The Finance Bill, 2013 has proposed to introduce a tax on the income distributed by a domestic company through buy-back of its shares, other than shares listed on a recognized stock exchange.
As per the proposed provisions, the consideration paid by the company for the buy-back of shares in excess of the amount received by the company on issue of such shares, referred to as “distributed incomesâ€, would be chargeable to tax at the rate of 20% (plus applicable surcharge and cess) in the hands of the company making the buy-back. Like Dividend Distribution Tax (“DDTâ€), the proposed tax would be in addition to the regular income tax, if any, payable by the company in respect of its total income. However, this tax is proposed to be a final levy in respect of such income and there would be no tax liability in India in the hands of the shareholders.
The proposed provisions will have a significant adverse impact on non-resident foreign investors who have made investments from countries such as Mauritius, Singapore, etc. where buy-back of shares would not have been taxable in India due to availability of tax treaty benefits.
The proposed provisions are also departure from the Shome Committee Recommendations on GAAR which clearly emphasize the fact that whether to pay dividend to its shareholder or buy-back its shares or to issue bonus shares is a business choice of a company. Further, the choice and timing thereof is a strategic policy decision which should not be questioned under GAAR.
Further, several aspects of the proposal could have significant implications for the company as well as the shareholders, some of which may not even have been envisaged or intended.
To begin with, the tax rate proposed is considerably higher than the present rate of DDT i.e. 15% (plus applicable surcharge and cess). That apart, it is double the rate specified by the Finance Act, 2012 for non-residents in respect of long-term capital gains arising from the transfer unlisted securities under the domestic tax law. If the rationale for introducing the proposed tax was to deem the transaction as akin to a dividend payout, it seems rather unreasonable to suggest a rate which is not only different from DDT but also higher than the rate otherwise applicable to non-residents under the domestic tax laws.
The next issue which requires attention is the mechanism prescribed for computing the amount of “distributed incomeâ€. As per the proposed provisions, the consideration for the buy-back would be reduced by the amount received by company on issue of the shares. This seems to presuppose that all buy-backs are made utilizing free reserves of the company, overlooking the fact that besides free reserves, a buy-back could be undertaken from the balance in securities premium account or proceeds of some other issue of shares or specified securities.
Further, it does not consider the scenario where the shares may have been acquired by the present shareholder (by way of transfer) at a price which is higher than the amount received by the company on issue of the shares.
For instance, the shares issued by the company to A at a price of Rs. 10 were acquired by B for Rs. 40. Thereafter, at the time of buy-back of the shares from B, say at Rs. 100, the amount liable to tax in the hands of the company would be Rs. 90 (and not Rs. 60 which would otherwise have been the amount taxable as capital gains in the hands of the shareholder B).
The other and more critical aspect is that the proposed tax is a tax on the company buying back its shares rather than a tax on the shareholder. Thus, there would be no recourse to the tax treaty to seek any exemption / beneficial provision which may have otherwise been available to non-resident shareholders like in the case of capital gains.
Further, the characterization of the income (i.e. capital gains or dividend) in the hands of the home country may be governed by its laws and accordingly, there could be an inconsistency in the tax treatment applied. This could result in a tax cost for the shareholder in the home country as credit for the tax paid by the company in India may not be available against the tax payable by the shareholder in the home country.
If the proposed amendment is enacted in its current form, most unlisted companies may avoid buy-back, unless absolutely necessary. Nonetheless, while structuring the transaction, the overall implications, including of issues highlighted above, should be duly examined and considered.
(Anil Talreja is a partner (M&A Tax) at Deloitte Haskins & Sells. Contributions from Vishal Hakani – Senior Manager and Shivali Valecha –Deputy Manager – Deloitte Haskins & Sells. Views expressed are personal.)
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