CA Surekha S Ahuja
The buy-back of shares has long been a preferred mechanism for Indian companies to return surplus funds to shareholders, restructure capital, and improve earnings per share (EPS). However, the Finance (No. 2) Act, 2024 fundamentally reshaped its taxation landscape — shifting the tax incidence from companies to shareholders.
Until 30 September 2024, under the company-level tax regime of Section 115QA, shareholders, including directors and promoters, enjoyed complete exemption under Section 10(34A). From 1 October 2024, however, buy-back proceeds are treated as “deemed dividends” under Section 2(22)(f) — fully taxable in shareholders’ hands at applicable slab rates, potentially as high as 51.12% (including surcharge and cess).
This change has made tax planning for buy-backs in FY 2024–25 (transition year) and FY 2025–26 onwards critical for both companies and directors.
Evolution of Law
| Period | Legal Basis | Tax Incidence | Key Sections | Tax Rate | Exemption |
|---|---|---|---|---|---|
| Up to 30.09.2024 | Section 115QA, Rule 40BB | Company level | 115QA, 10(34A) | 23.296% on “distributed income” | 100% exempt for shareholders |
| From 01.10.2024 | Section 2(22)(f) | Shareholder level | 2(22)(f), 115-O omitted, 46A amended | Slab rate up to 51.12% | Exemption withdrawn |
Intent of Amendment:
To restore tax parity between dividends and buy-backs, curb promoter-led arbitrage, prevent EPS manipulation, and ensure equitable treatment of minority shareholders.
Key Tax Mechanism Comparison
| Particular | Pre-1 Oct 2024 (115QA) | Post-1 Oct 2024 (2(22)(f)) |
|---|---|---|
| Taxpayer | Company | Shareholder |
| Tax Rate | 23.296% | Up to 51.12% |
| Tax Base | Buy-back consideration minus issue price (Rule 40BB) | Entire buy-back consideration |
| Shareholder Tax | Nil (Section 10(34A)) | Full deemed dividend income |
| Capital Gains | Not applicable | Capital loss = cost of acquisition (no indexation) |
| Carry-forward of Loss | N.A. | 8 years (Section 74) |
| TDS Obligation | None | 10% (resident) / DTAA (non-resident) |
| GAAR Risk | Moderate | High for promoter-centric schemes |
Transitional Tax Planning in FY 2024–25
During FY 2024–25, transactions completed before 30 September 2024 remained under the old regime, while those executed on or after 1 October 2024 faced the new shareholder-tax regime.
Thus, FY 2024–25 became the final window for company-level buy-back tax planning.
Pre–October 2024 Strategy (Old Regime):
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Buy-back before 30.09.2024: Company pays 23.296%; shareholders receive tax-free income.
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Ideal for: Director/promoter-heavy holdings and companies with substantial reserves.
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Tactics used:
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Preferential allotment or rights issue at higher price before buy-back of older low-cost shares.
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Buy-back to achieve promoter consolidation or capital restructuring without personal tax impact.
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Post–October 2024 Strategy (New Regime):
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Buy-back after 01.10.2024: Tax shifted to shareholders.
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Directors/promoters: Taxed at slab rates; can book capital loss equal to cost of acquisition.
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Company: No tax but must deduct TDS and comply with deemed dividend reporting.
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Revised approach:
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Opt for capital reduction u/s 66 of Companies Act, 2013 for balanced tax outcome.
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Explore dividend payout if shareholder tax bracket is lower.
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Consider gifting shares to family members in lower slabs before buy-back.
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Scenario-Wise Income-Tax Implications
Let’s illustrate through five representative cases relevant for professional planning:
(A) Shares Issued in FY 2015–16 at ₹10 — Bought Back in FY 2024–25 (Old Regime)
Company:
Distributed income = ₹890 (₹900 – ₹10) → taxed @ 23.296%.
Shareholder:
Exempt u/s 10(34A). No capital gain/loss.
Most tax-efficient model — company pays, shareholder receives tax-free.
(B) ESOP Shares Issued in FY 2018–19 at ₹10 (FMV ₹200) — Bought Back in FY 2024–25
At exercise (2018–19): ₹190/share taxed as salary.
At buy-back: Company taxed @ 23.296% on ₹890; shareholder exempt.
No double taxation. Salary perquisite already taxed earlier.
(C) Rights Shares Issued in FY 2024–25 at ₹900 — Company Buys Back Old Shares (₹10 Issue Price)
Objective: Capital restructuring before the 1 Oct 2024 deadline.
Old shares bought back → company pays tax @ 23.296%.
New rights shares held → higher capital base for future sale.
Partial tax efficiency achieved when paid-up capital is high — the company absorbs the tax once, while shareholders retain new shares for future appreciation.
(D) Only Old Shares Bought Back; Rights Shares Retained for Future
Old ₹10 shares bought back → company pays tax @ 23.296%.
