Section 115QA in Light of Capital Loss Suffered by the Shareholder(s)

Section 115QA of the Income Tax Act, 1961:

Section 115QA of the Income Tax Act, 1961 (hereinafter referred to as the “Act”) is a tax on a domestic company, on the distributed income to its shareholders in the form of buy back of unlisted shares. It was introduced as a tax in addition to the income tax chargeable in respect of total income and is levied on the company on the event of distribution of income out of its free reserves, securities premium account or the proceeds of any shares or other specified securities. Before 2013, the consideration received by the shareholders was taxable as ‘Capital Gains’ u/s 46A of the Act. Consequent to levy of tax u/s 115QA (hereinafter referred to as the “section”) paid by the company, the amount of consideration received by the shareholder is no longer included in the total income of the shareholder as per the amended provision of Section 10(34A) of the Act. In other words, the liability to pay tax on the event of buy back has shifted from the shareholders to the company.  In this column, I will be discussing about the failure of the legislature in perceiving the possibility of shareholder incurring capital loss in the buy-back transaction and its consequence  on the tax levied on the company u/s 115QA of the Act. The proponents of the issue argue that as Section 115QA is in the nature of tax collection section, the capital gains being experienced by shareholders is the upper half of the body, which is a must for the lower half of the body to function i.e. collection of tax on income of the shareholders from the company. Whereas, the opponents argue that the literal interpretation of the section makes it clear that tax is levied on the company on the “distributed income”, as defined in the section, and the loss suffered by the shareholder is of no consequence. The legislature is constantly bringing new additions to the section, like the words “determined in the manner as may be prescribed” have been inserted to the section [by the Finance Act 2016], and rules and regulations are being enacted, like Rule 40BB which lays down 12 different situations and the methodology of determining ‘amount received by the company’ in such situations [vide Notification No. 94//2016 dated 17 October, 2016] to resolve the confusion on the mechanism of computation of tax under the section. However, it fails to take into consideration the consideration paid by successive shareholders for buying the shares in question, post issue of the shares by the company, and the loss which the final shareholder may have incurred on the buy-back transaction.

In order to resolve the forestated debate, it is material to first examine the following questions:  1. Who bears the incidence of taxation imposed by 115QA? That is to say, does Section 115QA levy tax on the income of the Company buying back its previously issued shares; or, does it impose a tax upon the income of the shareholder selling the shares back to the company   2. If it is a tax on the income of the shareholder, then is it just to collect tax from the company even in instances where the shareholder has incurred a loss on the buy-back transaction (i.e. sold the shares back to the company for a price lower than the purchase price of the shares)? The companies try to save themselves from payment of tax under the section by stating that even though the tax is payable by the company, it is the income of the shareholder being taxed. The argument in favour of the companies which are assesses under the section is based on the settled principle of law that Income-tax is a tax on income, and by implication, without income, there can be no tax. In case of transfer of capital assets, the only person who could earn income is the shareholder. Section 5 of the Act, which defines scope of total income, yields that the gains received, arisen or accrued to a resident/non-resident out of the transfer capital asset located in India is said to be income of that person. Thus, charge on capital gains arises on transfer of a capital asset situated in India during the previous year. Therefore, the only person who may earn gains and resultantly can be termed to have earned income in the buy-back transaction is the shareholder.  Moreover, Section 2(24) of the Act which defines “Income” includes capital gains explicitly, but the legislature did not amend the said section to add “distributed profits” as income in terms of the scope of the Act.  It can also be argued that keeping in mind the object of the section mentioned in the Finance Bill, 2013 while reading the section, the net effect that emerges is, that the consideration which was received by the shareholder on buy back transaction which was earlier taxed as capital gains would now be payable by the company as a tax on distributed income. Thus, it is averred that the tax levied u/s 115QA is levied on the income received by the shareholder, and merely payable by the company.  Thus, from the above it can be said that the u/s 115QA of the Act, it is the income of the shareholder which is being charged. It is pertinent to note here that tax u/s 115QA is payable by a company when the transaction of buy back of shares results in a capital gain to the shareholder. In case the transaction results in a capital loss to the shareholder, the company distributing its income is not liable to pay tax. When a shareholder incurs loss under the head of capital gains, the same can be set off against the income under ‘capital gains’ and thus, are not taxable as laid down in Section 74 of the Act. The Revenue on the other hand contends that a literal interpretation of the Section should be made. It is settled principle of law that while implementing taxing statutes, the rule of literary construction should be followed. All that the court has to see is that the provision is unambiguous, and that the intent of the legislature is clear. The court need not go into equity and inference [Hiralal Ratanlal Vs. STO, AIR 1973 SC 1034]. The Section states that tax u/s 1115QA is an additional tax on the company buying back its shares and is the tax paid on the “distributed income” of the company. ‘Distributed income’ is defined in the explanation of Section 115QA of the Act as “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.” Thus, the loss suffered by the shareholder in the buy-back transaction or the consideration paid by the subsequent shareholders is of no relevance whatsoever. The ordinary, natural and grammatical meaning of the section and its explanation shows that the tax has to be paid by the company buying back its shares on the amount received by the company on buy back of shares reduced by the amount which was received on issue of such shares.  Moreover, even if it is agreed that the income is of the shareholder, the subject provision of the Act does not make a distinction between ‘levy’ of tax and ‘collection’ of tax. This infers that the tax u/s 115QA is leviable and payable by the company alone.    It can also be argued that as soon as a company enters in to an agreement of buy back of shares in favour of its shareholder, the amount determined for buy back of shares declared becomes income receivable by the shareholder. Thus, if tax is paid out of such amount declared whether by shareholder directly or by the company in an indirect manner, it is the distributed income which has suffered tax.  Thus, from the literal interpretation of Section 115QA, tax is on the ‘distributed income’ which arises on the date of buy back, the tax being an additional tax on the company and the shift of incidence of tax on the company from Section 115QA, the company is liable to pay a tax and capital loss suffered by AASL on buy back of shares in of no consequence The Mumbai Bench of the Income Tax Appellate Tribunal (Tribunal) in the case of Vora Financial Services Pvt Ltd. Vs. ACIT [ ITA No. 532/ Mum/ 2018] has an indirect reference to the issue. It discussed the applicability of Section 56(2)(x) to buy back of shares. Section 56(2)(x) levies tax on the difference between the consideration received and the fair market value of the property. The tax payer argued that as on buy back the property (share) ceases to exist, and the said section is applicable only on property, it has no application on the transaction of buy back of shares. The ld. Tribunal held that the assessee purchased its own shares under buyback scheme and the same has been extinguished by reducing the capital and hence the tests of “becoming property” and also “shares of any other company” fail in this case. Thus, Section 56(2)(x) is not applicable on buy back schemes   Thus, the judgment fails to answer the query at hand. This can be solved if the legislature enacts laws or regulations on the lines of Section 56(2)(x) or Section 50CA of the Act (which states that if consideration for transfer of an unlisted share is less than its fair market value, the fair market value is deemed to be the full value of consideration for the purpose of determining capital gains in the hands of the shareholders), governing buy back transactions.   

Author: Ramya Aggarwal is a third year law student at Amity law School Delhi, affiliated to Guru Gobind Singh Indraprastha University.