Buy back of unlisted shares - It is Still tax efficent.

Buy-Back is one of the important provisions in the Companies Act, 2013, which enables a company to purchase its own shares. Amongst other host of reasons, a program of buy-back is resorted to by a company to distribute surplus cash to its shareholders or to even provide investors an opportunity to exit from their investment, especially in case of unlisted/private companies.

A company having distributable reserves has two options to distribute the same to its shareholders: (i) declares dividend to shareholders; or (ii) purchases its own shares (i.e. buy-back of shares) at a consideration fixed by it. The present article is apropos provisions relating to buy-back of Equity Shares, in case of unlisted companies, under the Companies Act, 2013 and also the related tax incidence under the Income Tax Act, 1961 (ITA). Since, buy back of shares, in case of listed companies, also involve SEBI regulations, the same has been kept outside the preview of this article.

The endeavor, through the present article, is also to explain that with the change regarding taxability of dividends in the hands of shareholders, buy back of shares can prove to be a tax efficient tool for unlisted companies vis-à-vis distribution of dividend.

1. TAXABILITY OF DIVIDEND DISTRIBUTED BY COMPANY TO ITS SHAREHOLDERS

1.1. Uptill now domestic companies declaring, paying or distributing, dividend were  required to pay Dividend Distribution tax (DDT), at an effective tax rate of 20.35% (Rate of 15% – grossed up), as per Section 115-O of the ITA.  Also, dividend received by certain specified assessees (for instance Individuals, but excluding domestic companies), in excess of INR 10 lakhs, was chargeable to tax at a flat rate of 10%, as per Section 115BBDA.

1.2. The amendment through Finance Act, 2020, provides that DDT is no longer applicable to dividends declared, paid or distributed on or after 1st April, 2020 (AY 2021-22 onwards). Further, Section 10(34) 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to income, in the nature of dividend referred to in Section 115-O, i.e. dividends on which DDT had been paid, is no longer in force. Also, Section 115BBDA levying tax, at the rate of 10%, on dividend income in excess of INR 10 lacs is no longer applicable.

1.3. Resultantly, dividends received, on or after 1st April, 2020, will be taxed in the hands of the shareholders, at the rates applicable to them. 

1.4. Although, through this amendment, there is respite for smaller shareholders, however, for individual shareholders having taxable income of more than INR 50 Lacs and for corporate shareholders, the effective tax rate on dividend is between 34.32% to 42.744%, depending upon applicable slab rate and applicable surcharge.

2. TAXATION ON BUY BACK OF SHARES BY UNLISTED COMPANIES

2.1. 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.

2.2. 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.

2.3. Buy Back Tax is levied at the level of company, the consequential income arising in the hands of shareholders is exempt from tax, as per Section 10(34A) of the ITA.

2.4. Later on, Finance (No.2) Act, 2019 extended the scope of Section 115QA by including listed companies within its ambit.

2.5. 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.

2.6. Since, income arising in the hands of the shareholders, on account of buy back, on which “Buy Back Tax” has been paid, is exempt under Section 10(34A), there is no tax outflow in their hands, on account of buy back. Even for shareholders, which are companies, on whom provisions of Section 115JB are applicable, need not include such income for calculating MAT, as being exempt under Section 10. 

2.7. What is important to note is that shareholders falling in the higher income group, having income levels of more than INR 50 Lacs, or corporate shareholders, the effective rate at which tax is paid, when dividend is received by them is between 34.32% to 42.744%. Whereas, if in case surplus is distributed to such shareholders, by way of buy-back of shares, then the effective tax rate on such distribution is 23.296%.

2.8. Thus, buy back of shares by unlisted companies is a tax efficient mechanism for distributing surplus to its shareholders.

3. BUY BACK OF SHARES – WHETHER SECTION 56(2)(x) GETS INVOKED?

3.1. Now the next question which is 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.

3.2. As per Section 56(2)(x), where any person receives, in any previous year, any “property”:-

3.2.i. without consideration and the aggregate FMV of such property received during a previous year exceeds Rs. 50,000; or

3.2.ii. for a consideration which is less than the FMV and the aggregate of differences between FMV and consideration for such property received, during a previous year exceeds Rs. 50,000

Then such difference is taxable as income under the head ‘income from other sources’ in the hands of the person receiving such property.
3.3. “Property” is defined in Clause (vii) of Sub-section 2 of Section 56, to include, amongst other things, Shares and Securities.

