Taxation of buybacks by unlisted companies: a step toward greater clarity?

Buyback tax (BBT) provisions were introduced in the Income Tax Laws (ITL) in 2013 to check tax avoidance by unlisted companies, which resorted to buyback of shares instead of dividend distribution, particularly where the buyback distribution proceeds were tax-exempt for overseas shareholders under the treaty network.

BBT is payable by domestic unlisted companies in the event of a buyback; this liability is in addition to the corporate tax liability and cannot be mollified through tax treaties. It is about 23% of “distributed income,” which is the difference between the amount of consideration paid by the company on buyback and the amount received by the company when it issued such shares.

Various stakeholders raised concerns regarding lack of clarity in the determination of the amount received in situations where shares were issued by the company for different considerations, at different point in time or in lieu of shares of another company under a merger, demerger, conversion, succession, etc.

Acknowledging the concerns of stakeholders and in order to remove ambiguity, the Budget 2016 amended the ITLto empower the Central Board of Direct Taxes (CBDT) to make rules for the determination of the amount received by a company for issue of shares being bought back. Pursuant to that and as part of a consultative process, the CBDT issued draft rules in July 2016 in this regard.

Based on comments received from the public on draft rules, the CBDT recently released the final BBT rules (the Rules), which are effective from 1 June 2016 onward. The Rules provide the methodology for determining the amount received for the purposes of BBT levy under different scenarios depending upon the manner of issue of shares (for example, regular issue, merger and demerger).

The Rules cover several practical aspects — for example, convertible instruments, buyback of shares in demat form, shares issued under ESOP scheme and sweat equity shares issued.

In a practical scenario, shares may be issued in exchange for an asset, in settlement of liability or by way of share-swap deals; the Rules take cognizance of this and provide that the amount received in such cases should be computed with reference to the lower of fair value of the asset/liability as valued by a recognized merchant banker or amount credited to share capital and premium. The Rules even prescribe a proportionality principle for part-share deals.

The Rules also recognizes that reduction of the amount returned prior to buyback (on which the company has paid dividend-distribution tax, i.e., in a capital-reduction scenario) from the amount received results in double taxation for the company; therefore, the Rules have a specific proviso to provide that such amounts (on which dividend-distribution tax is paid) should not be reduced while computing the amount received for buyback purposes. Else, any amount paid on such reduction would have been reduced again for buyback purposes.

With respect to equity shares issued pursuant to the conversion of a firm into a company or succession of sole proprietorship by a company, the Rules provide that the amount received is to be determined with reference to the net book value of assets computed in the manner prescribed. Also, with respect to shares issued under the ESOP scheme or as sweat equity shares, the amount received is to be determined with reference to the fair value of shares computed in the manner prescribed (to the extent credited to share capital and share premium).

While the Rules undoubtedly cover situations aligned with commercial realities and bring in the much-needed clarity with respect to the computation of BBT in several scenarios, there are some areas that still remain ambiguous and may create room for potential litigation:

  • The Rules provide that the amount received by a company for the issue of bonus shares is deemed to be “nil.” This provision results in dual tax levy for the company: when it allots bonus shares to preference shareholders, it pays dividend distribution tax under the extant ITL at the time of issue, and when it buys back the bonus shares at a future date, it will again be liable to pay BBT on the buyback consideration.
  • The Rules have a “catch-all” clause, which states that for all cases for which no specific provision is made, the face value of shares will be considered as the amount received at the time of issuance of shares. The applicability of this clause may, in some cases, throw up non-intended results; for example, if shares are split or consolidated at a future date, the amount received for such shares will now be reckoned on the basis of their face value, even if the original shares were issued at premium. In contrast, if the original shares were bought back, the amount actually received, including premium, would be considered. Ideally, in such a situation, the proportionate amount actually received by the company in respect of shares that are eventually split/consolidated could have been considered as the “amount received.” However, the Rules remain silent on this aspect.

The Rules are indeed a step forward in the Government’s commitment toward tax simplification and certainty: having appreciated the business and commercial realities embracing the different scenarios of share issuance under the Rules, we expect that the few loose-ends will be addressed soon.

Views expressed are personal.

(Amrita Mehrotra, Manager, Transaction Tax, EY India also contributed to this article)

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