BUY-BACK OF SHARES

How to withdraw hard-earned tax-paid money from a Company has always been a challenge. Before any money can be paid to shareholders and promoters in the form Dividends or Buy back, the company already suffers a tax of 30% plus surcharge and Cess. The effective rate of Dividend Distribution Tax (which has been abolished from 01-04-2020) was 20.35%. Even now, after abolition of DDT, the dividend is taxable in the hand of recipient at a rate which may vary between 34.32% to 42.744%, depending upon applicable slab rate and applicable surcharge. Therefore, by the time money reaches to the shareholders, the Company and the recipient suffer a Tax incidence up to 62%, which discourages companies to take money out of the system.

Since, in the case of buyback of shares, it is the company which pays taxes @ 23.296% u/s 115QA, this is still a better tax saving option. Buy-back of shares is also preferred for improving certain financial ratios of the company, improving valuation of companies, providing tax-effective means of rewarding shareholders, providing an exit to the shareholders or reducing their stake.

 Income Tax Sections Triggered:

Applicable sections of Companies Act, 2013

• Section 68 – Power of company to purchase its own securities
• Section 69 – Transfer of certain sums to capital redemption reserve account
• Section 70 – Prohibition for buy-back in certain circumstances
• Rule 17 of the Companies (Share Capital and Debenture) Rules, 2014 stating norms to be complied with by the private companies and unlisted public companies for buy-back of their securities

Income Tax provisions

According to The Finance Act, 2020, Dividend Distribution Tax is no longer applicable to dividends declared, paid or distributed on or after 1st April, 2020 (AY 2021-22 onwards). Further, Section 10(34) has also been deleted, which provided for exemption to income, in the nature of dividend referred to in Section 115-O, i.e. dividends on which DDT had been paid. Section 115BBDA levying tax, at the rate of 10%, on dividend income in excess of INR 10 lakhs is also no longer applicable. Therefore, dividends received, on or after 1st April, 2020, will be taxed in the hands of the shareholders, at the rates applicable to them. However, amendments are beneficial only to small tax payers. Those individuals having taxable Income above Rs. 50 lakhs and corporate shareholders, the effective tax rate on dividend would go up to 34.32% to 42.744%.

According to Section 115QA, read with Section 10(34A), incidence of tax on buy back of shares by the company arises at the company level and thereafter no tax is required to be paid by the shareholder towards Capital Gains u/s 46A read with section 48. This also makes a case for non-applicability of 50CA.

The companies on whom provisions of Section 115JB are applicable, need not include such income for calculating MAT, as being exempt under Section 10.

The Finance Act, 2013, inserted Section 115QA, which provides for the levy of tax, on account of buy-back of shares, at an effective rate of 23.296% (20% + 12% SC + 4% H&EC), in case of a domestic unlisted company (which was made applicable to listed companies as well by the Finance Act, 2019). Buy-Back Tax has to be paid by the company on the distributed income which is nothing but the consideration paid by the company on buy back of shares, as reduced by the amount received by the company on issue of such shares, determined in the manner prescribed under Rule 40BB of the Income Tax Rules, 1962 (ITR). Also, such Buy Back Tax has to be paid by the company over and above the tax paid by it, if any, on its total income. The consequential income arising in the hands of shareholders is exempt from tax, as per Section 10(34A) of the ITA.

For the purpose of Section 115QA, ‘Buy-Back’ means purchase by the company of its own shares, in accordance with the provisions of Section 68 of the Companies Act, 2013.

Applicability of Section 56(2)(x)

Another important question to be considered is when a company carries out buy-back of its shares, then, whether the provisions of Section 56(2)(x) can be invoked on such company. If yes, then when the company does buy back of its shares by paying consideration less than the Fair Market Value (FMV) of the shares, determined in accordance with Rule 11UA of the ITR, then the differential amount (i.e. FMV of the shares Less Consideration paid) will be taxable, in the hands of the company, under Section 56(2)(x) of the ITA.

Provision of Section 56(2)(x) can, however, be invoked only if the property (being shares in this case) should become “Property” in the hands of recipient. In other words, for Section 56(2)(x) to be made applicable on a company, buying back its shares, the shares so bought back should become the “Property” of such company.

Section 68 of the Companies Act, 2013 sets out the provisions for Buy Back of shares by the company. As per Sub-Section (7) of Section 68 “Where a company buys back its own shares or other specified securities, it shall extinguish and physically destroy the shares or securities so bought back within seven days of the last date of completion of the buy-back..”

Therefore, in a scheme of buy back, shares bought back are no more in existence as they are extinguished by writing down the Share Capital. Hence, when a company buys back its shares, such shares do not become “property” or asset of the company.

Therefore, provisions of Section 56(2)(x) cannot be invoked in case a company buys back its own shares.

Valuation of Shares for Buy-back

The value to be assigned to the shares, by the company, for the purpose of buy back, is not required to be done in accordance with Rule 11UA and 11UAA, being applicable for the purpose of Section 56 and Section 50CA respectively. Rule 11UAA sets out the FMV of the shares to be determined in accordance with Rule 11UA. However, the value so determined should not be higher than the FMV of the shares of the company, as otherwise, the differential amount can be charged to tax as deemed dividend u/s 2(22)(e).

