A share buyback typically refers to a company repurchasing its shares from shareholders at the market price, thereby regaining ownership previously distributed.
At first glance, a company buying back its own shares seems surprising. After all, companies raise capital by issuing shares, so why spend money to repurchase them? The logic behind buybacks is strategic, and here's why companies do it:
- Compact Ownership: Large-scale shareholding means diluted ownership and higher capital costs. A buyback reduces the number of shareholders, leading to more concentrated ownership and a leaner capital structure.
- Correcting Share Price: If a company's shares are undervalued due to market fluctuations, a buyback can support price correction, signalling to investors that management believes in the stock's potential.
- Improving Financial Metrics: Reducing the total number of outstanding shares increases Earnings Per Share (EPS). This makes the company's financials look stronger and more attractive to investors.
- Increasing Promoter Shareholding: Promoters often use buybacks to increase their stake in the company, consolidating control without issuing new shares or diluting ownership.
Income Tax Implications of Buybacks
The buyback of shares is governed by Section 115QA of the Finance Act, 2013, initially applicable to unlisted companies. It imposed a 20% tax on distributed income to curb tax avoidance, as buybacks were used to bypass dividend distribution tax.
However, in Union Budget 2019, these provisions were extended to listed companies, effective for buybacks after July 5, 2019.
Key Provisions
| Listed Companies | Unlisted Companies |
| Tax applies to buybacks after July 5, 2019 (until October 1, 2024) | Tax applicable since the Finance Act 2013 (until October 1, 2024) |
| No capital gains tax for investors | No capital gains tax for investors since the Finance Act 2013 |
Buyback Tax Rates and Due Date
Under Section 115QA, companies must pay a 23.296% tax on the distributed income from buybacks. This includes a 20% base tax, 12% surcharge, and 4% health and education cess.
Companies must pay this tax within 14 days of distributing the buyback amount to shareholders. Late payments incur a 1% monthly interest on the unpaid tax.
Changes in Budget 2024
Post October 1, 2024, companies are no longer liable for buyback tax. Instead, the recipient shareholders will pay taxes on the buyback amount as a deemed dividend under Section 2(22)(f).
Conclusion
Buybacks serve several strategic purposes for companies-streamlining ownership, supporting stock prices, and improving financial metrics. However, the tax implications, especially post-October 2024, shift the burden from companies to shareholders, making it crucial for both parties to understand the tax landscape.
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