization of the transaction under the treaty should remain consistent, even if domestic law prescribes a different method of taxing the consideration.
• The first limb of the Dividend definition deals with “income from shares.” If this were interpreted to include income from the alienation of shares, it would render the Capital Gains Article redundant.
• The references to “other rights” or “other corporate rights” should be understood as rights arising from shareholding, not from the sale of shares. Klaus Vogel supports this interpretation, noting that “corporate rights” are meant to distinguish from “contractual rights” and should stem from a member’s rights within the company, not from a creditor’s right based on a contract or statute.

““With respect to the second element, income will stem from ‘corporate rights’ if it flows to the recipient because of a right held in the company, rather than against the company which implies a direct deviation from a member right as opposed to the right of a creditor based on any other contractual or statutory relationship.”

• The OECD Commentary on Articles 10 also suggests that payments reducing membership rights, such as buy-backs, do not fall within the definition of dividends. Following are relevant extracts:

“The reliefs provided in the Article apply so long as the State of which the paying company is a resident taxes such benefits as dividends. It is immaterial whether any such benefits are paid out of current profits made by the company or are derived, for example, from reserves, i.e., profits of previous financial years. Normally, distributions by a company which have the effect of reducing the membership rights, for instance, payments constituting a reimbursement of capital in any form whatever, are not regarded as dividends.”

Arguments Supporting that Dividend under Section 2(22)(f) Does Fall Within the Definition of Dividend under the DTAA:

• The DTAA does not exhaustively define “dividend,” leaving it to the contracting states to provide definitions. As such, Section 2(22)(f) could fall within the scope of the DTAA’s definition.
• Characterising capital gains transactions as dividends is not unprecedented. For instance, Section 2(22)(c), which deals with capital reduction, treats payments as deemed dividends to the extent of accumulated profits.
• The Mumbai Tribunal in KIIC Investment Company vs. DCIT⁸ sdealt with whether deemed dividends under Section 2(22)(e) fall within the Dividend Article of the India-Mauritius DTAA. The Tribunal held that, given the explicit reference to domestic law in the third limb of the definition, deemed dividends under Section 2(22)(e) should be considered dividends under the DTAA. Following are relevant extract:

“We have considered the aforesaid plea of the assessee, but do not find it acceptable. The India-Mauritius Tax Treaty prescribes that dividend paid by a company which is resident of a contracting state to a resident of other contracting state may be taxed in that other state. Article 10(4) of the Treaty explains the term “dividend” as used in the Article. Essentially, the expression ‘dividend’ seeks to cover three different facets of income; firstly, income from shares, i.e., dividend per se; secondly, income from other rights, not being debt claims, participating in profits; and, thirdly, income from corporate rights which is subjected to same taxation treatment as income from shares by the laws of contracting state of which the company making the distribution is a resident. In the context of the controversy before us, i.e., ‘deemed dividend’ under Section 2(22)(e) of the Act, obviously the same is not covered by the first two facets of the expression ‘dividend’ in Article 10(4) of the Treaty. So, however, the third facet stated in Article 10(4) of the Treaty, in our view, clearly suggests that even ‘deemed dividend’ as per Sec. 2(22)(e) of the Act is to be understood to be a ‘dividend’ for the purpose of the Treaty. The presence of the expression “same taxation treatment as income from shares” in the country of distributor of dividend in Article 10(4) of the Treaty in the context of the third facet clearly leads to the inference that so long as the Indian tax laws consider ‘deemed dividend’ also as ‘dividend’, then the same is also to be understood as ‘dividend’ for the purpose of the Treaty.”

8 [2019] 101 taxmann.com 19 (Mumbai - Trib.)

• The OECD Commentary on Article 13 supports the idea that domestic law treatment can be decisive in determining whether a transaction falls within the Dividend Article, even when the transaction involves the alienation of shares.

