Buyback Tax Impact
Retail investors to be hit harder by new share buy-back rule from Oct 1: Here’s the maths
Sept 1, 2024
Tax on buy-back of shares has an oscillating history. Prior to 2013, share buybacks were taxable in the hands of the shareholders as capital gain. The old rule allowed the deduction of cost of acquisition to calculate the capital gains. With the introduction of dividend distribution tax in 2013, they were taxed in the hands of the company doing the buy-back. In the July 2024 budget, we are back to taxing the buy-backs in the hands of the shareholders. While the intention behind this is well understood, the way they have treated the taxability of the share buy-back is quite unusual and does impact the retail investor with a higher effective tax rate.
Buy-back tax rules till September 30, 2024
Before the 2024 budget, the share buy-back was taxed in the hands of the company. For example, if company X buys back its shares, the company would pay the tax on the buy-back and any amount received in the hands of the shareholder was tax-free. In this, though the gains were made by the investors, the tax was paid by the company. This rule is applicable until September 30, 2024.
This method of paying tax was considered unfair. In this since the taxes were paid by the company.the impact of buy-back tax was on all the shareholders, irrespective of whether they participated in buy-back or not. Accordingly, there was a necessity to change the tax law to ensure that only those shareholders who participated in the buy-back program pays tax.
New buy-back tax rules from October 1, 2024
The easiest and the most logical way to go about this was to treat buy-back of shares as taxable in the hands of the shareholders, just like any other capital gains. However, the government had other plans.
In the 2024 budget, the new rule (effective from October 1, 2024) states that the buyback amount received in the hands of shareholders is a form of dividend and such amount should be taxed as dividend. The purchase cost of shares bought back by the company shall be treated as capital loss which can be set-off against any other capital gains during the year and if the capital gains during the year are inadequate, it can be carried forward and set-off against the future capital gains in subsequent 8 years.
How new rule leads to loss for small retail investors
On first reading, the new rule seems fair except for the probable timing difference in taxing the buy-back as a dividend and set-off of the capital loss in certain cases. However, due to the muddled tax laws of India, the new rule inadvertently impacts small investors with a higher effective tax rate. This can be best explained through an example.
Ms. A (an investor with lower capital gains) and Ms. B (an investor with significant capital gains), both, had shares of Company X and Company Y. During the year, Company X carried out buyback of its shares. Further, Ms. A and Ms. B sold their shares in Company Y, however, Ms. B sold more shares of Company Y than Ms. A. These shares were held by both of them for more than a year and qualify as long-term assets.
|
|
Ms. A (Investor with lower capital gains) |
Ms. B (Investor with significant capital gains) |
||
|
|
Company X |
Company Y |
Company X |
Company Y |
|
Purchase Cost |
90,000 |
90,000 |
90,000 |
215,000 |
|
Buyback Price |
100,000 |
– |
100,000 |
– |
|
Sale Price |
– |
180,000 |
– |
430,000 |
|
Profit |
10,000 |
90,000 |
10,000 |
215,000 |
|
Total Profit (A) |
100,000 |
225,000 |
||
Now, let us calculate the tax liability for both of them.
|
|
Ms. A (Investor with lower capital gains) |
Ms. B (Investor with significant capital gains) |
|
Company X |
|
|
|
Sale Price |
0 |
0 |
|
Less: Purchase Price |
90,000 |
90,000 |
|
Capital Gain / (Loss) (B) |
(90,000) |
(90,000) |
|
|
|
|
|
Company Y |
|
|
|
Sale Price |
180,000 |
430,000 |
|
Less: Purchase Price |
90,000 |
215,000 |
|
Capital Gain / (Loss) (C) |
90,000 |
215,000 |
|
|
|
|
|
Dividend Income(1) |
100,000 |
100,000 |
|
|
|
|
|
Tax Liability |
|
|
|
Long Term Capital Gain (B + C) |
0 |
125,000 |
|
Less: Exemption (2) |
– |
(125,000) |
|
Long Term Capital Gain |
0 |
0 |
|
Tax on Long Term Capital Gain (@12.5%)(3) |
0 |
0 |
|
|
|
|
|
Tax on Dividend Income (30%)(4) |
30,000 |
30,000 |
|
|
|
|
|
Net Tax Liability |
30,000 |
30,000 |
|
Pre-tax Profit (As per A) |
100,000 |
225,000 |
|
Effective Tax Rate |
30% |
13.3% |
Notes:
- Any amount received from buy-back is considered as dividend.
- Under Section 112A of Income Tax Act, long term capital gains up to Rs 1.25 lakh are tax exempt.
- Surcharge and education cess are ignored for simplicity purposes. Adding them will increase the tax difference.
- Assumption of applicable tax slab of 30%
The increase in effective tax rate for investors with lower capital gains is on account of changing the nature of buyback proceeds from capital receipt to dividend receipt and their consequent inability to take the benefit of LTCG exemption of Rs 1.25 lakh. This could well have been avoided if the buyback proceeds were considered for capital gains as against dividend income.
It will be wise for the government to have a re-look at this and make the changes fair and equitable for all taxpayers.
By: Vishal Shah, SEBI Registered Investment Advisor and founder of Bachhat
Sept 1, 2024
(Disclaimer: This is not a financial advice and the readers should reach out to registered investment advisors for any financial advice. Registration granted by SEBI, membership of BASL and certification from National Institute of Securities Markets (NISM) in no way guarantee performance of the intermediary or provide any assurance of returns to investors. Investment in securities market are subject to market risks. Read all the related documents carefully before investing.)