“BUY-BACK OF SHARES AND SECURITIES OF

COMPANY – TAXATION PERSPECTIVE”

Project submitted to the School of Excellence in Law in partial

fulfillment of the requirement for the Degree of L.L.M (BUSINESS
LAW) for the subject
(CORPORATE TAXATION)
Submitted by

NAME :R.K.VARSHINI

COURSE : L.L.M- II Year ( BUSINESS LAW)

SEMESTER: IV SEMESTER

REGISTER NUMBER: BUL1919

SCHOOL OF EXCELLENCE IN LAW (SOEL)

THE TAMIL NADU DR. AMBEDKAR LAW UNIVERSITY

 TABLE OF CONTENTS
INTRODUCTION:

1. BUY BACK OF SHARES AND SECURITIES: AN OVERVIEW

1.1. Concept of Buyback of Shares

1.2. Reasons to Choose the Process for Buyback of Shares in India

1.3. Laws Governing the Process for Buyback of Shares in India

1.3.1. Sources of Buy-back

1.3.2. Modes of Buy Back

1.3.3. Conditions for Buy-Back

1.3.4. Circumstances in which Buy-back is prohibited

1.3.5. Securities which can't be brought back

1.4 Procedure for Buyback of Shares India

2. TAXATION OF BUY-BACK SHARES

2.1. Taxability of dividend distributed by company to its shareholders

2.2. Taxation on Buy Back of Shares by Unlisted Companies

2.2.1. What does Section 115QA say?

2.2.2. The provision of Section 115QA is not applicable under all of the
situations below

2. 3. Buy Back of Shares – Whether section 56(2)(x) gets invoked?

2.4. Buy back of shares – whether section 50ca gets invoked?

2.5. Determination of value of shares for Buy Back

2.6. Buy back from existing shareholders on proportionate basis

2.7. Taxability in the hands of shareholders not participating in share buyback scheme

2.8. General Anti Avoidance Rule (GAAR) – Implications Thereof

 2.8.1. Whether incorrect determination of price for buy back of shares may fall
within the rigors of GAAR?

2.9. Non-Resident Shareholders

2.10. Stamp duty on Buy Back

CONCLUSION

REFERENCE

BIBLIOGRAPHY

WEBLIOGRAPHY
INTRODUCTION:

Buy-Back is one of the important provisions in the Companies Act, 2013, which enables a
company to purchase its own shares. Amongst other host of reasons, a program of buy-back is
resorted to by a company to distribute surplus cash to its shareholders or to even provide
investors an opportunity to exit from their investment, especially in case of unlisted/private
companies.

A company having distributable reserves has two options to distribute the same to its
shareholders:

(i) declares dividend to shareholders; or

(ii) purchases its own shares (i.e., buy-back of shares) at a consideration fixed by it.

The paper is apropos provisions relating to buy-back of Equity Shares, in case of unlisted
companies, under the Companies Act, 2013 and also the related tax incidence under the Income
Tax Act, 1961 (ITA). The endeavour, through the present paper, is also to explain that with the
change regarding taxability of dividends in the hands of shareholders, buy back of shares can
prove to be a tax efficient tool for unlisted companies vis-à-vis distribution of dividend.

1. BUY BACK OF SHARES AND SECURITIES: AN OVERVIEW

1.1. Concept of Buyback of Shares

The term Buyback of Shares or Stock Buyback denotes a corporate action wherein the company
repurchases its issued shares from the existing shareholders. Further, during stock buyback, the
price of a share is usually higher than the market price.1 Also, it shall be relevant to state that
there must be at least one year gap between two buybacks, and the debt – equity ratio for the
company must not exceed the threshold of 2:1.2

1.2. Reasons to Choose the Process for Buyback of Shares in India

The reasons to choose the process for Buyback of Shares in India are as follows:

• Increases Earning Per Share of the Company;

