Buyback tax, a word of caution

By Vikas Vasal

  • 08 Aug 2016

Under India’s tax laws, a company declaring a dividend is liable to pay the dividend distribution tax (DDT). The dividends are not taxable at the hands of the recipient or the shareholders. Thus, foreign shareholders are not able to claim any relief for concessional tax treatment under the tax treaties that India has entered into with other countries.  Also, it is debatable whether the foreign shareholders can claim credit in the foreign tax jurisdiction for the DDT paid by the Indian company. 

In view of the above, some companies exercised their option to buy back their shares. Earlier, the income or gains arising from the buyback of shares by a company was taxable in the hands of the shareholders. Therefore, foreign shareholders from a tax friendly jurisdiction were eligible to claim treaty relief, as per the respective treaties.

To bring such cases under the tax net, the government introduced a tax on the distributed income by a company to its shareholders on buyback of unlisted shares at the rate of 20% plus surcharge and education cess. 

Shah Junaid/VCCircle

As is the case with any new tax, many issues surfaced in case of buyback of shares under different scenarios, relating to ‘distributed income’, which has been defined to mean the consideration paid by the company on buyback of shares as reduced by the amount, which was received by the company for issue of such shares, determined in the manner as may be prescribed.

Recently, the draft rules have been issued which prescribe the methodology to determine the amount received for issue of shares under a few scenarios.  Comments have also been invited from different stakeholders. Following points highlight the scenarios that government has proposed to address through these draft rules.

In case the shares are issued upon subscription, it has been clarified that the paid-up amount along with the premium received by the company shall be considered to be the amount received by the company. In case, before the buyback, any sum has been returned by the company, then such sum shall be reduced from the amount received by the company for this purpose.

Interestingly, merger/amalgamation and demerger scenarios have also been covered under the draft rules. In case shares are issued by an amalgamated company, under a scheme of amalgamation, in lieu of the shares of an amalgamating company, it has been clarified that the amount received by the amalgamating company in respect of shares, determined in accordance with this rule shall be considered to be the amount received by the amalgamated company in respect of the shares so issued by it.

In case of demerger, the amount received by the resulting company in respect of shares issued by it under a scheme of demerger shall be the amount which bears to the amount received by the demerged company in respect of the original shares determined in accordance with this rule, the same proportion as the net book value of the assets transferred in a demerger bears to the net worth of the demerged company immediately before such demerger. Further, the amount received by the demerged company in respect of the original shares in the demerged company shall be deemed to have been reduced by the amount determined as aforesaid.

In case shares are issued on conversion of a bond or debenture, debenture stock or deposit certificate, it has been clarified that it shall be the amount received by the company in respect of the instrument so converted.

In case shares are issued without any consideration on the basis of existing shareholding, the amount received by the company shall be considered to be nil. In other cases (residuary category), the face value of shares shall be the amount received by the company.

These draft rules provide clarity in the above scenarios. However, there are few areas that require some consideration. In respect of shares issued for kind, share swaps, employee stock options, sweat equity etc. whether the determination will be done under the residuary category at face value in case of buyback of shares or a different methodology will be prescribed later. Similarly, some guidance is required in case of shares issued in dematerialized form, where the shares issued under different scenarios lose their individual identity.

Overall, these draft rules are in line with the government’s approach in the recent past to provide certainty and clarity to the tax payers, increase the tax net, plug loopholes and usher in an era of non-adversarial tax regime, where tax payers have clarity on the tax implications arising from a particular transaction.

Vikas Vasal is Partner-tax at KPMG in India

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