A buy-back is a corporate action in which a company buys some of its shares from the existing shareholders at a price higher than market price. Proceeds for the buy-back come out of the profits earned in the past years and retained by the company after paying dividends over the years. So a buy-back becomes an indirect way of paying dividend without attracting Dividend Distribution Tax (DDT).
There is also an additional advantage. Listed securities, not sold on a recognised stock exchange in India such as private transactions between two individuals as also buy-back of its own shares from its shareholders do not suffer STT. In such cases, LTCG is charged to tax @20% on CG (with indexation) or @10% of the profit (without indexation), whichever is lower. STCG is payable at normal rate applicable to the assessee. Companies have discovered a novel way of bypassing even this 10% or 20% tax. The buy-back transaction, if routed through a recognized stock exchange in India, STT is payable at as low a rate of 0.1% on the gross receipts. Once the STT is paid, the entire long-term capital gains (holding period of more than one year), irrespective of its size, becomes exempt. Excellent!
Let us see how excellent this strategy is through a live example. On 20.5.2004 Ramesh had purchased 300 shares of tech major Infosys @ ` 628.13/share. Over the years thereafter, Ramesh continued buying Infosys. He had also received a 1:1 bonus on 15.6.15. He accepted the recent buy-back offer of Infosys @ ` 1,150/share. He was entitled to 90 buy-backs. Since he was aware of the fact that there are many investors who would not accept this offer, either because of their lethargy or non-availability or any other reasons, Ramesh offered all his holdings for the buy-back and was surprised to find that Infosys bought back as many as 209 shares from him. The amount paid by Infosys was ` 2,40,350 (= 209*1150) on which STT applicable was ` 240 (=0.1% of 240350). This STT enabled him to claim exemption on the LTCG Ramesh had earned.
How much LTCG Ramesh had earned? The index for FY 04-05 is 113 and that for the current financial year 2017-18 is 272. Consequently, his indexed cost of acquisition per share was ` 1,531 (=(628.13*272/113)). The LTCG per share = 1150 – 1531 = a long term loss of 381 /share. The total long-term loss = 79,629. Since for transactions which suffer STT, the LTCG is tax-free, the loss is also tax-free.
In other words this loss is lost to him. He cannot set it off against any long or short term gain earned during the year. Had Ramesh not sold the shares through his broker and submitted these directly to the R&T agents of Infosys, no STT was payable and therefore, if this transaction had resulted into a gain, Ramesh would have had to pay tax @10% without indexation and @20% with indexation, whichever is lower. If it resulted into a loss (` 79,629 in the present case), it can be set off against any other capital gains earned during the year and thereafter it can be carried forward for 8 successive years for similar set offs. Some time ago, anyone had the option of going through the broker or directly.
For example, based on the above, Ramesh would have benefited by routing the transaction outside the exchange and not paying STT. However, market regulator Securities and Exchange Board of India (SEBI) has made this direct route unavailable through Circulars dt 24.3.2015, 13.4.2015 and 9.12.16. Investors do not have an option anymore and have to mandatorily route the transaction through the exchange.
In other words, to gain the benefit for the exemption from LTCG, investors such as Ramesh have to pay STT. Additionally, there are brokerage, exchange charge, SEBI turnover fee, stamp duty, and Goods and Services Tax (GST) payable.
Another nuance of buybacks
Some creative promoters / investors had used the provisions of the buy-back structure to earn a quick tax-free buck. In the case of a non-resident shareholder, for the capital gain emanating out of buy-back, the tax treaty provisions would apply, to the extent they are more favourable.
Typically, under the tax treaties India has entered into with Mauritius, Cyprus and Singapore, capital gains is not taxable in India under their domestic tax laws. Consequently, buyback of shares by unlisted companies were not subject to tax either in India or in the foreign country. This route started commonly being used by non resident Indians (NRIs) to mitigate the DDT which is otherwise payable when profits are distributed as dividends.
FA13 has inserted Sec. 115QA to plug this loop hole by levying an ‘additional income tax’ on distribution of income by way of buyback of shares by unlisted companies. Accordingly, besides the standard corporate tax, an additional income tax will be charged @23.69% = (20% + Surcharge of 15% + Cess of 3%) on the difference between consideration received by the shareholder on buyback as reduced by the amount received by the company for issue of such shares. Since the tax will be levied on the Indian company making the share buy-back, a non-resident shareholder will not be able to reduce the impact of the tax by claiming treaty protection. This additional tax is applicable even if the normal tax payable by the company is nil! This additional tax is applicable even if an Indian company buys back its shares from a Resident. To avoid double taxation of same transaction, Sec. (10)(34A) is inserted to exempt the gain, if any, arising in the hands of shareholders. Consequently, loss arising on such transaction, if any, cannot be set off or carried forward.
Moreover, no deduction under any other provisions shall be allowed to the company or shareholders on the amount which has been charged to this tax. This is rather harsh. Capital gains tax on share buy-backs would have been better for the share holder of the unlisted company.
All said and done, we strongly feel that the investor should be given the option to go directly to the company or through his broker, whatever is more advantageous to him. On deeper analysis, we have found that in most of the cases the direct route scores over the broker route. It is difficult to fathom the wisdom behind the broker being brought into the picture in any buy-back transaction.
This is strictly a transaction between the company and the investor. The broker is a third party who has no role to play in this. The investor is unnecessarily getting penalised by forcing him to pay the brokerage. We sincerely entreat the regulating authority to take a step backward and reinstate the earlier provisions.
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