Section 115QA Buy-Back Tax Amendment – What Shareholders Need to Know

The amendment to Section 115QA in the Finance Act, 2024, changes the tax treatment of income distributed by a domestic company during a buy-back of shares. Previously, companies paid a buy-back tax at 23.296%, including surcharge and cess, while shareholders were exempt from further taxation on this income under Section 10(34A). The amendment now treats the income received by shareholders from a buy-back as deemed dividend, taxable at their applicable rates under "income from other sources." Consequently, shareholders can no longer claim deductions or set off capital losses against this income, and the buy-back consideration will be deemed NIL for capital gains calculation, resulting in a capital loss that can only offset other capital gains. This amendment impacts the buy-back process by shifting the tax burden from the company to shareholders, effective from October 1, 2024.

Table of Content

1. Amendment to Section 115QA(1) and Other Consequential Amendments
2. Rationalisation of Taxation of Capital Gains
3. Amendments to Section 112 of the Act Explained
4. Period of Holding of Capital Assets after the Amendments Made by the Finance (No. 2) Act, 2024
5. Tax Rates
6. The Following List Containing FAQs was Issued by the Government on New Capital Gains Taxation Regime after Introduction of Finance (No. 2) Bill, 2024 in the Lok Sabha on 23rd July, 2024
7. NRIs to Pay More Tax on Capital Gains vis-à-vis Sale of Unlisted Shares
8. Amendment of Section 56 of the Act

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1. Amendment to Section 115QA(1) and Other Consequential Amendments

The provisions of section 115QA(1) of the Act dealing with tax on distributed income to shareholders before the amendment by the Finance Act, 2024 provided that

“Notwithstanding anything contained in any other provisions of the Income-tax Act in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount of distributed income by the company on buy-back of shares from a shareholder was to be charged to tax and such company was to be liable to pay additional income-tax at the rate of twenty per cent on the distributed income.”

The effective rate of tax that was payable by the domestic company thus worked out to 23.296% (after adding surcharge of 12% to the above-stated 20% tax with cess @ 4% added to total of tax and surcharge).

Rule 40BB of the Income-tax Rules, 1962 provided the manner in which such tax was payable by the domestic company. The relevant rule provided that tax would be applicable on the distributed income meaning the consideration paid by the company on buy-back 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.

Such tax was applicable irrespective of the fact that the company was liable for tax on its income or not.

Further, no credit or deduction for such amount was to be allowed either to the shareholder or the company.

Section 46A of the Act prescribed that when a shareholder received any consideration from any company for purchase of its own shares or other specified securities, it would be deemed to be capital gains subject to the provisions of section 48 of the Act, the amount of consideration less the cost of acquisition, would be chargeable to tax under the head capital gains.

Further provisions of section 10(34A) of the Act provided that any income arising to a shareholder on buy back of shares referred to in section 115QA, was exempt in the hands of the shareholder, the reason being that as the company had already paid the buy-back distribution tax on such income, it would not be chargeable to tax again in the hands of shareholders.

With a view to widening and deepening of tax base and as a measure of anti-avoidance there has been amendment on tax on distributed income of domestic company for buy-back of shares.

The purpose of the amendment to section 115QA of the Act was explained by the Memorandum explaining the provisions in the Finance (No. 2) Bill, 2024 under the heading “Tax on distributed income of a domestic company for buy-back of shares” thus.

Special provisions relating to tax on distributed income of a domestic company from the buy-back of shares were introduced by the Finance Act, 2013, in line with the then schema of dividend distribution tax. Prior to the amendments made by the Finance Act, 2020, a company had to pay dividend distribution tax (DDT), on the distributed profits by way of dividends in addition to the income-tax chargeable in respect of the total income for any assessment year. DDT was done away with by the Finance Act, 2020 with effect from 1st April, 2020.

Representations have been received stating that pay-outs on buy-back of shares should be taxed in the hands of recipients, in line with similar regime in place for taxation of dividend.