“If shares are alienated by a shareholder in connection with the liquidation of the issuing company or the redemption of shares or reduction of paid-up capital of that company, the difference between the proceeds obtained by the shareholder and the par value of the shares may be treated in the State of which the company is a resident as a distribution of accumulated profits and not as a capital gain. The Article does not prevent the State of residence of the company from taxing such distributions at the rates provided for in Article 10: such taxation is permitted because such difference is covered by the definition of the term “dividends” contained in paragraph 3 of Article 10 and interpreted in paragraph 28 of the Commentary relating thereto, to the extent that the domestic law of that State treats that difference as income from shares.”

• Klaus Vogel’s Commentary (5th Edition, Page 939) also emphasises that domestic law treatment should prevail when determining whether a payment is considered a dividend, thereby supporting the inclusion of Section 2(22)(f) within the DTAA’s Dividend Article.

“Sale proceeds of shares and other corporate rights generally fall under Article 13 and not under Article 10 ODCD and UN MC, as such income is not derived from shares within the meaning of the OECD MC but stems from the alienation of shares. If one considered sale proceeds to come within the meaning of ‘income from shares’, Article 13 OECD and UN MC would still prevail, however, by virtue of its more specialised nature regarding such transactions. Problems may arise, however, in either case, to the extent that such proceeds may represent undistributed profits of the paying company, as it would open up an easy way to avoid source taxation, in particularly by way of share repurchase in lieu of dividend distribution. Thus, the OECD MC Comm. Acknowledges that Article 13(5) does not prevent source State from taxing ‘the difference between the selling price and the par value of the shares’ as dividend in accordance with Article 10 OECD and UN MC where the shares are sold to the issuing company.
……… (Page 981)

Moreover, nothing in the provision requires income to be derived from an ‘equity investment’: a mere recharacterisation of the income (rather than the underlying right) under domestic law is sufficient to trigger the application of Article 10.”

In the author’s view, the reference to domestic law is broad enough to encompass payments falling within the scope of Section 2(22)(f), allowing them to be treated as dividends under the DTAA. This interpretation aligns with the intention to provide clarity and consistency in the application of tax treaties.

TRANSFER PRICING IMPLICATIONS

Under the Buy-Back Tax (BBT) regime, it was possible to argue that in cases involving Associated Enterprises (AEs), the amount of consideration paid by the company needed to be benchmarked against the Arm’s Length Price (ALP) criteria. Shareholders were largely indifferent to this aspect since the income from the buy-back was exempt in their hands. However, the new taxation regime introduces an intriguing dimension to this issue.

Transfer pricing regulations focus on the substance of the transaction. While the transaction is still treated as a dividend in the hands of the company, it will now require benchmarking as if the buy-back were a transfer, meaning the company must determine the ALP of the consideration paid. Theoretically, there should not be any adverse implications if the consideration paid does not align with the ALP, since buy-back payments are not deductible expenses for the company. The company’s primary responsibility remains the withholding of tax.

A plausible interpretation is that the withholding tax obligation applies to the transaction value rather than the ALP value. In hands of shareholder Section 46A deems the consideration to be Nil for tax purposes. This fiction is absolute and is not affected by the ALP price. Thus, benchmarking needs to be done for compliance purposes without any impact on tax computation.

INTERPLAY WITH SECTION 56(2)(X)

Buybacks often involve a company using its free cash flow to purchase its own shares, leading to an increase in the remaining shareholders’ stakes without them having to dip into their own cash reserves. This tactic has become a popular method for realigning shareholding structures, particularly in the context of family arrangements or the elimination of cross holdings. However, when buy-backs are executed at prices below the Rule 11UA value, questions inevitably arise regarding the applicability of Section 56(2)(x).

At first glance, Section 56(2)(x) applies to the “receipt” of property, a term that has been interpreted to mean the receipt that benefits the recipient. In the case of a buy-back, the shares are technically received by the company solely for the purpose of cancellation, with no economic enrichment resulting from this transaction. This lack of enrichment leads to the failure of the charge under Section 56(2)(x). This line of reasoning has found favour in various judicial decisions⁹.

