Starting in October 2024, share buyback proceeds will be treated as dividend income and taxed according to the shareholder’s applicable income tax slab.
Starting October 1, 2024, the landscape for share buyback in India will undergo a significant transformation. The government’s new income tax rules shift the tax burden from companies to shareholders, fundamentally altering how companies approach capital distribution and investment strategies.
Current Share Buyback Tax Framework
Under the existing tax regime, domestic companies conducting share buybacks are subject to a 20% tax on the net distributable income, with shareholders receiving the proceeds tax-free. This share buyback tax mirrors the now-defunct dividend distribution tax (DDT), which was applicable until March 2020. Since April 2020, dividends have been taxed in the hands of shareholders. However, under the new rules effective from October 2024, the entire amount received from buybacks will be taxed as dividend income for shareholders.
Key Changes in Buyback Taxation
Starting in October 2024, share buyback proceeds will be treated as dividend income and taxed according to the shareholder’s applicable income tax slab. Companies will be responsible for withholding tax (TDS) at a rate of 10% for resident individuals (if the buyback proceeds are Rs. 5,000 or more) and 20% for non-resident individuals, subject to tax treaty benefits.
Capital Gains and Losses
One notable change is that buyback proceeds will no longer be taxed as capital gains. Instead, the cost of acquiring shares tendered in a buyback will be classified as a capital loss (either short-term or long-term) for shareholders. This loss can be offset against other capital gains or carried forward for up to eight years, offering a potential but deferred tax benefit.
Impact on Companies and Shareholders
This shift in tax liability could discourage companies from favouring share buybacks as a method of returning capital to shareholders, especially if the new tax burden on shareholders outweighs the benefits.
Beneficiaries of the New Rules
Mutual funds stand to gain from the new buyback tax rules, as they often pay minimal or no taxes due to available exemptions under income tax laws. Additionally, non-resident shareholders could benefit from leveraging lower tax rates under tax treaties, typically ranging from 5% to 15%. This change allows non-residents to claim tax credits in their home countries, a benefit not available under the current regime.
For example, UK shareholders in Indian companies could benefit from the India-UK tax treaty, which offers a lower tax rate of 10% or 15% on dividend income. However, the applicability of treaty benefits may vary depending on the specific tax treaty and jurisdiction, such as the India-Mauritius tax treaty.
Challenges for Resident Shareholders
Resident shareholders, particularly those in higher tax brackets, may face an increased tax burden under the new rules. This could make share buybacks less appealing, as the entire buyback amount is now taxable, not just the net gain. High-net-worth individuals, in particular, could see a substantial tax impact, potentially reducing the attractiveness of buybacks as a capital return strategy.
Broader Market Implications
The new buyback tax rules are likely to have a ripple effect on the financial markets. With buybacks becoming less attractive, companies may need to rethink their capital distribution strategies. This shift could lead to a reduction in buyback activities, impacting overall market liquidity. Additionally, companies will face increased compliance and reporting requirements to adhere to the new tax provisions.
Conclusion
While the new buyback tax rules aim to promote fairness and reduce tax arbitrage between dividends and buybacks, the increased tax burden on shareholders and the deferred benefits of capital losses pose significant challenges. Companies and investors will need to carefully navigate these changes, reassessing their strategies to optimize returns and ensure compliance with the new regulations.
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