Both dividend as well as buy-back are methods for the company to distribute accumulated reserves and thus ought to be treated similarly. In addition, there is extinguishment of rights for the shareholders who are tendering their shares in the buy-back by domestic company, to the extent of shares bought back by such company from shareholders. The cost of acquisition of such shares also needs to be accounted for in some manner.

It is therefore, proposed that, the sum paid by a domestic company for purchase of its own shares shall be treated as dividend in the hands of shareholders, who received payment from such buy-back of shares and shall be charged to income-tax at applicable rates. No deduction for expenses shall be available against such dividend income while determining the income from other sources. The cost of acquisition of the shares which have been bought back would generate a capital loss in the hands of the shareholder as these assets have been extinguished. Therefore, when the shareholder has any other capital gain from sale of shares or otherwise subsequently, he would be entitled to claim his original cost of acquisition of all the shares (i.e. the shares earlier bought back plus shares finally sold). It shall be computed as follows:

• deeming value of consideration of shares under buy-back (for purposes of computing capital loss) as nil;
• allowing capital loss on buy-back, computed as value of consideration (nil) less cost of acquisition;
• allowing the carry forward of this as capital loss, which may subsequently be set-off against consideration received on sale and thereby reduce the capital gains to this extent.

Example:

These amendments will take effect from the 1st day of October, 2024, and will accordingly apply to any buy-back of shares that takes place on or after this date. [Clauses 3, 4, 18, 24, 39 & 52]

1.1 What is the impact on account of amendments?

This can be explained with the help of an example-

A company issued 25,000 shares at a price of INR 30 per share (FV – INR 10) on 08th April, 2015. Subsequently in April 2022, the company bought back 10,000 shares out of them at a price of INR 50 per share. Now in this case the company is paying INR 20 (INR 50-30) per share of buy-back premium. This would be liable to Buy-back distribution tax at the rate of 23.296%. So, the company would pay tax of INR 47,920 (10,000 × 20 × 23.296%) as per section 115QA.

The income was exempt in the hands of shareholders under section 10(34A) of the Act as it related to pre-amendment period.

1.2 How will it be taxed after the amendment?

Now that amendments have been made to section 115QA as also to sections 10(34A), 46A, 2(22), 57 and 194 of the Act. The exemption under section 10(34A) of the Act has now been removed for any buy-back on or after 1st Oct, 2024.

As explained above by the Memorandum, the consideration in respect of buy-back of shares would be taken as NIL.

Now coming to the taxability in the hands of shareholders. Section 46A states that in case of any buy-back of shares on or after 01.10.2024, the consideration in the hands of the shareholder shall be considered as NIL. Where the shareholder receives any consideration of the nature referred to in sub-clause (f) of clause (22) of section 2 from any company, in respect of any buy-back of shares, that takes place on or after the 1st day of October, 2024, then for the purposes of this section, the value of consideration received by the shareholder shall be deemed to be nil and as per additional clause inserted in section 2(22) of the Act definition of dividend has been widened by insertion of clause (f) which reads as under:—

“(f) any payment by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 68 of the Companies Act, 2013;”

Therefore, on combined reading of provisions of sections 2(22)(f) and 46A of the Act, it can be inferred that on or after 1st Oct, 2024, any consideration received by the shareholder due to buy-back of shares, shall be taxable as a dividend income under the head other sources.

Further, the consideration shall be NIL for the purposes of section 46A of the Act, thus resulting in a capital loss in the hands of the shareholder. Such loss can be adjusted against any other capital gain similar to any other capital loss.

Furthermore, as per the second proviso inserted by the Finance (No. 2) Act in section 57 of the Act, no deduction shall be allowed under the head other sources from such income. Such consideration shall also be liable to TDS as per the amended provisions of section 194 at the rate of 10%.

1.3 Continuing the same example, let us analyse the situation post amendment

Example – Subsequently in April 2025, the company buys back 10,000 shares out of them at a price of INR 60 per share. Now in this case the company is paying INR 30 (INR 60-30) per share of buy-back premium.