9. Vora Financial Services (P.) Ltd. v ACIT [2018] 96 taxmann.com 88 (Mumbai); DCIT v Venture Lighting India Ltd [2023] 150 taxmann.com 523 (Chennai - Trib.); VITP (P.) Ltd v DCIT [2022] 143 taxmann.com 304 (Hyderabad - Trib.);

Section 115QA adds another layer of defence. By shifting the liability to pay Buy-Back Tax (BBT) onto the company, Section 115QA acts as a special provision and a self-contained code. According to the principles of statutory interpretation, a special provision like Section 115QA should override more general provisions such as Section 56(2)(x).

However, the new taxation regime introduces a fresh angle to the interplay with Section 56(2)(x). Section 2(22)(f) deems the payment by a company on the purchase of its own shares as a dividend. Sections 194 and 195 impose an obligation on the company to withhold tax on such payments. Following the fiction created by Section 2(22)(f) to its logical conclusion, this payment should be treated as a dividend for all purposes under the Act, effectively preventing the application of Section 56(2)(x) from the outset.

In the absence of any anti-abuse provision requiring the company to pay dividends at fair market value, it is arguable that considerations below the Rule 11UA value should not be taxed under Section 56(2)(x).

COMPARISON WITH CAPITAL GAIN

Under the new regime, long-term capital gains are taxed at a rate of 12.5 per cent, and short-term capital gains are taxed at 20 per cent on net gains (i.e., consideration minus the cost of acquisition). For non-resident shareholders, dividend income is taxed according to the provisions of the applicable DTAA, with most DTAAs providing a concessional rate of 10 per cent for dividend taxation.

Shareholders, particularly those holding stakes in startups or joint ventures, will need to carefully evaluate buy-back as an alternative to conventional exit strategies. In cases where shares have significantly appreciated, opting for buy-back could result in the gains being taxed as dividends, potentially reducing the overall cash tax outflow. Additionally, the cost of acquisition can be offset against other capital gains, thereby improving overall tax efficiency.

This scenario presents an opportunity to structure transactions more efficiently. Instead of providing an exit through secondary sales, shareholders might consider infusing equity into the company, followed by a buy-back. This approach could optimize the tax implications and enhance the financial outcome of the transaction.

BUY-BACK AND INDIRECT TRANSFER

Explanation 5 to Section 9(1)(i) of the Income-tax Act provides that the shares of a company are deemed to be situated in India if they derive their value substantially from assets located in India. Circular No. 4 of 2015, dated 26th March, 2015, clarified that the declaration of dividends by a foreign company does not trigger the provisions of indirect transfer under Indian tax law. The term “dividend” in this context, as stated in the Circular, derives its meaning from Section 2(22)(f) of the Income-tax Act, which includes payments made by a company on the purchase of its own shares from a shareholder in accordance with the provisions of Section 68 of the Companies Act, 2013.

A pertinent issue arises when considering buy-backs by foreign companies, which are not conducted in accordance with Section 68 of the Companies Act, 2013. This raises the question of whether a buy-back under the corporate law of a foreign jurisdiction falls within the scope of the indirect transfer provisions.

Non-resident shareholders may consider invoking the Non-Discrimination Article under the applicable DTAA to address this issue. Article 24(1) of many DTAAs provides that nationals of one contracting state shall not be subjected in the other contracting state to any taxation or related requirements that are more burdensome than those imposed on nationals of the other state under similar circumstances.

An argument can be made that the reference to Section 68 should be interpreted as indicative of a buy-back governed by corporate law in general, rather than being limited to Indian law. Non-resident shareholders should not be expected to comply with Section 68 of the Companies Act, 2013, as it applies exclusively to Indian companies. The argument of discrimination has been accepted by the Tribunal in the context of Section 79 in the case of Daimler Chrysler India (P.) Ltd. vs. DCIT¹⁰, where similar principles were considered.

