Tax Implications on Sale of Unlisted Equity Shares
Extract from Income Tax Act
Insertion of new Chapter XII-DA.
31. After Chapter XII-D of the Income-tax Act, the following Chapter shall be inserted with effect from the 1st day of June, 2013, namely:—
'CHAPTER XII-DA
SPECIAL PROVISIONS RELATING TO TAX ON DISTRIBUTED INCOME OF DOMESTIC COMPANY FOR BUY-BACK OF SHARES
115QA. Tax on distributed income to shareholders.—(1) Notwithstanding anything contained in any other provision of this Act, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount of distributed income by the company on buy-back of shares (not being shares listed on a recognised stock exchange) from a shareholder shall be charged to tax and such company shall be liable to pay additional income-tax at the rate of twenty per cent on the distributed income.
Explanation.—For the purposes of this section,—
| (i) | "buy-back" means purchase by a company of its own shares in accordance with the provisions of section 77A of the Companies Act, 1956 (1 of 1956); | |
| (ii) | "distributed income" means the consideration paid by the company on buy-back of shares as reduced by the amount which was received by the company for issue of such shares. |
(2) Notwithstanding that no income-tax is payable by a domestic company on its total income computed in accordance with the provisions of this Act, the tax on the distributed income under sub-section (1) shall be payable by such company.
(3) The principal officer of the domestic company and the company shall be liable to pay the tax to the credit of the Central Government within fourteen days from the date of payment of any consideration to the shareholder on buy-back of shares referred to in sub-section (1).
(4) The tax on the distributed income by the company shall be treated as the final payment of tax in respect of the said income and no further credit therefor shall be claimed by the company or by any other person in respect of the amount of tax so paid.
(5) No deduction under any other provision of this Act shall be allowed to the company or a shareholder in respect of the income which has been charged to tax under sub-section (1) or the tax thereon.
115QB. Interest payable for non-payment of tax by company.— Where the principal officer of the domestic company and the company fails to pay the whole or any part of the tax on the distributed income referred to in sub-section (1) of section 115QA, within the time allowed under sub-section (3) of that section, he or it shall be liable to pay simple interest at the rate of one per cent for every month or part thereof on the amount of such tax for the period beginning on the date immediately after the last date on which such tax was payable and ending with the date on which the tax is actually paid.
115QC. When company is deemed to be assessee in default.—If any principal officer of a domestic company and the company does not pay tax on distributed income in accordance with the provisions of section 115QA, then, he or it shall be deemed to be an assessee in default in respect of the amount of tax payable by him or it and all the provisions of this Act for the collection and recovery of income-tax shall apply.'
Simplified Explanation in Easy Language
Section 115QA of the Income Tax Act, 1961 regulates taxability on buying back shares. Further, income tax is levied on these shares. Buy back shares constitute repurchase of existing company shares. Moreover, these companies buy back their shares at a higher value than market value.
If you want to know more on this topic, then read on!
What is Section 115 QA of Income Tax Act?
Section 115 QA of the Income Tax Act states that company owners will have to pay a 20% surcharge and 12% if they buy back their shares. Moreover, the Government of India issued this tax to curb companies who tried evading tax payments.
Section 115 QA will not be applicable on the following:
- When the stock exchange lists a company
- A company has to announce that it is buying back shares
- Further, the public announcement needs to be made under the Securities and Exchange Board of India Regulations provisions.
Earlier, after buying back shares, the amount was distributed among shareholders. Shareholders had to pay the taxes in the form of capital gains. However, the company did not have to pay taxes in any form. Eventually, it became a gateway for companies to avoid paying taxes, especially unlisted ones.
Additionally, Section 115 QA applied only to unlisted companies, but the Union Budget of 2019 made it applicable to listed companies as well. Further, this amendment is effective on all repurchased shares after July 5 2019.