Now, the company would not pay any tax in such case. The shareholders have to offer the consideration received on such buy-back as income from dividend under the amended section 2(22)(f) of the Act under the head other sources. As per the amendment no deduction shall be allowed from it. Also, the amount of purchase price would be a capital loss in the hands of the shareholders. As the loss under the capital gain head cannot be set off form any other head, such loss cannot be adjusted against the dividend income.

So, in the hands of shareholders, amount of INR 3,00,000 (10,000 × 30) shall be allowed as capital loss and the amount of INR 6,00,000 (10,000 × 60) shall be taxable under other sources. Also, no deduction shall be allowed from such amount.

This amendment will bring a very big tax impact on the shareholders. Now they will have to pay tax as per there slab rates which may be 30% plus applicable surcharge plus cess. The tax payable by the assessee-shareholder in the case of such buy-back of shares is more when compared to the amendments made in sections 111A,112 and 112A of the Act wherein the capital gains are to be taxed only at the rate 20%, 12.5% and 12.5% respectively. Moreover, the loss would be under the head capital gain which cannot be adjusted against any other head of income. Thus, the benefit of the capital loss may or may not be available to a particular shareholder depending on his other income under the head capital gains.

It is to be noted that the tax payable by the company on buy-back of shares will only be on the income portion whereas the shareholders have to shell out tax on the entire consideration at the rate of taxation applicable to them in the year of receipt.

This amendment will thus create a big impact affecting the buy-back of shares in future.

In the case of non-residents (NRIs) income received by them by way of dividend is chargeable to tax under the provisions of section 115A of the Act at the tax rate of 20%, however subject to claiming benefits of the Double Taxation Avoidance Agreement (DTAA) entered into between India and their resident country. If the benefits accorded by way of tax rate as per domestic law is more favourable than DTAA then the NRI can adopt domestic law and it is otherwise then he may opt for rate as per DTAA.

It is expressed in some professional circles that the situation after the amendment will not be as simple as one envisages with regard to taxation of NRIs.

The reason for such an apprehension is simple.

By these amendments two heads of income viz. capital gains and income from other sources are involved. On one side because of buy-back of shares there is capital loss and on the other side there arises income from other sources which is taxable as dividends.

So, the question that arises is (as) to which article of DTAA reference should be made, whether to article dealing with capital gains or article dealing with dividends?

It is noteworthy that in certain treaties the definition of the term Dividends is quite wide. Such definitions may cover the above situation. Also, in quite a lot of treaties, the capital gains are to be taxed in the source country and as per the provisions of domestic law. Thus, it needs to be analysed critically based on the facts and circumstances of each case and on the basis of the definitions in respective treaties.

However as in the case of all amendments brought in any section of Income-tax Act law, there would be suitable and necessary instructions from the Government as the situation needs and important guidelines that would emanate from judicial authorities in the days to come.

2. Rationalisation of Taxation of Capital Gains

The Finance (No. 2) Act, 2024 has streamlined rate of taxation so far as taxation of capital gains is concerned. There are three components to this rationalization. These three components have been very well explained under the heading “Rationalisation and Simplification of taxation of Capital Gains” in the Memorandum explaining the provisions in the Finance Bill, 2024 and they have been analysed below.

What are the three components?

Firstly, there are now only two holding periods, 12 months and 24 months, for determining whether the capital gain is a short-term capital gain or long-term capital gain. The holding period for listed securities is now 12 months and for all other assets, it is 24 months. Accordingly, amendment has been made in clause (42A) of section 2 of the Act with regard to definition of a short-term capital asset and as a result of this amendment, units of listed business trust are now at par with listed equity shares at 12 months instead of earlier 36 months. The holding period for bonds, debentures, gold has now got reduced from 36 months to 24 months. However, the holding period for unlisted shares and immovable property would remain at 24 months.