10 [2009] 29 SOT 202 (Pune)

CONCLUDING REMARKS

There’s no denying that Income Tax is fundamentally a tax on real income — at least, that’s the theory. However, with the numerous fictions introduced over the years — each one merrily overriding the last —the Income-tax Act has started to resemble a novel with more plot twists than logic. It’s like watching a thriller where the protagonist, just when you think you understand the story, wakes up to find themselves in an entirely different movie.

As we navigate these convolutions, it’s worth remembering that all of this complexity is supposed to bring us closer to fairness and clarity. But in reality, it’s a bit like trying to assemble flat-pack furniture without the instructions — there’s always one piece that doesn’t seem to fit, and you’re never quite sure if that extra screw was supposed to go somewhere.

With the introduction of a new Income-tax Act on the horizon, one can’t help but feel a mix of hope and trepidation. Will this new Act finally streamline these fictions, or will it just add a few new chapters to the saga? Either way, as tax professionals, we’ll be here — armed with our calculators and a good sense of humour — ready to decipher the next instalment of this ever-evolving tax code.

BCAJ Admin

The maiden Budget of the Government in their third innings promises simplification and rationalisation of Capital Gains tax regime under the Income-tax Act, 1961 (“the Act”). With the said purpose, the Finance (No. 2) Act, 2024 (“FA (No. 2) 2024”) provides for standardisation of tax rates for the majority of short-term and long-term capital gains tax as well as period of holding of the majority of listed and unlisted capital assets. However, simultaneously, the Capital Gains Chapter of the Act has been amended at various other places making those provisions more complex and litigious thereby clearly contradicting the intention propagated by the Government.

This Article discusses the various amendments brought in by the FA (No. 2) 2024 under the said Chapter1 and the issues arising therefrom.

PERIOD OF HOLDING

Section 2(42A) of the Act determines “Period of Holding” relevant for the purpose of classifying an asset as short-term or long-term. Earlier, there were three holding periods, namely, 12 months, 24 months and 36 months. The period of 12 months was applicable for selected assets such as listed shares, listed equity oriented funds and zero coupon bonds. Further, the period of 24 months was applicable to unlisted shares and immovable properties, being land or building or both.

The said section has now been amended with effect from 23rd July, 2024 so that now, all listed securities shall be regarded as long-term capital asset if held for more than twelve months and all other capital assets shall be regarded as long-term capital asset if held for more than 24 months.

The same is summarised as under:

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Important Amendments by the Finance (No.2) Act, 2024 are covered in six different Articles. It is not possible to cover all amendments at length and hence the focus is only on important amendments but with a detailed analysis of their impacts. These in-depth analysis will serve as a future guide to know the existing provisions, current amendments and their rationale, and the revised provisions. We hope the readers will enrich by the detailed analysis. – Editor

For the past several years, charitable institutions have awaited the Finance Bill of each year with dread and trepidation, as to what further compliance, burden and complexity would be imposed upon them. Since 2009, many new provisions for charitable institutions have been introduced, making the requirement of claiming exemption increasingly difficult.

Fortunately, some of this year’s amendments have sought to alleviate some of the difficulties being faced by charitable institutions. However, there have been no amendments in respect of many other complex and pressing problems faced by charitable institutions (such as the applicability of the proviso to section 2(15) as to what activity constitutes a business, applicability of tax on accreted income under certain circumstances, the low reporting requirement of a cumulative ₹50,000 for substantial contributors, etc).

The amendments made are analysed below:

MERGER OF SECTION 10(23C) EXEMPTION REGIME WITH SECTION 11 EXEMPTION REGIME

Currently, there are two major schemes of exemption for charitable institutions – one contained in various sub-clauses of section 10(23C) available for educational and medical institutions and certain other specific types of institutions. In particular, exemption under the following sub-clauses requires approval of the CIT – these are applicable to:

(iv) charitable institutions important throughout India or a State;

(v) public religious institutions;

(vi) university or other educational institution existing solely for educational purposes and not for purposes of profit, not wholly or substantially financed by the Government and whose gross receipts exceed ₹5 crore;

(vii) hospital or other institution for the reception and treatment of persons suffering from illness or mental defectiveness or for the reception and treatment of persons during convalescence or of persons requiring medical attention or rehabilitation, existing solely for philanthropic purposes and not for purposes of profit, not wholly or substantially financed by the Government and whose gross receipts exceed ₹5 crore.

