The Ghost of Buy-Back Tax Continues to Haunt Corporates
The government has introduced a slew of tax measures in the union budget 2019 directed at taxing rich individuals and entities. One of these measures was the proposal to levy a tax on listed companies when they buy back shares from the shareholders. The imposition of 20% tax on share buyback which was earlier applicable only to unlisted companies drew in a lot of flak and concerns from corporate giants.
The stipulation was brought in as an anti-abuse provision to discourage buyback of shares and encourage dividend distribution to shareholders in case of surplus earnings by a company. There was a feeling that listed companies took to the buy-back route to avoid paying the dividend distribution tax (DDT) pegged at an effective rate of 20.5576%. Therefore, it was deemed essential to plug this loophole that corporates were exploring to evade taxes. However, it is unfair to look at the corporate action of share buyback from such a narrow perspective. Apart from being a tax saving option, buyback also increases earnings per share of the company, avail positive debt-equity ratio and facilitates an exit route to shareholders. On that account, the government needs to issue a clarification regarding the applicability of the announcement to existing buyback proposals and other legal implications of the same.
What Constitutes Buyback?
The corporate action of a share buyback is a route for companies to return the extra income earned to the shareholders while potentially boosting their earning per share and value of the share over a long term. In a share buyback a company will extinguish the shares bought back or treated as treasury stock as permitted under IND AS.
Section 115QA of the Income-Tax Act, 1961 which provides for the imposition of tax on distributed income of a domestic company for buy-back of unlisted shares would now be amended to include shares listed on a recognized stock exchange. As a consequence, over and above the tax on income chargeable in respect of the total income of a domestic company for any assessment year, any amount of distributed income by all corporates on buy-back of shares from a shareholders is to face an additional tax at 20% on the distributed income.
The Tax Impact
Prior to the Budget announcement, a listed company had to pay corporate tax at 30% plus applicable surcharge and cess and the profits after tax when distributed among shareholders in the form of dividend attracted an additional effective tax rate of 20.56% in at the hands of the company. In addition, a specified assessee is required to pay income tax of 10 % when the amount of dividend received by him exceeded 10 lakh rupees as provided u/s 115BBDA of the Income Tax Act.
So the option for listed companies was to go for buyback of share which would not attract any additional tax apart from the corporate tax so that it could benefit the shareholders most.
Whereas now, in case of buyback of shares, entities will have to pay 20% on the difference of the initial value of the share and the buyback tender offer. Here it is pertinent to note that shareholders were exempted from capital gains tax arising in case of buyback of unlisted shares by companies u/s 10(34A). Now the budget amendment has extended similar exemption to shareholders of a listed shares of companies u/s 10(34A).
Further, questions such as what happens when there is a market-based buyback and not a tender offer buyback needs to be clarified. Also, what would be the status if there is a capital loss in the hands of the shareholder and not a gain? Whether the capital loss would be allowed to be set off in subsequent years needs to be addressed.
Application of the proposal
As per the Union Budget, 2019 any Buyback implemented post-July 5th, 2019 by listed Companies is subject to an additional tax @20%. Therefore, another relevant question that needs to be addressed immediately is whether the intention is to offer prospective or retrospective tax levy. A lack of clarity on this has pushed KPR Mill Limited, a prominent player among listed companies, to withdraw its offer to buy back its securities. Another listed entity facing the dilemma, SKP Securities, has brought its concern regarding the same to the attention of the market regulator and has also enquired whether it could withdraw its call for a buyback. Therefore, whether a Corporate can withdraw its offer to buy back while the scheme is announced and open needs to be elucidated. It is vital to comprehend and evaluate what the regulator and the governing laws offer to address this dilemma.
Corporates listed in the Secondary market are governed by the SEBI (Buy-back of Securities) Regulation 2018. The regulations in this regard unambiguously state that once a corporate submits the offer letter pertinent to the scheme with the regulator, or in this regard, a public announcement is made, the Corporate cannot withdraw the said scheme.
It is worth noting that in this regard, the Companies law also offers similar provisions by way of Companies (Share Capital and Debentures) Rules 2014. The rules are clear: Post the announcement of an offer to its shareholders, one cannot withdraw the scheme.
Consequently, KPR mills could only withdraw after citing difficulties in getting shareholder approval for the enhanced disbursement and the legal impediment in availing funds to cover it.
Although it seems that another objective that the government sought to achieve through this measure was to ensure investment by listed companies in furtherance of its business or diversification of its operation which would lead to job opportunities and boost the economy. Also, taxing rich corporates would supplement the government’s financial requirements which would help in running welfare schemes and achieving the goal of the 5 trillion USD economy that we hope to achieve by the year 2024. Rather than taxing individuals, this route would help tax corporates that have the means to pay for it. Also, it gives a level playing field to unlisted and listed companies.
However, the measure drives one to question whether it is possible to achieve an effective tax administration in the presence of such loopholes and grey areas in the tax system. In addition, the announcement flouts the well-known “Canons of Taxation, “ which prescribe Canon of Certainty and Canon of Convenience among the other prescribed canons. Till the regulator or the government addresses the afore-mentioned dilemmas, it seems that the said proposal is contrary to the world-known principles of taxation.
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the measure drives one to question whether it is possible to achieve an effective tax administration in the presence of such loopholes and grey areas in the tax system. In addition, the announcement flouts the well-known “Canons of Taxation, “ which prescribe Canon of Certainty and Canon of Convenience among the other prescribed canons. Till the regulator or the government addresses the afore-mentioned dilemmas, it seems that the said proposal is contrary to the world-known principles of taxation.