PROVISIONS UNDER COMPANIES ACT, 2013

Provisions governing the buy back under Companies Act, 2013 are contained in Section 68 to Section 70 and also Rule 17 of the Companies (Share Capital and Debenture) Rules, 2014.

Section 68 has an overriding effect on the other provisions contained in the Companies Act, 2013.  Section 68(2), sets out the pre-requisites for a buy-back to take place. Such pre-requisites, as applicable on unlisted companies are as under:

1. Buy-back is to be authorized by Articles of Association.
2. Special resolution is passed by the company authorizing buy-back. However, if the buy-back is 10% or less of the total paid-up equity capital and free reserves (including securities premium), board resolution is the sufficient requirement.
3. Buy back can be done out of free reserves, securities premium account, proceeds of issue of any shares or other specified securities.
4. Debt-equity ratio post buy-back not to exceed 2:1
5. All the shares or other specified securities for buy-back are fully paid up.
6. There cannot be more than one such offer of buy-back in a period of 365 days.

Other provisions to be complied with by the company are as under:-

1. The notice of the meeting at which the Special Resolution is proposed to be passed shall be accompanied by an explanatory statement stating particulars like necessity for buy back, class of shares, etc.
2. Every buy-back should be completed within 12 months from the date of passing Special Resolution or the Board Resolution.

• After completion of buy-back the company cannot make any further issue of same kind of shares within a period of six months. (Exceptions: Bonus issue, discharge of subsisting obligations, conversion of preference shares or debentures).

1. Further, Declaration of Solvency by the Board of Directors of the Company to be filed in Form No. SH.9 with ROC with an affidavit signed by at least 2 Directors, one of whom should be a Managing Director, if any, to the effect that the company is capable of meeting its liabilities and will not be rendered insolvent within one year from the date of declaration adopted by the Board.
2. Company shall extinguish and physically destroy the shares or securities so bought back within seven days of the last date of completion of buy back.
3. Company shall maintain a register (in Form No. SH.10) of the shares bought, the consideration paid, the date of cancellation of shares, the date of extinguishing and physically destroying the shares.

• After completion of buy back, a return to be filed (in Form No. SH.11) with the ROC containing particulars like date of board meeting, objective of buy back, class and no. of shares bought back, method adopted, buy-back price and basis of calculating the same, etc.
• Certificate in Form No. SH.15 shall be annexed with Form No. SH.11 signed by Two directors certifying that the buy-back of securities has been made in compliance with the provisions of the Act and the rules made there under.

1. Company shall file Form No. SH.8 with the ROC before buy back.
2. Letter of offer to be dispatched to the shareholders immediately after filing the same with ROC but not later than 20 days from its filing with the ROC.
3. Offer for buy back shall remain open for a period of 15-30 days.

• Company shall immediately after the date of closure of the offer, open a separate bank account and deposit sum required for discharging the consideration.
• Company cannot withdraw the offer once it has been announced.
• Company cannot utilize proceeds of borrowings from banks or financial institutions or from an earlier issue of same type of shares.

1. A sum equal to the nominal value of the shares bought back to be transferred to the capital redemption reserve account and details of such transfer shall be disclosed in the balance sheet.

• Sub-Section (5) of Section 68 provides that the Buy Back may be from the existing shareholders or security holders on a proportionate basis.

SECTION 70 – PROHIBITION FOR BUY-BACK OF SHARES

As per Section 70 of the Companies Act, 2013 a company shall not buy-back its shares or other specified securities:

1. Through any subsidiary company, including its own subsidiary company.
2. Through any investment company or group of investment companies.

• If default subsists in repayment of public deposits accepted or interest payable thereon, redemption of debentures or preference shares or payment of dividend to any shareholder or repayment of any term loan or interest payable thereon to any financial institution or bank; The prohibition is lifted if the default has been remedied and a period of 3 year has elapsed after such default ceased to exist.

2013. Further, no company shall, directly or indirectly, buy back own shares in case such company has not complied with the provisions of Sections 92 (Filing of Annual Return), Section 123 (Declaration of Dividend), Section 127 (Punishment for Failure to distribute dividend) and Section 129 (Preparation of Financial Statements) of the Companies Act, 2013.

BUY BACK FROM EXISTING SHAREHOLDERS ON PROPORTIONATE BASIS

According to Section 68 (5) buy-back “may” be undertaken by the company from its existing shareholders on a proportionate basis. It implies that the offer for buy back has to be given by the company to its existing shareholders and such offer of buy back has to be in proportion to the existing holding of the shareholders. However, as per Section 68(2), a company cannot buy back more than 25% of its Paid-up Equity Share Capital and Free reserves.

TAXABILITY IN THE HANDS NON-RESIDENT SHAREHOLDERS

According to Section 195, “any person” making payment to a non-resident is required to withhold tax from any sum paid or credited to a non-resident which is chargeable to tax in India. Tax is required to be withheld at the time of payment or credit whichever is earlier. This implies that tax under Section 195 is only required in case the payment made to non-resident is taxable in India

Since the income received by the shareholder in case of buy back by an unlisted company is exempt as per Section 10(34A), the company buying back its shares from a non-resident shareholder is not required to deduct any tax at source under Section 195.

Thank you

Sushil Kumar Sharma

Senior Partner at G R A N D M A R K & ASSOCIATES