Section 111A of the Income-tax Act (the Act) deals with tax on short-term capital gains in certain cases. As the Government felt that the rate of tax was too low and benefit from such low rate was flowing largely to high-net-worth individuals, it has increased the tax on short-term capital gains to 20% from 15% in respect of STT paid equity shares, units of equity oriented mutual fund and unit of a business trust. However, there is no change in respect of other short term capital gains and that they are continued to be taxed at the existing rate

The long-term capital gains being listed shares on which STT is paid is now being taxed at 12.5 % as against the old rate of 10%. The basic exemption has been raised from ` 1 lakh to ` 1.25 lakhs on STT paid equity shares, units of equity-oriented fund and business trust. For listed bonds and debentures, the rate of tax now stands at 12.5%. Unlisted debentures and unlisted bonds are of the nature of debt instruments and therefore any capital gains on them are being taxed at applicable rate, whether short-term or long-term.

The unlisted debentures and unlisted bonds have been brought to tax at applicable rates by including them under provisions of section 50AA of the Act.

Section 50AA is a special provision dealing with computation of capital gains in respect of Market Linked Debenture which term has been defined in the explanation. As per provisions of section 50AA of the Act the gains arising from the transfer of capital asset as defined in this section notwithstanding anything contained in clause (42A) of section 2 or section 48, shall be deemed to be the capital gains arising out of a transfer of a capital asset.

This amendment in section 50AA has come into effect from the 23rd day of July, 2024.

This is the second component so far as rationalisation of capital gains (tax) is concerned.

Second proviso to section 48 at the introduction of the Finance (No. 2) Bill, 2024 provided that “where long-term capital gain arises from the transfer of a long-term capital asset, other than capital gain arising to a non-resident from the transfer of shares in, or debentures of, an Indian company referred to in the first proviso, the provisions of clause (ii) shall have effect as if for the words “cost of acquisition” and “cost of any improvement”, the words “indexed cost of acquisition” and “indexed cost of any improvement” had respectively been substituted”.

The Finance (No. 2) Bill, 2024, as introduced in the Lok Sabha on 23rd July, 2024 as the third component in the rationalisation process had proposed to amend the second proviso by removing the indexation benefit extended thus far in view of the rationalisation of tax at 12.5%.

In other wards, the rate of tax on transfer of a capital asset on or after 23rd July, 2024 was proposed to be charged to tax at 12.5% without any indexation as against 20% with indexation.

However, on representation from Chambers of Commerce and other public bodies the Resident Individuals and HUFs are permitted to adopt indexation benefits with tax rate of 20% in respect of properties acquired before 23rd July, 2024 and sold after 23rd July, 2024. For detailed discussion on amendment to section 112 please see serial no. 3 below.

A few workings have been shown below under various situations to understand the tax implications arising out of change in tax scenario.

Table A: Situations When Property was Acquired After 01-04-2001

Table B: Situations When Property was Acquired Prior to 1-4-2001

3. Amendments to Section 112 of the Act Explained

The provisions of section 112 of the Act, as they stand, after their amendment by the Finance (No. 2) Act, 2024 (only relevant provisions required for discussion extracted) read as under:—

In Section 112 of the Income-tax Act, in sub-section (1) for the clauses (a), (b), (c), (d) and the first proviso the following shall be substituted and shall be deemed to have been substituted with effect from the 23rd day of July, 2024, namely:—

“(a) in the case of an individual or a Hindu undivided family, being a resident,—

(i) the amount of income-tax payable on the total income as reduced by the amount of such long-term capital gains, had the total income as so reduced been his total income; and

(ii)the amount of income-tax calculated on such long-term capital gains,—

(A) at the rate of twenty per cent for any transfer which takes place before the 23rd of July, 2024; and

(B) at the rate of twelve and one-half per cent for any transfer which takes place on or after 23rd day of July, 2024:

Provided that where the total income as reduced by such long-term capital gains is below the maximum amount which is not chargeable to income-tax, then such long-term capital gains shall be reduced by the amount by which the total income so as reduced falls short of the maximum amount which is not chargeable to income-tax and the tax on the balance of such long-term capital gains shall be computed at the rate as applicable in sub-clause (ii):

Provided further that in the case of transfer of a long-term capital asset, being land or building or both, which is acquired before the 23rd day of July, 2024, where the income-tax computed under (B) exceeds the income-tax computed in accordance with the provisions of the Act, as they stood immediately before their amendment by the Finance (No. 2) Act, 2024 such excess shall be ignored.

