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Budget 2023: Indian Corporates Seek A Relook At Buyback Tax

The buyback tax needs changes to make it fairer. But there is one key hurdle, experts say.

<div class="paragraphs"><p>Source:&nbsp;Freepik</p></div>
Source: Freepik

It's the season of wish lists for India Inc. The Union Budget is two weeks away, and one of the requests is that the finance minister consider amendments to the buyback tax. The chorus has gotten louder after a sub-group set up by market regulator SEBI to review the buyback framework recently suggested making the levy fairer.

Generally, the surplus profits of a company are distributed either by way of dividends or by buying back shares from the shareholders.

Currently, for both listed and unlisted companies, buyback tax is paid by the corporate entity at a rate of about 20%. The amendment for listed companies was made in 2019 after the government noticed abuse of the provisions. It was noted that companies would choose to distribute surplus profits via buybacks instead of paying dividends to their shareholders. The tax arbitrage was possible since the tax rate for capital gains to be paid by the shareholders was lower than the Dividend Distribution Tax, which was payable by the company.

Then, in 2020, the government amended the income tax law to shift the dividend distribution levy from the company into the hands of the shareholders.

Since the basis of the arbitrage between DDT and capital gains has gone away, the ask now is to move the buyback tax too in the hands of the shareholders

The Unfairness of Buyback Tax

In FY20, 68 listed companies announced buybacks. According to the SEBI sub-group's report from November last year, 19 promoters tendered shares in excess of their pre-buyback shareholding. Consequently, these companies ended up paying buyback tax not only on the shares tendered by the promoters as per their pre-buyback shareholding but also on the additional shares tendered by them as some of the existing public shareholders did not tender their shares.

In these 19 companies, the total tax paid by these companies aggregated to Rs. 2988.79 crore. of which the tax paid by these companies on the shares tendered by the promoters was Rs. 2734.35 crore.
SEBI Committee

It’s this unfairness that the SEBI committee has asked the government to fix.

All the continuing shareholders have to share the burden of the tax payable by the listed company on the buyback proceeds of the shares tendered by exiting shareholders.

The finance ministry must be considering this proposal very seriously because the SEBI paper speaks about high numbers with respect to promoters' shares accepted as a percentage of the total buyback wherein the promoters of the company have carried out the buyback, Rahul Charkha, partner at ELP, said.

These promoters are generally high-net-worth individuals who are taxed in a very high tax bracket. Therefore, by virtue of the current system, the government is actually facing tax leakages by not taxing this class of individuals while also being unjust to the small shareholder.
Rahul Charkha, Partner, ELP

Given the statistics in the report, the ministry would be more than happy to revert to the original structure of taxing buybacks in the hands of the shareholders, Charkha added.

Amit Singhania, a partner at Shardul Amarchand Mangaldas, concurred, saying the burden of the buyback tax of an exiting shareholder is borne by the continuing shareholder by way of depletion of reserves. Also, since the tax on buybacks is not borne by shareholders, non-resident shareholders don't get credit for such taxes in an offshore jurisdiction, he added.

In terms of potential revenue loss, Singhania said it’ll make little difference if the shareholders are in India since the rate of buyback tax and long-term capital gains tax, which is about 23%, is almost the same. But if the shareholders participating in the buyback are non-residents, there will be a loss to the exchequer as the rate of capital gains tax in that case is 10.9%, he explained.

Besides a potential revenue loss, the implementation of the levy when the shareholder is a non-resident is a real hurdle as well.

In case the proposal was to go through, questions will arise on manner of withholding especially where payments are made to non-residents, Ritesh Kumar, partner at JSA, told BQ Prime.

"Practically, it will be very difficult for the listed companies to be able to assert with certainty the quantum of tax to be withheld. Also, the law requires one to obtain tax deduction certificates, which can cause tremendous delays in being able to execute the transaction."