How taxation skews share buyback over dividend payout
Hiren Bhatt, partner–deal advisory, M&A tax and private equity tax, KPMG in India, explains the differences in tax treatment of share buyback and dividend payout
Is the tax treatment of share buyback by a company different from dividend payout?
The Income-tax Act, 1961 (the Act), provides for different tax treatment both for share buyback and dividend payout. While dividend has been subject to dividend distribution tax, to be paid by the company, taxation of buyback would depend upon whether it is a buyback of listed shares or unlisted shares. Also, both dividend and buyback would have different tax treatment in the hands of the shareholders.
Is a company liable to pay any tax when it declares the dividend to its shareholders?
When any company declares the dividend, whether interim or final, such dividend is subject to dividend distribution tax (DDT) at the effective rate of 20.56 per cent on the payout.
Will such dividend be also taxed in the hands of the shareholders?
Yes. Any dividend receipt above ~10 lakh is taxable at 10 per cent in the hands for certain categories of shareholders, like individual, Hindu Undivided Family and firm.
What would be the tax treatment when a listed company undertakes buyback of its shares?
With regard to listed companies, two scenarios of taxability arise. When a buyback is not conducted through stock exchanges and securities transaction tax (STT) is not paid, long-term capital gains on buyback is subject to tax in the hands of the shareholder at 20 per cent with indexation, or at 10 per cent without indexation. Further, when STT is paid, long-term capital gains will be taxed at 10 per cent. Short-term capital gains in the above two scenarios i.e. without and with STT payment, will be taxed at applicable slab rates and 15 per cent, respectively.
What are the tax implications for unlisted companies when buyback of its shares is undertaken?
Buyback of shares undertaken by an unlisted company is governed by the specific provisions of Section 115QA of the Act. As per these provisions, any unlisted company undertaking buyback of its shares will pay buyback tax at the rate of 20 per cent on the difference between the consideration paid by the company to the shareholders on the buyback and the amount received by the company on the issue of such shares. This section is akin to dividend distribution tax wherein responsibility is cast on the company to pay the tax. It is important to note that cost-step up and indexation available to shareholders cannot be considered by the company while computing the amount of buyback tax payable. This may adversely impact the taxation on the buyback of shares acquired by shareholders through secondary acquisition.
Will there be any taxation in the hands of the shareholders of an unlisted company undertaking the buyback?
The Act provides for a specific provision which exempts income from a buyback in the hands of the shareholders, if the company has paid buyback tax under the Act.
Does Section 115QA cover buyback of all kind of shares issued by an unlisted company?
The term buyback (as defined under Section 115QA of the Act) was amended by the Finance Act 2016 to cover all types of buyback of unlisted shares within its purview, including preference shares. Will it be fair to say that the tax treatment is skewed in favour of share buyback vis-a-vis dividend payout?
As discussed above, when a listed company undertakes buyback of its shares, the effective tax rate for its shareholder ranges from 10 per cent to 30 per cent on capital gains (as may be applicable) and for an unlisted company, the tax rate is 20 per cent with no tax on shareholders.
In contrast, the aggregate taxation on dividend distributed by the company could be 20.56 to 30 per cent. So, there is no straight forward answer and depends on a case-to-case basis.
All the tax rates mentioned (other than DDT) are exclusive of surcharge and cess.
What should companies keep in mind when deciding between share buyback and dividend payout?
While dividend payout largely depends on profits available for distribution, the buyback will be subject to multiple considerations as required under the Companies Act, 2013. Some of the key criteria for buyback of shares could be the debtequity ratio of the company, the availability of free reserves or securities premium account, the maximum cash payout and the maximum amount of paid-up capital which can be bought back. Also, if a listed company is carrying out buyback, the Sebi regulations will have to be appropriately considered. Needless to say, income-tax implications as discussed above would also have to be considered.