1
Arak, Marcelle, (1999), “Stock Buybacks and Earnings Per Share”, Journal of Financial Education, Vol.25,
pp.21-25.
2
Debanshu Mukherjee and Rachit Jain., Buy-back of Shares:A lucrative proposition for companies”, , 2008 82
SCL 26 available at http://jurisonline.in/2008/09/buy-back-of-securities-a-criticalapproach/(accessed on 25th of
March, 2021)
 • Offers Funds instead of Dividends to Shareholders;
• Protects Company against Hostile Takeovers;
• Maintains Debt Equity Ratio;
• Provide an Exit Route to the Shareholders;
• Increases Return on Capital;
• Increases Return on Investment;
• Services Equity more Effectively;
• Reduces Share Capital of the Company;

1.3. Laws Governing the Process for Buyback of Shares in India

The laws governing the process for Buyback of Shares in India are as follows:

• Section 68 – 70 of the Companies Act 2013;

• Rule 17 of the Companies (Share Capital & Debentures) Rules 2014;
• SEBI (Buyback of Securities Amendment) Regulations 2013;

1.3.1. Sources of BuyBack:

Pursuant to section 68 (1) of Companies Act, 2013, a company whether public or private, may
purchase its own shares or other *specified securities* out of following sources: -

• Its free reserves; or

• The securities premium account; or
• The proceeds of the issue of any shares or other specified securities.

However, buy-back of any kind of shares or other specified securities shall not be made out
of the proceeds of an earlier issue of the same kind of shares or other specified securities.3

** Specified Securities includes employees stock option or other securities as may be notified
by the Central Government from time to time.

1.3.2. Modes of Buy Back: A company may buy-back its shares by any of the following modes:

• From the existing shareholders on a proportionate basis; or

3
Abhinav Singh, Buy Back of Securities – An Overview, available at
http://www.goforthelaw.com/articles/fromlawstu/article40.htm”(accessed on 25th March, 2021)
 • From the open market: -
• Book Building process
• Stock Exchange; or4
• From odd lot holders, i.e., where the lots of shares is smaller than tradable lot; or
• By purchasing the shares issued to employees of the company pursuant to scheme of
stock option or sweat equity

1.3.3. Conditions for Buy-Back:

Pursuant to section 68 (2) and 68 (7) of Companies Act, 2013, no company shall purchase its
own shares or other specified securities unless the following conditions are fulfilled:

• Buy-back is authorized by the Articles of Association of the Company;

• Board Resolution is passed where the buy-back is up to 10% or less of the total paid-
up equity capital and free reserves of the company; whereas, a Special
Resolution would be required at a General Meeting of the company where the buy-
back is more than 10% of the total paid-up equity capital and free reserves of the
company but upto 25% or less of the aggregate of paid-up capital (equity and
preference) and free reserves of the company.
• Maximum number of shares that can be bought back in any financial year shall not
exceed 25% of paid-up equity capital;
• The ratio of the aggregate of secured and unsecured debts owed by the company after
buy-back cannot be more than 2:1 ratio i.e., twice the paid-up capital and its free
reserves.5
• All the shares or other specified securities for buy-back should be fully paid-up;
• the buy-back of the shares or other specified securities listed on any recognized stockv
exchange are in accordance with the regulations made by SEBI.
• The buyback in respect of shares or other specified securities not listed on any
recognized stock exchange are in accordance with Companies (Share Capital and
Debentures) Rules, 2014.
• No offer of Buyback under this sub section shall be made within a period of one
year reckoned from the date of closure of the preceding offer of buy-back, if any.

4
Aarushijain, Buy Back of Securities: A Critical Approach, JurisOnline.in, September 6, 2008
5
Kavita Rekh, Buy-back of Shares or Specified Securities, available at
http://pkpandya.com/index.php?option=com_content&view=article&id=84(acessed on 25th March, 2021)
 • A Company should extinguish and physically destroy shares bought back within 7
days of completion of the buy-back.

1.3.4. Circumstances in which Buy-back is prohibited:

Pursuant to section 70(1) of Companies Act, 2013, no company shall directly or indirectly
purchase its own shares or other specified securities: -

• Through any subsidiary company including its own subsidiary companies;

• Through any investment company or group of investment companies
• If a default, is made by the company, in the repayment of deposits or interest payment
thereon, redemption of debentures or preference shares or payment of dividend to any
shareholder, or repayment of any term loan or interest payable thereon to any financial
institution or banking company.