3.4. Section 56(2)(x) starts with “where any person receives, in any previous, or persons on or after the 1st day of April, 2017, any property, other than immovable property….”.

3.5. Thus, primary condition for invoking the provision of Section 56(2)(x) is that the property (in the present case shares) 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.

3.6. Section 68 of the Companies Act, 2013 sets out the provisions apropos 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..”

3.7. Thus, 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.

3.8. As a result, provisions of Section 56(2)(x) cannot be invoked in the case of any company buying back its own shares.

3.8. ITAT Mumbai Bench in the case of Vora Financial Services P. Ltd. [2018] 171 ITD 646 (Mum), held that buy back of shares is not covered under the ambit of section 56(2)(viia). It was observed that for the purpose of taxing buy-back under section 56(2)(viia), shares should become "property" of recipient-company whereas in case of buy-back, such shares are mandatorily cancelled and cannot become property of a company. Accordingly, buy back of shares should be out of the ambit of section 56(2)(viia) of the Act.

3.9. The aforementioned decision has been rendered in the context of Section 56(2)(viia) which was effective till 31.03.2016. With effect from 1.04.2017, new clause (x) has been inserted to sub-section (2) to Section 56. Provisions of Clause (viia) are similar to clause (x) which is applicable to all the persons, including unlisted companies. Thus, the ratio laid down by ITAT, Mumbai Bench in the case of Vora Financial Services P. Ltd. (Supra), shall apply with equal force in the present times, wherein, Clause (x) to Sub-Section 2 to Section 56 is applicable.

4. BUY BACK OF SHARES – WHETHER SECTION 50CA GETS INVOKED?

4.1. Next question which crops up is whether provisions of Section 50CA, of the ITA, would be applicable on the shareholders offering their shares for buy back?

4.2. Section 50CA is a special provision, which provides that in case of transfer of unquoted shares, FMV of such shares should be considered to be the “Full Value of Consideration” for the purpose of Section 48, if greater than the actual consideration received or accrued as a result of transfer. For such purposes, FMV of the shares has to be determined in accordance with Rule 11UAA of the ITR.

4.3. As discussed hereinabove, taxability of buy back of shares is governed by Section 115QA, introduced by Finance Act, 2013. Section 115QA(1) starts with “Notwithstanding anything contained in any other provision of this Act”.  Thus being a non-obstante clause it shall supersede other provisions, in relation to buy back in the ITA.  

4.4. Further, Section 10(34A), also introduced through Finance Act, 2013, provides for exemption of “any income” arising to an assessee, being a shareholder, on account of buy back by a company, as referred to in Section 115QA. Thus, whatever income arises to a shareholder of unlisted company on account of buy back of shares is exempt.

4.5. As per 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. Thus, shareholder need not calculate any income under the head Capital Gains, in accordance with Section 46A, read with 48, of the ITA.

4.6. Since there is no taxability, under the head Capital Gains, of the income arising to the shareholder on buy back, computational provisions as contained in Section 48 are not invoked. Resultantly, there is no applicability of Section 50CA. 

4.7. In view of the aforementioned discussion, one can conclude that in case of buy back of shares by a company, neither Section 56(2)(x) nor Section 50CA of the ITA can be invoked.

5. DETERMINATION OF VALUE OF SHARES FOR BUY BACK

5.1. Determination of 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.  

5.2. As Rule 11UA is not applicable, does that mean that a company can buy back its shares by fixing any value of the shares, which can be greater or even less than the FMV of the shares, determined in accordance with Rule 11UA?

5.3. Although, there does not appear to be any bar on the company, to determine the value at which the buy back of the shares can be undertaken, however, still, value of the shares has to be determined on some basis.

5.4. The value 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), if relationship between the shareholder and company, as provided under that section is satisfied.