The conditions for exemption under these 4 sub-clauses of section 10(23C) are contained in the 23 provisos to section 10(23C), and by the Finance Act, 2022, these conditions were almost fully aligned with the requirements contained in section 11 for claim of exemption. Only a few minor differences remained, such as option to spend in subsequent year and exemption for capital gains on reinvestment in capital asset, which are available under section 11 but not available under section 10(23C). Given this alignment, it was expected that the exemption under these 4 sub-clauses would finally be merged with the exemption under section 11.

The Finance (No 2) Act 2024 now begins the process of merger of these two exemption regimes. The first and second provisos to section 10(23C) have now been amended to provide that application for approval or renewal of approval under sub-clauses (iv), (v), (vi) and (via) of section 10(23C) can only be made before 1st October, 2024, and that the Commissioner shall only process such applications made before 1st October, 2024. A 24th proviso has been added to section 10(23C) stating that no approvals shall be granted for applications made on or after 1st October, 2024. Simultaneously, amendments have been made to section 12A(1)(ac) with effect from 1st October 2024, requiring such charitable entities to make an application for registration under that section.

This effectively means that charitable entities whose approval expires on 31st March, 2025, can still apply for renewal up to 30th September 2024 since the application for renewal has to be made six months prior to the expiry of approval. Such applications would be processed, and approvals continued to be granted under section 10(23C). Given that the approval would normally be valid for 5 years, they can therefore continue to claim exemption under sub-clauses (iv), (v), (vi) or (via) till 31st March, 2030 (AY 2030-31). Thereafter, they will have to switch to registration under section 12A, and would then be entitled to exemption under section 11 post registration with effect from A.Y. 2031-32.

In case such entities are late in making an application for approval (beyond 30th September, 2024), they will then have to apply for registration under section 12A, and post registration which would be granted with effect from
1st April, 2025, their claim for exemption would then be under section 11 with effect from A.Y. 2026-27.

In case of other entities whose approval under any of the above 4 sub-clauses of section 10(23C) expires after 31st March 2025, if such approval is expiring shortly after March 2025, such entities may choose to make an application before 1st October, 2024 or thereafter, since there is only a minimum prior period for application (since the application has to be made at least 6 months prior to the expiry of approval), and there is no specification as to the maximum prior period within which one can make such an application. Depending on whether the application for renewal is made before 1st October, 2024 or thereafter, the application would have to be made either under any of the above 4 sub-clauses of section 10(23C) or under section 12A, respectively.

All entities whose approval under any of these 4 sub-clauses of section 10(23C) is in force can continue to claim exemption under section 10(23C) till the expiry of that approval.

Effectively therefore, over the next 5 years, all approvals under section 10(23C) will cease to have effect, and entities would migrate to registration under section 12A and consequent claim of exemption under section 11.

Further, exemption for charitable entities under the various other sub-clauses of section 10(23C) and other clauses of section 10 are not being phased out and would continue. These include:

• Educational or medical institutions wholly or substantially financed by the Government or having gross receipts of less than ₹5 crore – 10(23C)(iiiab), (iiiac),(iiiad) and (iiiae),
• Research associations – 10(21),
• Professional regulatory bodies – 10(23A),
• Khadi and village industries development institutions – 10(23B),
• Regulatory bodies for charitable or religious trusts – 10(23BBA),
• Investor Protection Funds of stock exchanges, commodity exchanges and depositories – 10(23EA), 10(23EC) and 10(23ED),
• Core Settlement Guarantee Fund of clearing corporation – 10(23EE),
• Notified bodies set up by the Government – 10(46),
• Housing Boards, Planning & Development Authorities, and other regulatory bodies set up under a State or Central Act – 10(46A), etc.