However, buyback is not prohibited in aforesaid case if default is remedied and a period
of three years has lapsed after such default ceased to subsist.6

1.3.5. Securities which can’t be bought back:

The Company shall not buyback the following securities:

• Lock-in securities: Any securities issued by a listed company to its promoters or group
of employees, which subject to lock-in period are not available for buyback before
expiry of lock-in period.
• Partly paid-up shares: A company can’t buy-back its partly-paid up shares, on which
call money is in arrears.
• Non-transferrable securities: Those securities which are subject to lien or are pledged
or restricted by a court can’t be bought-back by the company.

1.4 Procedure for Buyback of Shares India

Now that you are aware of the conditions and if you meet the requirements, then you can go
for the process for buyback of shares in India7:

6
Swati Agarwal, Corporate Law and Govrenance ‐ Race of Bottom, Working Paper No 215, 2006
7
Aarushijain, Buy Back of Securities: A Critical Approach, SCL, , September 6, 2008, at p. 53
Step 1: Convene the Board Meeting
Firstly, the applicant needs to call a board meeting. For the same, a notice must be sent to the
directors of the company at least 7 days prior to the date of the meeting.

Step 2: Approval for EGM

In the board meeting, the applicant company needs to approve the buy-back, fix the date of the
EGM (Extra-Ordinary Meeting), and approve the EGM’s notice along with the explanatory
statement under Section 102.

Step 3: Send the notice for EGM

Once the notice for EGM is approved, the applicant must send it at least 21 days before the
date of the meeting.

Step 4: Passing of Special Resolution for Buy-Back of Shares

In the EGM, a special resolution must be passed for the approval of the Buy-back of shares.

Step 5: File SH-8

After the resolution has been passed, one must file the Letter of Offer in Form SH-8 with the
Registrar. Furthermore, the form must contain the signature of two directors of the company.

Step 6: Declaration of Solvency

Along with the form SH-8, you need to annex form SH-9 which is the declaration of solvency.
Again, the form must be signed by the two directors of the directors.

Step 7: Letter of Offer to the Shareholders

Within 20 days of the filing of SH-8 with the Registrar, the applicant needs to dispatch the
‘Letter of Offer’ to the shareholders of the company. Moreover, the Letter of Offer needs to be
kept open for at least 15 days and a maximum of 30 days.

Step 8: Acceptance of Offer

The Offer will be considered as accepted if there’s no communication of rejection within 21
days of offer closure.

Step 9: Opening of a Bank Account

So, if the shareholders have accepted the offer, the applicant company has to open a separate
bank account. Besides, the total consideration amount for the shares offered to be paid in Buy-
back should be deposited in a separate bank account. Furthermore, the consideration must be
paid within seven days of verification. Moreover, shares that are to be bought back should be
destroyed within seven days of the completion of buyback.

Step 10: Filing of SH-11

Lastly, the applicant needs to file form SH-11 within thirty days of the completion of the
buyback return.8

2. TAXATION OF BUY-BACK SHARES

Buy Back of shares means the company purchases its own shares from the existing
shareholders at a price decided by the Board or management as the case may be.

A company having distributable reserves has two options to distribute the same to its
shareholders:

(i) declares dividend to shareholders; or

(ii) purchases its own shares (i.e., buy-back of shares) at a consideration fixed by it.

Taxation perspective of Buy Back shares can be read in following heads:

1. Taxability of dividend distributed by company to its shareholders

2. Taxation on buy back of shares by unlisted companies

3. Buy Back of Shares – Whether section 56(2)(x) gets invoked?

4. Buy back of shares – whether section 50ca gets invoked?

5. Determination of value of shares for buy back

6. Buy back from existing shareholders on proportionate basis

7. Taxability in the hands of shareholders not participating in share buyback scheme

8
Akma Hidayu Dol and Abdul Wahid, (2013),” Measuring the Motivating Factors for Share Buyback: Evidence
from Malaysian Companies”, Online Journal of Social Sciences Research, ISSN 2277-0844; Volume 2, Issue 2,
pp. 35-50
8. General Anti Avoidance Rule (GAAR) – implications thereof

9. Non-Resident Shareholders

10. Stamp duty on buy back

2.1. Taxability of dividend distributed by company to its shareholders

Prior to Amendment, the domestic companies declaring, paying or distributing, dividend were
required to pay DDT at a tax rate of 20.35% (Rate of 15% – grossed up), as per Section 115-O
of the ITA. Also, dividend received by certain specified assessees (for instance Individuals,
but excluding domestic companies), in excess of INR 10 lakhs, was chargeable to tax at a flat
rate of 10%, as per Section 115BBDA.