5.5. ITAT Bangalore Bench in the case of Fidelity Business Services India (P.) Ltd. [2017] 164 ITD 270 (Bangalore – Trib.) held that payment in the name of buy back of shares made by the assessee, to its related party, in excess of FMV of the share of the assessee company would fall in the ambit of Section 2(22)(e), i.e. Deemed Dividend. ITAT in the said case held that in case the buy back price is not based on the real valuation and it is “artificially inflated” by the parties then it is certainly a device for transfer of the reserves and surplus to the holding company by avoiding the payment of tax and therefore it will be treated as a colorable device. Aforementioned judgment of ITAT, Bangalore Bench, has been subsequently affirmed by the Karnataka High Court [[2018] 257 Taxman 266 (Karnataka)]

5.6. Even otherwise, General Anti Avoidance Rules (GAAR), discussed hereinafter, will act as a deterrent for any company to buy back its shares by fixing price, without any basis.

6. SECTION 68 (COMPANIES ACT, 2013) – PRE-REQUISITES FOR BUY-BACK

6.1. Before further discussing the other related provisions of the ITA, it is important to first understand the provisions applicable in case of buy back under the Companies Act, 2013.

6.2. 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.

6.3. Section 68 starts with “Notwithstanding anything contained in this Act…”. This would imply that 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, specifically for an unlisted company have been set-out hereunder:-

6.3.i Buy-back is authorized by its Articles of Association.

6.3.ii 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, in this regard, will suffice.

6.3.iii The buy-back has to be 25% or less of the total paid up Equity Capital and Free Reserves (including securities premium) of the Company.

6.3.ivThe Ratio of debt (secured and unsecured) owed by the company is not more than twice the Share Capital and its free reserves (2:1) after such buy-back.

6.3.v All the shares or other specified securities for buy-back are fully paid up.

6.3.viThere cannot be more than one such offer of buy-back in a period of 365 days.

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

6.4.i 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.

6.4.ii Every buy-back should be completed within 12 months from the date of passing Special Resolution or the Board Resolution.

6.4.iii 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)

6.4.iv 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.

6.4.v 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.

6.4.vi 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.

6.4.vii 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.

6.4.viii Certificate in Form No. SH.15 shall be annexed with Form No. SH.11 signed by 2 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.

6.4.ix Company shall file Form No. SH.8 with the ROC before buy back.

6.4.x 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.

6.4.xi Offer for buy back shall remain open for a period of 15-30 days.

6.4.xii Company shall immediately after the date of closure of the offer, open a separate bank account and deposit sum required for discharging the consideration.

6.4.xiii Company cannot withdraw the offer once it has been announced.

6.4.xiv Company cannot utilize proceeds of borrowings from banks or financial institutions or from an earlier issue of same type of shares.

6.4.xv 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.

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

7. SECTION 70 (COMPANIES ACT, 2013) – PROHIBITION FOR BUY-BACK OF SHARES

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

7.1.i Through any subsidiary company, including its own subsidiary company;

7.1.ii Through any investment company or group of investment companies;

7.1.iii 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.

7.2. 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.

8. BUY BACK FROM EXISTING SHAREHOLDERS ON PROPORTIONATE BASIS

8.1. Sub section (5) of Section 68 states that the 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.

8.2. However, one will have to bear in mind that a company, as per sub-section (2) of Section 68, cannot buy back more than 25% of its Paid-up Equity Share Capital and Free reserves.

8.3. This can be explained with the help of an example. XYZ Private Limited has total Paid-Up Equity Share Capital of Rs. 1,00,000, divided into 10,000 shares of Face Value of Rs. 10 each and also Reserves and Surplus of Rs. 10,00,000 as per the latest Audited Financials. The entire shareholding is held by four shareholders – A, B, C and D in equal percentage i.e. 25% each. Thus, A, B, C and D hold 2,500 shares each in XYZ Private Limited.

8.4. The aggregate consideration that can be paid by XYZ Private Limited, under buy back, in accordance with Section 68(2), cannot exceed 2,75,000, being 25% of total Paid Up Equity Capital and Free Reserves i.e. 25% of 11,00,000 [1,00,000 + 10,00,000]. Further, not more than 2,500 Equity Shares can be bought back by the company. Under the Companies Act, 1956, the total number of Equity Shares that could be bought back was restricted to 25% of the Total Number of Equity Shares. However, Companies Act, 2013, set out the restriction with reference to the percentage of Paid up Capital and Free Reserves and doesn’t talk about the maximum number of shares that can be bought back.  However, as a matter of precaution, the upper limit apropos the number of shares, as provided in Companies Act, 1956, should also be adhered to.