While no amendment is made to section 11(5) regarding permitted investments, the provisions of section 13(1)(d) have been amended, by adding one more exception in the proviso to section 13(1)(d). The following assets have now been also excluded from the purview of section 13(1)(d):

a. Any asset held as part of the corpus of the trust as on 1st June, 1973;

b. Equity shares of a public company held by the trust as part of the corpus as on 1st June, 1998;

c. Any accretion to such shares held as part of corpus (bonus shares, etc);

d. Debentures issued by a company/corporation acquired by the trust before 1st March, 1983;

e. Jewellery, furniture or other notified article received by way of voluntary contribution. No other article seems to have been notified so far.

AMENDMENT OF SECTION 11(7)

Section 11(7) of the Income Tax Act provides that a trust granted registration under section 12AB cannot claim exemption under section 10, except under certain clauses of section 10. These clauses were:

• agricultural income – clause (1),
• educational, medical and other institutions – clause (23C),
• Investor Protection Fund of Commodity Exchanges – clause (23EC),
• notified bodies set up by the Government – clause (46), and
• Housing Boards, Planning & Development Authorities, and other regulatory bodies set up under a State or Central Act – clause (46A).

In some of these cases, once they are approved or notified under the respective clauses, their section 12AB registration becomes inoperative, and can be made operative only by making an application to the Commissioner for doing so. Once section 12AB registration becomes operative, the approval or notification under the respective clause ceases to have effect, and thereafter no claim for exemption can be made under those respective clauses of section 10.

The Finance (No 2) Act, 2024 has added clauses (23EA) – Investor Protection Fund of a stock exchange, (23ED) – Investor Protection Fund of a depository, and (46B) – National Credit Guarantee Trustee Company and trusts managed by it, to these alternative clauses of exemption.

CONDONATION OF DELAY IN MAKING APPLICATION FOR REGISTRATION/RENEWAL OF REGISTRATION U/S 12A

Section 12A(1)(ac) of the Income Tax Act provides that a trust would be entitled to exemption under sections 11 and 12 if it makes an application for registration to the Commissioner/Principal Commissioner and application for renewal within the specified timelines. Given the complex provisions specifying the timelines, with six alternative clauses, many charitable organisations mistakenly filed applications for registration/renewal of registration late. Their applications for registration/renewal of registration were rejected by the Commissioner on the ground that the application was made beyond the prescribed time.

Given the fact that such rejection had severe consequences of applicability of the provisions of tax on accreted income under section 115TD, such trusts filed appeals to the Tribunal against such rejection as well as made applications to the CBDT seeking condonation of delay in filing such applications. Almost all the appeals to the tribunal were decided in favour of the trusts, with the matters being sent back to the Commissioner for processing the application on the merits of each case. The CBDT granted condonations from time to time, the latest condonation being vide CBDT circular No. 7/2024 dated 25th April, 2024, whereunder belated/rectified applications could be made till 30th June, 2024.

The Finance (No. 2) Act, 2024 has now inserted a proviso to section 12A(1)(ac) with effect from 1st October, 2024, giving powers to the Commissioner/Principal Commissioner to condone any delay in making of such applications if he considers that there is a reasonable cause for delay in filing the application. On condonation of delay, the application shall be deemed to have been filed within time.

By this amendment, on or after 1st October, 2024 the Commissioner can consider condonation of any genuine delays in making of such applications which may be noticed during the course of processing such applications, irrespective of whether the delay was before or after 1st October, 2024. This is a much-needed amendment, so that trusts now need not have their applications rejected merely on account of delay in filing the application due to the Commissioner not having the powers to condone any delay.

MODIFICATION OF TIME LIMITS FOR PROCESSING APPLICATIONS UNDER SECTION 12A(1)(ac)

The applications for registration/renewal of registration under section 12A(1)(ac) are required to be processed by the Commissioner/Principal Commissioner within the timelines specified in section 12AB(3), which requires the order under section 12AB(1) to be passed within such timelines. These timelines have now been amended as under with effect from 1st October 2024:

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