The amendment through Finance Act, 2020, provides that DDT is no longer applicable to
dividends declared, paid or distributed on or after 1st April, 2020 (AY 2021-22 onwards).
Further, Section 10(34) which provided for exemption to income, in the nature of dividend
referred to in Section 115-O, i.e., dividends on which DDT had been paid, is no longer in force.
Also, Section 115BBDA levying tax, at the rate of 10%, on dividend income in excess of INR
10 lacs is no longer applicable.

Resultantly, dividends received, on or after 1st April, 2020, will be taxed in the hands of the
shareholders, at the rates applicable to them.

Although, through this amendment, there is respite for smaller shareholders, however, for
individual shareholders having taxable income of more than INR 50 Lacs and for corporate
shareholders, the effective tax rate on dividend is between 34.32% to 42.744%, depending
upon applicable slab rate and applicable surcharge.

2.2. Taxation on Buy Back of Shares by Unlisted Companies

The amount distributed as buy-back of shares was chargeable to capital gains. Being treated as
capital gains, the income tax was paid at lower rates on buyback of shares. In order to avoid
the tax, unlisted companies started resorting to buyback of shares instead of declaring
dividends. As an anti-tax avoidance measure, the government introduced Section 115QA under
the Income Tax Act vide the Finance Act, 2013.
Provisions of Section 115QA were initially applicable only to unlisted companies. However,
vide the Finance (No. 2) Act, 2019, the provisions of Section 115QA were amended and the
same is made applicable to the listed companies also.

2.2.1. What does Section 115QA say?

• Both listed and unlisted companies are liable to pay additional income tax on the
amount of distributed income on buyback of shares from shareholders.
• The tax on distributed income (i.e. buy-back) is payable by the company even if such
company is not liable to pay income tax.
• The company is liable to pay tax at 20% plus surcharge at 12% plus applicable cess.
• The company is liable to pay the tax within a period of 14 days from the date of payment
to the shareholders on the buyback.
• The tax on buyback shall be treated as final payment of tax. No further credit shall be
claimed either by the company or any other person in respect to the tax so paid.
• As companies are now liable to pay tax on buyback of shares. Furthermore,
shareholders do not have to pay any tax on any income arising from the buyback.

2.2.2. When are the provisions of Section 115QA not applicable?

The provision of Section 115QA is not applicable under all of the situations below:

• The company is listed on the recognized stock exchange; and

• The company has announced buyback of its shares; and
• The public announcement took place before July 5, 2019; and was in accordance with
the provisions of the Securities and Exchange Board of India (Buyback of Securities)
Regulations, 2018.
• The Finance Act, 2013, inserted Section 115QA, which provides for the levy of tax, on
account of buy-back of shares, at an effective rate of 23.296% (20% + 12% SC + 4%
H&EC), in case of a domestic unlisted company.
• Buy Back Tax is levied at the level of company, the consequential income arising in
the hands of shareholders is exempt from tax, as per Section 10(34A) of the ITA.
• Since, income arising in the hands of the shareholders, on account of buy back, on
which “Buy Back Tax” has been paid, is exempt under Section 10(34A), there is no tax
outflow in their hands, on account of buy back. Even for shareholders, which are
 companies, on whom provisions of Section 115JB are applicable, need not include such
income for calculating MAT, as being exempt under Section 10.
• What is important to note is that shareholders falling in the higher income group, having
income levels of more than INR 50 Lacs, or corporate shareholders, the effective rate
at which tax is paid, when dividend is received by them is between 34.32% to 42.744%.
Whereas, if in case surplus is distributed to such shareholders, by way of buy-back of
shares, then the effective tax rate on such distribution is 23.296%.

Thus, buy back of shares by unlisted companies is a tax efficient mechanism for distributing
surplus to its shareholders.

2. 3. Buy Back of Shares – Whether section 56(2)(x) gets invoked?