A company raises capital by distributing its shares among shareholders. Therefore, they contradict their actions when they buy those shares back. Some reasons to repurchase those shares include:
- Increase Promoter Share hold: Companies often repurchase their shares from existing shareholders when they notice that promoters are increasing their shareholding in the company.
- Compact Ownership: If an individual or company owners have a substantial hold on company shares, they have widespread ownership. Moreover, it reduces the cost of capital.
- Attractive Financials: The reduced number of shares increases the earning of each share after the buyback. Hence, the said company’s shares become profitable in the eyes of the investors.
- Correction of Share Prices: Companies can buy back shares if the market price of their shares is undervalued. This way, the company can increase the market value of the shares.
Section 115 QA of Income Tax Act, 1961 states that both listed and unlisted companies will have to pay additional income tax. Moreover, the effective rate of tax levied is 23.296% (20% + 12% SC + 4% H & EC). Besides, the company pays these taxes on distributed income of shareholders that they earn from those to buy back shares. Further, Section 115 QA tax exempts the shareholders’ income.
Furthermore, the company is required to pay taxes within a 14 days period. These 14 days are calculated from the payment date to shareholders after getting paid for buying back shares. Moreover, the IT department will consider the tax on buying back shares as the final payment.
When are the Provisions of Section 115QA Not Applicable?
Provision on Section 115 QA will not be applicable for the following cases:
- When the listed company has announced buyback of its shares
- Further, the announcement is made per the Securities and Exchange Board of India (Buyback of Securities) Regulations, 2018
This section balances out both buyback shares and dividend pay-out. Most companies are now showing more preferences toward dividend pay-outs.
Besides, a more significant concern for listed companies is that calculation of amount received for issuing these shares can be absurd. Additionally, another concern for listed companies is that they are tradable. Hence, shareholders will incur capital gains on the differential price.
Further, the Government abolished the DDT on dividends during the 2020 Budget. Therefore, according to this announcement, companies did not have to pay taxes on dividends. The Government of India will impose taxes on individual shareholders now.
Example to Illustrate Buyback of Shares under Section 115QA of Income TaxAssume that you had bought shares of company XYZ at Rs.800. After a period of 6 months you accepted the buyback offer by the company at Rs.1000. The profit of Rs.200 will be treated as short term gains as the shares were held for less than 1 year and taxed at the rate of 15%. That is the simpler part of it. The real complication arises when the buyback results in long term capital gains in the hands of the shareholder (i.e. held for more a period of more than 1 year). Here are 5 things you need to know about taxation of buybacks.
Let us first look at listed companies. One way to do a buyback is to do a buyback directly from the shareholders of the company. In this case, even if the gain is a long-term capital gain, the tax on LTCG will be payable at the lower of the two (20% with indexation or 10% without indexation). That is because when there is a direct buyback from shareholders there is no payment of STT by the shareholders. So LTCG on buyback is taxable!
Alternatively, the company can also affect the buyback of shares through the stock exchange, in which case the STT becomes payable on the transaction. However, since the STT is already paid in this case, the long-term capital gains will be entirely exempt.
In both the cases above, the taxation incidence, if any, is only on the shareholder and not on the company. That changes when we talk about buyback by an unlisted company. In that case, the company in question is also liable to pay tax.
In case of unlisted companies, there is no tax imposed on the person who benefits from the buyback of shares irrespective of whether the gain from the buyback is short term gain or long-term gain.
The entire buyback may have become slightly complicated after the Union Budget 2018 as now capital gains beyond Rs.1 lakh during a fiscal year will be taxed at 10% without the benefits of indexation. This will be applicable from April 1st, 2018 but this is likely to largely take away from the attractiveness of buybacks, especially for promoters with large holdings in companies.
Buybacks had emerged as a smart tool for promoters and large investors to avoid the payment of huge taxes on dividends. However, with the introduction of the tax on LTCG without the benefit of indexation, the advantages of buyback of shares may have largely diminished.
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