8.5. If XYZ Private Limited decides to buy back its shares, say, upto 25% of the total Paid Up Equity Capital  or i.e. 2,500 shares, then the company will have to offer for buy back of shares to all the four shareholders on a proportionate basis. Also the maximum consideration which can be paid by the company for buy back cannot exceed Rs. 2,75,000 (Being 25% of Paid up Capital of 1,00,000 and Free reserves of Rs. 10,00,000).

8.6. Now, to each of the shareholders, XYZ Private Limited will offer 2,500 x 25% i.e 625 shares for buy back.

8.7. If suppose all the four shareholders decide to enter into transaction of buy back with the company, then the company will have to buy back from each of the shareholder 625 shares.

8.8 There may also be a situation that C and D may not be willing to give their shares for Buy Back. As a result, XYZ Private Limited can Buy Back shares from the remaining shareholders i.e. A and B to the extent of 625 shares each.

8.9. There may be another situation that XYZ Private Limited wants to buy back 25% of the total Equity Shares and C and D do not want to participate. It is even possible, to buy back the requisite number of shares from a single or a group of shareholders, provided adequate documentation is done by the company by bringing on record no objection to the transaction of buy back by the shareholders not participating in buy-back. This may be in the form a no objection letter or an agreement etc.

8.10 Thus, in order to avoid any possible litigation, as an added safeguard, the company can take concurrence from C and D for entering into transaction of buy back with A and B for buy back of 1250 shares each.  As a result, 2500 shares can be bought back from A and B together.

8.11 In other words, an unlisted company can even buy back shares from a single shareholder or a group of shareholders provided adequate concurrence is taken of the arrangement from the shareholders not wanting to offer their shares for buy back. Thus, buy back can even be a tool for unlisted companies to re-organize their capital structures, in a tax efficient manner.

8.12 Supreme Court in the case of Miheer H. Mafatlal Vs. Mafatlal Industries Ltd. AIR 1997 SC 506, with reference to Section 391 of Companies Act, 1956 (Section 230 of Companies Act, 2013), held that while sanctioning the scheme court does not sit in appeal over the commercial wisdom of majority of the class of persons who with their open eyes have given their approval to the scheme and thus court cannot refuse the scheme on the ground that the better scheme for the benefit of the members or creditors could have been formed. What is important is that the scheme should not be violative of any provision of law and all the relevant material should be provided to the shareholders in order to take an informed decision on the subject matter.

8.13 National Consumer Disputes Redressal Commission in the case of Godrej Industries Limited vs. Smt. Ritu Bhargava [(2014)C PJ377(NC )] held that once the company takes appropriate steps to inform the shareholders about the scheme of buy back, seeking their option for continuing to hold the shares or not, the shareholder cannot complain, at a later stage, seeking for any relief.

8.14 Applying the same principles that when adequate approval is taken from the shareholders not participating in the buy-back offer by the company, then there cannot be much chance of litigation even at a later state in this regard. Thus, the interest of the company is safe guarded. 

9. TAXABILITY IN THE HANDS OF SHAREHOLDERS NOT PARTICIPATING IN SHARE BUY BACK SCHEME

9.1. As discussed above, a company, although is required to offer buy back of shares to all the shareholders on a proportionate basis, however, the company can still buy back shares from a single or a group of shareholders more than the proportion related to them, if such scheme is passed by way of a resolution participated by all the shareholders, including the shareholders not willing to avail such offer. However, it is reiterated that the overall limit of buy back for a company has to be 25%, in accordance with sub-section (2) of section 68.

9.2. One may argue that the shareholders not willing to participate in buy back scheme, when providing their no objection for carrying out buy back from other shareholders, in turn, transfer a right in favour of those shareholders and thus, would be chargeable to Capital Gains.

9.3. One needs to understand that in case of buy back, an offer is given to the shareholders whether they want to participate in such buy back or not. No right of any nature is created in favour of such shareholders.