• Section 56(2)(x), where any person receives, in any previous year, any “property”: -

i. without consideration and the aggregate FMV of such property received during a previous
year exceeds Rs. 50,000; or

ii. for a consideration which is less than the FMV and the aggregate of differences between
FMV and consideration for such property received, during a previous year exceeds Rs. 50,000

such difference is taxable as income under the head ‘income from other sources’ in the hands
of the person receiving such property.9

• “Property” is defined in Clause (vii) of Sub-section 2 of Section 56, to include, amongst

other things, Shares and Securities.
• Section 68 of the Companies Act, 2013 sets out the provisions apropos Buy Back of
shares by the company. As per Sub-Section (7) of Section 68 “Where a company buys
back its own shares or other specified securities, it shall extinguish and physically
destroy the shares or securities so bought back within seven days of the last date of
completion of the buyback.”

Thus, in a scheme of buy back, shares bought back are no more in existence as they are
extinguished by writing down the Share Capital. Hence, when a company buys back its
shares, such shares do not become “property” or asset of the company. As a result,

9
Notification No. 42/2020/F. No. 370149/143/2019-TPL dated 30 June 2020
provisions of Section 56(2)(x) cannot be invoked in the case of any company buying back
its own shares.

ITAT Mumbai Bench in the case of Vora Financial Services P. Ltd.10 held that buy back of
shares is not covered under the ambit of section 56(2)(viia). It was observed that for the purpose
of taxing buy-back under section 56(2) (viia), shares should become "property" of recipient-
company whereas in case of buy-back, such shares are mandatorily cancelled and cannot
become property of a company. Accordingly, buy back of shares should be out of the ambit of
section 56(2)(viia) of the Act.

2.4. Buy back of shares – whether section 50ca gets invoked?

• Section 50CA is a special provision, which provides that in case of transfer of unquoted
shares, FMV of such shares should be considered to be the “Full Value of
Consideration” for the purpose of Section 48, if greater than the actual consideration
received or accrued as a result of transfer. For such purposes, FMV of the shares has to
be determined in accordance with Rule 11UAA of the ITR.
• Taxability of buy back of shares is governed by Section 115QA, introduced by Finance
Act, 2013. Section 115QA(1) starts with “Notwithstanding anything contained in any
other provision of this Act”. Thus, being a non-obstante clause, it shall supersede other
provisions, in relation to buy back in the ITA.
• As per Section 115QA, read with Section 10(34A), incidence of tax on buy back of
shares by the company arises at the company level and thereafter no tax is required
to be paid by the shareholder. Thus, shareholder need not calculate any income under
the head Capital Gains, in accordance with Section 46A, read with 48, of the ITA.
• Since there is no taxability, under the head Capital Gains, of the income arising to the
shareholder on buy back, computational provisions as contained in Section 48 are not
invoked. Resultantly, there is no applicability of Section 50CA.

2.5. Determination of value of shares for Buy Back

• There does not appear to be any bar on the company, to determine the value at which
the buy back of the shares can be undertaken, however, still, value of the shares has to
be determined on some basis. The value determined should not be higher than the FMV

10
[2018] 171 ITD 646 (Mum)
 of the shares of the company, as otherwise, the differential amount can be charged to
tax as deemed dividend u/s 2(22)(e), if relationship between the shareholder and
company, as provided under that section is satisfied.
• ITAT Bangalore Bench in the case of Fidelity Business Services India (P.) Ltd.11 held
that payment in the name of buy back of shares made by the assessee, to its related
party, in excess of FMV of the share of the assessee company would fall in the ambit
of Section 2(22)(e), i.e. Deemed Dividend. ITAT in the said case held that in case the
buy back price is not based on the real valuation and it is “artificially inflated” by the
parties then it is certainly a device for transfer of the reserves and surplus to the holding
company by avoiding the payment of tax and therefore it will be treated as a colorable
device. Aforementioned judgment of ITAT, Bangalore Bench, has been subsequently
affirmed by the Karnataka High Court 12

2.6. Buy back from existing shareholders on proportionate basis

Sub section (5) of Section 68 states that the buy-back “may” be undertaken by the company
from its existing shareholders on a proportionate basis. It implies that the offer for buy back
has to be given by the company to its existing shareholders and such offer of buy back has
to be in proportion to the existing holding of the shareholders. However, one will have to
bear in mind that a company, as per sub-section (2) of Section 68, cannot buy back more
than 25% of its Paid-up Equity Share Capital and Free reserves.

