FINANCE Act, 2013 has inserted section 115QA into the Act, wherein buy back of shares of Unlisted Domestic Company is made taxable in the hands of company. Before insertion of this section, Buy back of shares was always taxable u/s 46A of the Act in the hands of shareholders. Such a reversal in mechanism is infixed as a part of tax avoidance measure to counter the practice of foreign companies distributing dividend in the garb of buyback of shares.
Purpose of Section 115QA:
Under Income Tax Act, every company distributing dividend to its shareholders is liable to pay DDT @15% u/s 115O of the Act. However, taking advantage of DTAA entered into by India, many foreign subsidiaries started using provisions of DTAA to avoid the payment of DDT on distribution of dividends. As a part of Tax avoidance scheme, company distributed dividend to its shareholders through Buy back of shares, particularly those shareholders where capital gain arising to them, from buy back of shares, was not liable to tax. As a result, neither company nor shareholder was liable to pay tax and consequently, entire transaction used to escape the tax net. In the past, Mauritius companies have used this device to their advantage by making full use of Article 13 of DTAA read with Mauritius tax laws, which virtually guarantees them zero payment of taxes.
Scope of Section 115QA:
Let's have a look at the some of the critical provisions of section 115QA to understand various implications involved.
Section 115QA- Tax on Distributed Income of Domestic company for Buy-Back of shares:
"(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
(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."
As evident from the language, section 115QA overrides all the sections of the Act and separately charges the tax on buyback of shares by an Unlisted Domestic company. Intention behind bringing this section was to inhibit the tax avoidance measures adopted by foreign subsidiaries, still its application is not restricted to foreign companies but, all the Unlisted Indian companies are covered within its scope. Further, insertion of section 115QA has in turn confined the scope of section 46A to buyback of shares of listed company.
Under section 115O taxis payable by the company on the amount distributed to shareholders from"accumulated profits", however it would be worthwhile to note that under section 115QA company is not liable to pay tax on accumulated profits but, on "distributed income" which is defined to mean difference between price of share at the time of buyback reduced by price at which it was issued. Now, as per section 77A of the Companies Act, company is permitted to buyback shares from securities premium account, or proceeds of any shares or securities.Sole purpose of 115QA is to tax dividend distributed by the company through buyback of shares but, in case where company buys the shares from securities premium account, or proceeds of any shares or securities, there is no distribution of dividend by the company nevertheless, company would be still liable to pay tax u/s 115QA as application of this section is not restricted to companies having "accumulated profits."
Computation of Distributed Income:
Since section 115QA is a separate charging section and overrides all the provisions of the Act, it is imperative that it must have its own computation provision. Explanation to sub section (1) embodies such computational provision which provides the formula for computing the amount chargeable to tax.
Clause (ii) of explanation states as follows:
"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."
Hence, tax is payable on the difference between the buyback price and its issue price. As long as above difference is positive company would be liable to pay tax. On closer scrutiny of computation provisions, it can be observed that word used is "amount which was received" which is different from the words "Consideration received" found in the other provisions of the Act. Section 56(2)(vii), (viia), (viib) specifically uses the words "Consideration received"which not only covers money received but, money's worth. However, clause (ii) of Explanation uses the words "amount which was received" which entails that legislature intends to tax only those transactions where shares are issued for cash as computation provision does not govern a situation where shares are issued for consideration other than cash. Therefore, in such a case computational provision fails. Since charging section and computational provision is one integrated code and when there is a case to which computation provisions cannot apply, such a case is not intended by the legislature to fall within the charging section as held by Supreme Court in CIT vs. B.C. Srinivasa Setty
It is possible to contend that in case where shares are issued for consideration other than cash, amount received on issue shall be taken ‘Nil'. Such an interpretation is also not possible as the words "amount which was received" are not qualified by words "if any". Further, it's a cardinal principle of interpretation of statutes that meaning must be given to each and every word used in the Act. Plain and natural meaning of words "amount which was received" points to only one situation i.e. where shares are issued for cash. Therefore, in my opinion, ratio laid down in B.C. Srinivasa Setty (supra) is applicable and company is not liable to pay tax on shares issued for consideration other than cash.
Other tax implications:
To avoid double taxation of same transaction section 10(34A) is inserted in chapter III of the Act to exempt the gain, if any, arising in the hands of shareholders. However, this would also imply that since gain is not chargeable to tax, loss arising on such transaction accordingly would not be allowed to set off or carried forward as held in case of CIT vs. Harprasad & Co. (P.) Ltd.
Different tax implications to share buyback
Buyback through submission
One way of buyback could come through the route of contacting the shareholders and buying the shares back from them directly. When this process is undertaken then there is a distinct way in which things are done. This happens due to shares being transferred to the demat account of the buyer. Hence, there is a separate schedule that is drawn up for this purpose. The buyer which in this case is the company itself; would ensure that they contact the investors directly and then are provided the required information with respect to the action that they need to take. For this purpose they would need to fill in a specific form and then transfer the shares to the company. There are two ways in which this can be done. One involves transfer to the demat account directly and the other would involve using a transfer form if the shares are present in physical form. There is a specific price that is determined for the purpose of the buyback. This would be the amount that is paid to the shareholder. When this direct buyback route is taken, then the investor does not get the benefit of the zero rate of tax on long term capital gains. The conditions related to the application of these rates are not fulfilled. The investor does not transact on the stock exchange and there is no securities transaction tax paid. So this will not allow for the application of the zero tax rate. The tax would be 20 percent with the benefit of indexation or 10 percent without the benefit of indexation.
Buyback through market
The other way in which the company can buyback shares is through the open market. Here there is a limit or ceiling price that is suggested by the company wherein it would buy the shares at a price that is lower than this. The company then has the discretion to buy the shares from the market as and when it feels is appropriate. This results in a situation where the investor might actually be selling shares to the company as a buyback but they would not know about the details. This is because they are undertaking a normal sale on the stock exchange and have no idea who the buyer is. This is important because the price that the investor gets for the sale of the shares is the one that is prevailing in the market. It could be far less than the ceiling that has been suggested. A benefit of this route is that the buyer will be able to get the advantage of the zero rate of tax on long term capital gains because the necessary conditions for this purpose are satisfied. This happens as the transaction is on the stock exchange and securities transaction tax is paid on this. This will ensure that there is no tax liability if the gains have arisen after the shares have been held for a period of more than a year. This can result in a lot of tax savings for the investor especially when the gains are large.
Section 115QA is rightly introduced to keep a check on the tax avoidance by the foreign companies and it is essential that foreign companies making use of resources of our country must contribute to the government's kitty. However, provisions of section 115QA operates beyond the mischief sought to be remedied and effect of it is felt exterior to its intendment; Legislature could have made suitable changes in the existing section 2(22) to provide the solution for the above problem.