The capital gain taxation in respect of profit arising out of transfer of land or building or both by an NRI is contained in (amended) clause (c) of section 112 of the Act and among other things, this clause does not give an option to an NRI to adopt one of the two methods i.e. taxation of capital gains at 12.5% without indexation and at 20% with indexation. Any profit arising on transfer of land or building or both by an NRI, on or after 23rd July, 2024, will be subject to tax at 12.5% without any indexation.

So, from analysis of the provisions of section 112 of the Act, as amended and as set out above, the roll-back of indexation benefits as claimed in certain quarters of the press and in group discussions conducted at various levels does not appear to be fully so, in the opinion of the author.

Of course, while the Government deserves lot of credit for what they have done in partially rolling back the proposal to do away with indexation, yet it is submitted, with respect, whether the change brought in through the amendment really brings out the change needed or expected or claimed in most of the quarters as” rolling back the indexation proposal”? In the opinion of the author, it does not appear to be so as the changed section says “if the tax computed in accordance with the new enacted section exceeds tax computed under the law as it stood before the amendment, such excess shall be ignored.”

Though the purpose of amendment is not to burden resident individuals or HUFs with additional taxes due to the initial proposed change by doing away with indexation, yet it cannot be stated that indexation has been restored or rolled back. So, the usage of the phrase “grandfathering”- a popular phase in vogue ever since “grandfathering” was introduced in respect of shares and debentures held prior to 31st January 2018 may not be appropriate in the strict sense when one were to analyse the real benefits in the light of what appeared in headlines like “rolling back the indexation proposal.”

Some of the experts in taxation field have already expressed their view that in view of the language in second proviso (as extracted earlier) the loss which may arise would no longer be available either for set-off against other capital gains in the current year or for carrying over to next year for adjusting against capital gains that may arise in future. The author is also inclined to agree with such view from the reading of the amended section.

So though there is no additional burden due to the present amendment (from the amendment proposed in the Finance (No. 2) Bill, 2024) yet can it be stated that whether earlier benefits have been restored?

In the field of tax planning, certainty in tax laws is absolutely essential. Will the Government come out with necessary clarification in this matter or should clarity come only from judicial authorities?

4. Period of Holding of Capital Assets after the Amendments Made by the Finance (No. 2) Act, 2024

The Finance (No. 2) Act has simplified the holding periods; now only two categories prevail, 12-month and 24-month period, for classification of any capital asset into long-term or short-term. Holding period of 36 months (except in the case of business undertaking) has been done away with.

The following table summarizes the classification:

In case of business undertaking, there is still a requirement of 36 months for long-term categorization.

Period of Holding of Capital Asset

5. Tax Rates

There are notable changes in the tax rates which have been summarized below:

With regard to rates of taxation vis-à-vis indexation reference may be made to serial no.3 under the caption “Amendments to section 112 of the Act explained.”

NRIs are not permitted to adopt the old rate of taxation of 20% with indexation benefits. The NRIs have no other choice except to adopt 12.5% rate of taxation without any indexation benefits but there is no prohibition for both Residents and Non-residents to adjust capital loss or carry over loss if loss, per chance, arises on transfer of capital asset (even) without indexation.

6. The Following List Containing FAQs was Issued by the Government on New Capital Gains Taxation Regime after Introduction of Finance (No. 2) Bill, 2024 in the Lok Sabha on 23rd July, 2024