This can be explained with the help of an example. XYZ Private Limited has total Paid-Up
Equity Share Capital of Rs. 1,00,000, divided into 10,000 shares of Face Value of Rs. 10
each and also Reserves and Surplus of Rs. 10,00,000 as per the latest Audited Financials.
The entire shareholding is held by four shareholders – A, B, C and D in equal percentage
i.e., 25% each. Thus, A, B, C and D hold 2,500 shares each in XYZ Private Limited. The
aggregate consideration that can be paid by XYZ Private Limited, under buy back, in
accordance with Section 68(2), cannot exceed 2,75,000, being 25% of total Paid Up Equity
Capital and Free Reserves i.e. 25% of 11,00,000 [1,00,000 + 10,00,000]. Further, not more
than 2,500 Equity Shares can be bought back by the company. Under the Companies Act,
1956, the total number of Equity Shares that could be bought back was restricted to 25%

11
[2017] 164 ITD 270 (Bangalore – Trib.)
12
[2018] 257 Taxman 266 (Karnataka)
 of the Total Number of Equity Shares. However, Companies Act, 2013, set out the
restriction with reference to the percentage of Paid up Capital and Free Reserves and
doesn’t talk about the maximum number of shares that can be bought back. However, as a
matter of precaution, the upper limit apropos the number of shares, as provided in
Companies Act, 1956, should also be adhered to. If XYZ Private Limited decides to buy
back its shares, say, up to 25% of the total Paid Up Equity Capital or i.e. 2,500 shares, then
the company will have to offer for buy back of shares to all the four shareholders on a
proportionate basis. Also, the maximum consideration which can be paid by the company
for buy back cannot exceed Rs. 2,75,000 (Being 25% of Paid-up Capital of 1,00,000 and
Free reserves of Rs. 10,00,000).

Now, to each of the shareholders, XYZ Private Limited will offer 2,500 x 25% i.e 625
shares for buy back. If suppose all the four shareholders decide to enter into transaction of
buy back with the company, then the company will have to buy back from each of the
shareholder 625 shares. There may also be a situation that C and D may not be willing to
give their shares for Buy Back. As a result, XYZ Private Limited can Buy Back shares from
the remaining shareholders i.e. A and B to the extent of 625 shares each. There may be
another situation that XYZ Private Limited wants to buy back 25% of the total Equity
Shares and C and D do not want to participate. It is even possible, to buy back the requisite
number of shares from a single or a group of shareholders, provided adequate
documentation is done by the company by bringing on record no objection to the
transaction of buy back by the shareholders not participating in buy-back. This may be in
the form a no objection letter or an agreement etc.13

Thus, in order to avoid any possible litigation, as an added safeguard, the company can take
concurrence from C and D for entering into transaction of buy back with A and B for
buyback of 1250 shares each. As a result, 2500 shares can be bought back from A and B
together. In other words, an unlisted company can even buy back shares from a single
shareholder or a group of shareholders provided adequate concurrence is taken of the
arrangement from the shareholders not wanting to offer their shares for buy back. Thus,

13
Chan, Konan; Ikenberry, David; Lee, Inmoo; Wang, Yanzhi (2010). "Share repurchases as a potential tool to
mislead investors". Journal of Corporate Finance. 16 (2): 137–158.
 buy back can even be a tool for unlisted companies to re-organize their capital structures,
in a tax efficient manner.

Supreme Court in the case of Miheer H. Mafatlal Vs. Mafatlal Industries Ltd.14 with
reference to Section 391 of Companies Act, 1956 (Section 230 of Companies Act, 2013),
held that while sanctioning the scheme court does not sit in appeal over the commercial
wisdom of majority of the class of persons who with their open eyes have given their
approval to the scheme and thus court cannot refuse the scheme on the ground that the
better scheme for the benefit of the members or creditors could have been formed. What is
important is that the scheme should not be violative of any provision of law and all the
relevant material should be provided to the shareholders in order to take an informed
decision on the subject matter.