Rights shares (₹900) remain; if later sold below cost, capital loss allowable u/s 74.
Loss set-off opportunity emerges in later years.
(E) Shares Purchased from Another Shareholder at Same Price as Original Issue (₹10) — Buy-Back at ₹900
Example:
A director buys shares in FY 2023–24 at ₹10. Company originally issued them in FY 2015–16 at ₹10. Buy-back happens in FY 2024–25 at ₹900.
(i) Under Section 115QA (Before 1 Oct 2024)
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Company taxed on ₹890/share (₹900 – ₹10).
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Shareholder exempt under Section 10(34A).
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Buyer’s purchase price irrelevant — tax linked to original issue price.
No double taxation; ideal for restructuring before the deadline.
(ii) Under Section 2(22)(f) (From 1 Oct 2024)
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Entire ₹900 treated as deemed dividend in shareholder’s hands.
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Capital loss = ₹10 (cost of acquisition) allowed to be carried forward 8 years.
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TDS @ 10% by company.
Tax burden shifts to shareholder, but capital loss becomes compensatory.
Numerical Illustration:
A director purchased shares for ₹10 lakh.
Company buys back at ₹40 lakh.
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Taxable income (dividend): ₹40 lakh → taxed up to 51.12%.
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Capital loss: ₹10 lakh (can offset future capital gains).
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If future gain = ₹20 lakh → ₹10 lakh offset → taxable ₹10 lakh only.
Partial tax optimization possible through capital loss leverage.
Tax Planning & Compliance Framework for FY 2025–26
With the new shareholder-tax regime fully operative from FY 2025–26, companies and directors must realign their strategies.
(A) For Companies
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No buy-back tax under 115QA.
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Deduct TDS @ 10% u/s 194K or 195 (as applicable).
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Ensure Section 2(22)(f) compliance, valuation report, and justification of buy-back rationale to avoid GAAR exposure.
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Maintain transparent board minutes, shareholder approvals, and SEBI compliance (Rule 17, Buy-back Regulations).
(B) For Directors/Promoters (Shareholders)
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Tax burden rises steeply (up to 51.12%), but capital loss serves as a limited compensatory tool.
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Plan timing: If buy-back value < cost → immediate capital loss claim.
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Intra-family transfers before buy-back can help reallocate income to lower slabs.
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Maintain accurate documentation of acquisition cost and transaction trail.
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Prefer capital reduction over buy-back for cleaner tax outcomes.
(C) For ESOP Holders
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Buy-back proceeds = deemed dividend; perquisite already taxed earlier.
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Capital loss (equal to cost of acquisition) allowable u/s 74.
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Ensure employer deducts TDS correctly and reflects in Form 16 / Form 26AS.
GAAR and Judicial Backdrop
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Cognizant Technology Solutions (ITAT Chennai, 2023):
Court-approved buy-back-cum-capital-reduction scheme held colourable; GAAR applied.
→ Reinforces need for commercial substance and proper structuring. -
CBDT Circular (2024):
Clarifies buy-back post-1 Oct 2024 attracts TDS under Section 194K / 195. -
SEBI Regulations (2018, amended 2023):
Prescribe limits (25% of paid-up capital + reserves), tender offer norms, and 15% reservation for small shareholders.
Policy & Economic Rationale Behind the Shift
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Tax Equity: Align buy-backs with dividend taxation.
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Revenue Protection: Eliminate promoter-led tax arbitrage.
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Market Stability: Prevent EPS manipulation through repeated buy-backs.
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Fairness: Avoid minority shareholders indirectly bearing company-level buy-back tax.
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Transparency: Encourage declared dividend routes over disguised capital returns.
Strategic Takeaways for FY 2025–26 Onwards
| Strategy | Benefit | Risk/Compliance Focus |
|---|---|---|
| Capital Reduction (Sec. 66) | Returns capital with balanced tax incidence | Procedural complexity |
| Gifting shares before buy-back | Family-level tax optimization | Document gift deeds, avoid circular transfers |
| Synchronize buy-back losses with other capital gains | Tax-efficient offset | Timing and reporting precision |
| Avoid preferential + buy-back combos | GAAR exposure | Maintain genuine commercial purpose |
| Maintain valuation & rationale reports | Defence under scrutiny | Board & shareholder resolutions critical |
Conclusion
The abolition of Section 115QA marks a decisive shift in India’s tax policy — from corporate to shareholder accountability.
While the old regime allowed tax-free exits for directors and promoters, the new regime demands careful, forward-looking planning.
Companies with high paid-up capital may still achieve partial tax efficiency through capital reduction or rights-cum-buy-back structures, but only with sound commercial logic and transparent documentation.
For shareholders — especially directors and promoters — the focus must now move from zero-tax extraction to structured tax optimization: leveraging capital losses, intra-family transfers, and timing of transactions to sustain overall tax efficiency within the ambit of law.