National Consumer Disputes Redressal Commission in the case of Godrej Industries

Limited vs. Smt. Ritu Bhargava15 held that once the company takes appropriate steps to
inform the shareholders about the scheme of buy back, seeking their option for continuing
to hold the shares or not, the shareholder cannot complain, at a later stage, seeking for any
relief.

Applying the same principles that when adequate approval is taken from the shareholders
not participating in the buy-back offer by the company, then there cannot be much chance
of litigation even at a later state in this regard. Thus, the interest of the company is safe
guarded.

2.7. Taxability in the hands of shareholders not participating in share buyback scheme

• The shareholders not willing to participate in buy back scheme, when providing their
no objection for carrying out buy back from other shareholders, in turn, transfer a right
in favour of those shareholders and thus, would be chargeable to Capital Gains.
(Question)In case of buy back, an offer is given to the shareholders whether they want
to participate in such buy back or not. No right of any nature is created in favour of
such shareholders16

14
AIR 1997 SC 506
15
[(2014) C PJ377(NC )]
16
Damodaran, A. (2008). Corporate Finance: Theory and Practice (2nd Edition ed.). New Delhi: Wiley India (P)
Ltd..
• When certain shareholders provide their no objection, then they are not renouncing any
form of a right in favour of other shareholders from whom the company buys back the
shares. They simply convey their no objection towards the company buying back shares
from other shareholders. This is unlike renouncing/transfer of the rights assigned to a
shareholder to subscribe to the shares of the company.
• Thus, in the process, no right is created which can be construed as a Capital Asset,
under Section 2(14) of ITA and resultantly, there would not be any incidence of Capital
Gains taxation in such cases.

2.8. General Anti Avoidance Rule (GAAR) – Implications Thereof

• Section 95 of the ITA, GAAR is applicable on those “arrangements” which can be

categorized as “impermissible avoidance arrangement”. Section 102(1) defines an
arrangement to include singular transaction, or multiple transactions. It also includes a
“step in” or a “part of the” transaction. Buy back of shares undertaken by a company
can be considered as an “arrangement”. In the process of buy back, since the company
has to determine the price at which buy back of shares is to be undertaken, then
“determination of such price” can be considered as “step in” or “part of the transaction”
of buy back.
• In accordance with Section 96, GAAR is only applicable to “impermissible avoidance
arrangement”. In the present context, only picking up the relevant provisions of Section
96, a buy back transaction, or even determination of price of shares for buy back, can
be categorized as an avoidance arrangement if (i) there is tax benefit; (ii) if it result
into misuse of provisions of ITA.
• CBDT, vide Circular No. 7, dated 27.1.2017, in answer to Q.No. 3 on stated that GAAR
will not interplay with the right of taxpayer to select a method of implementing a
transaction. It means that if there is one or more bona fide ways of doing a transaction,
then the taxpayer can select the manner he wants. There shall not be any applicability
of GAAR.
• Since, in the present case, both the methods for distribution of surplus, by way of
dividend or through buy back of shares, is provided in the ITA itself, both can be
considered as equally legitimate of doing a transaction. The same principles can apply
if the buy back is undertaken by the company for re-aligning the share capital. It is not
 the purpose of GAAR that the taxpayer should opt for an alternative mode of
completing the transaction which results in maximum payment of tax.

2.8.1. Whether incorrect determination of price for buy back of shares may fall within
the rigors of GAAR? This may again be divided into two parts

(i) If the price at which buy back is done is greater than the FMV of the shares;
(ii) If the price at which buy back is done is less than the FMV of the shares.

• If the price of the shares at which buy back is done is greater than the FMV of the
shares, then GAAR provisions may apply. As it may result in tax benefit and at the
same time misuse or abuse of the provisions of law. It may result into tax benefit, as
instead of normal transaction of buy back, the company may want to pass on additional
surplus to its shareholders in the garb of buy back. Tax benefit will arise in those cases
where tax outflow on dividend would be greater in comparison to buy back of shares.(1st
case)
• On the other hand, if the price of the shares determined for the purpose of buy back is
less than the FMV, then there may not be any applicability of GAAR. The reason for
this is that the primary condition to be fulfilled is there should be some tax benefit
arising out of taxable income. As discussed hereinbefore, Section 56(2)(x) is not
applicable in the hands of the company carrying out buy back. Thus, at the company
level there cannot be any income arising out of buy back of shares. For GAAR to apply
there has to be some income arising out of the transaction for the parties, however,
where there is no income, GAAR provisions cannot be invoked. (2nd Case)
• As per Rule 10U of the ITR, threshold is specified so that GAAR is not invoked where
tax benefit arising in the relevant assessment year to all the parties to the arrangement
does not exceed INR 3 crores. Thus, any tax benefit arising out of determination of the
price on which buy back is to be done is less than INR 3 crores, there shall not be any
applicability of GAAR.

2.9. Non-Resident Shareholders

• As per Section 195 of the ITA, “any person” making payment to a non-resident is
required to withhold tax from any sum paid or credited to a non-resident which
 is chargeable to tax in India. Tax is required to be withheld at the time of payment or
credit whichever is earlier.
• Thus, withholding of tax under Section 195 is only required in case the payment made
to non-resident is taxable in India. If in case, such payment is not taxable in India then
there is no requirement to deduct tax at source under Section 195.17
• The income received by the shareholder in case of buy back by an unlisted company is
exempt as per Section 10(34A). As a result, the company buying back its shares from
a non-resident shareholder is not required to deduct any tax at source under Section 195
on the payment made.

2.10. Stamp duty on Buy Back

• Transfer of shares of unlisted companies was subject to Stamp Duty at the rate of 0.25%
of the value of shares, in accordance with Indian Stamp Act, 1899 (Article 62, Schedule
I). However, the stamp duty payable on such transfer after 1st April, 2020 has been
reduced to 0.015% of the sale consideration.
• However, buy-back of shares by a company is not a transfer as the share bought back
by the company have to be statutorily extinguished within seven days from the
completion of buy back, in accordance with sub-section (7) of Section 68. Further, no
registration of such shares takes place in the name of the company.18
• As a result, there is liability apropos payment of stamp duty on the buyback of shares
undertaken by the company.

CONCLUSION:

A share buyback is an effective way for management to boost up the company’s undervalued
share price and reduce dilution. The process requires management to show confidence in their
business operations. It is not necessary that every buyback automatically benefits shareholders.
It is important being an investor one should gauge the purpose and the timing of a buyback and
also have a look at the overall financial situation of the company. A shareholder must
reconsider all his views before purchasing shares of the company which is involved in the
process of a buyback. The Taxation laws present for the Buy Back of Shares is some what

17
“The structure and reform of Direct Taxation” ‟ The Institute of fiscal studies, report submitted by Prof JE
Meade, 1978
18
“Trends and Issues in tax policy and reform in India” written by M. Govind Rao and R. Kavita Rao
clear. However, with the present Amendment and insertion of new provisions with effect to
finance Act had made the law narrowed down in this aspect.

REFERENCE:

• BIBLIOGRAPHY:

1. Badrinath, S. G., & Ferling, N. P. (2001). Share Repurchase:To Buy or Not to Buy.
Financial Management

2. Dr. Girish Ahuja and Dr. Ravi Gupta, Bharat‟s Taxation of Capital Gains with
Illustrations, published by Bharat Law House Pvt. Ltd. New Delhi 2018.

3. Dr. V K Singhania and Dr. Kapil Singhania, Taxman‟s Publication (Pvt.) Ltd., New
Delhi. 58th Edition 2017.

4. Dr. Kailash Rai, Taxation Laws, P. No. 183 Allahabad Law Agency, Allahabad, Eighth
edition 2008

5. M.V. Kamath, Nani A. Palkiwala- A Life, Nani A Palkiwala Memorial Trust, Hay House
Publication, New Delhi, 2007

• WEBLIOGRAPHY:

1. https://itatonline.org/articles_new/buy-back-of-shares-by-unlisted-company-tax-
efficient-tool/

2. https://swaritadvisors.com/learning/procedure-for-buyback-of-shares-and-other-
specified-securities/

3. https://taxguru.in/income-tax/income-tax-buyback-shares.html

4. https://swaritadvisors.com/blog/process-for-buyback-of-shares/