9.4. When certain shareholders provide their no objection, then they are not renouncing any form of a right in favour of other shareholders from whom the company buys back the shares. They simply convey their no objection towards the company buying back shares from other shareholders. This is unlike renouncing/transfer of the rights assigned to a shareholder to subscribe to the shares of the company.

9.5. Thus, in the process, no right is created which can be construed as a Capital Asset, under Section 2(14) of ITA and resultantly, there would not be any incidence of Capital Gains taxation in such cases.  

10. GENERAL ANTI AVOIDANCE RULE  (GAAR) – IMPLICATIONS THEREOF

10.1. Purpose of GAAR is to keep aggressive tax payers under a threat that a planning predominantly carried out for tax benefit, as against a commercial purpose, can be questioned by tax authorities.

10.2. As per Section 95 of the ITA, GAAR is applicable on those “arrangements” which can be categorized as “impermissible avoidance arrangement”. Section 102(1) defines an arrangement to include singular transaction, or multiple transactions. It also includes a “step in” or a “part of the” transaction.

10.3. In the present case, buy back of shares undertaken by a company can be considered as an “arrangement”. In the process of buy back, since the company has to determine the price at which buy back of shares is to be undertaken, then “determination of such price” can be considered as “step in” or “part of the transaction” of buy back.

10.4. GAAR can be made applicable to the arrangement as a whole, in this case buy back of shares, or even to a step in or part of the arrangement, i.e. even to the extent of determination of the correct price for buy back of shares.

10.5. In accordance with Section 96, GAAR is only applicable to “impermissible avoidance arrangement”. In the present context, only picking up the relevant provisions of Section 96, a buy back transaction, or even determination of price of shares for buy back, can be categorized as an avoidance arrangement if (i) there is tax benefit; (ii) if it result into misuse of provisions of ITA.

10.6. First we need to analyze whether a transaction of buy back, as a whole, can be considered as an impermissible avoidance arrangement. One may argue that buy back of shares fall in the category of impermissible avoidance arrangement, because if the company, for distribution of surplus, would have resorted to payment of dividend, then it would have resulted into higher tax outgo, in comparison to buy back of shares. [34.32% to 42.744% vs. 23.296%]

10.7. However, CBDT, vide Circular No. 7, dated 27.1.2017, in answer to Q.No. 3 on stated that GAAR will not interplay with the right of taxpayer to select a method of implementing a transaction. It means that if there is one or more bona fide ways of doing a transaction, then the taxpayer can select the manner he wants. There shall not be any applicability of GAAR.

10.8. Since, in the present case, both the methods for distribution of surplus, by way of dividend or through buy back of shares, is provided in the ITA itself, both can be considered as equally legitimate of doing a transaction.  The same principles can apply if the buy back is undertaken by the company for re-aligning the share capital. 

10.9 It is not the purpose of GAAR that the taxpayer should opt for an alternative mode of completing the transaction which results in maximum payment of tax. Legitimate tax planning within permissible limits continues to be protected even under GAAR.

10.10 Next question is whether incorrect determination of price for buy back of shares may fall within the rigors of GAAR? This may again be divided into two parts (i) If the price at which buy back is done is greater than the FMV of the shares; (ii) if the price at which buy back is done is less than the  FMV of the shares.

10.11 If the price of the shares at which buy back is done is greater than the FMV of the shares, then GAAR provisions may apply. As it may result in tax benefit and at the same time misuse or abuse of the provisions of law. It may result into tax benefit, as instead of normal transaction of buy back, the company may want to pass on additional surplus to its shareholders in the garb of buy back. Tax benefit will arise in those cases where tax outflow on dividend would be greater in comparison to buy back of shares. Similar view was taken by ITAT Bangalore Bench in the case of Fidelity Business Services India (P.) Ltd. (Supra) which has also been upheld by the Karnataka High Court.  This shall also result in abuse or misuse of the provisions of law, as whatever amount is received by the shareholders on buy back is exempt under Section 10(34A) and there is no Capital Gains taxation and thus no applicability of Section 50CA.

10.12 Section 98 of ITA empowers the tax authority to evaluate the impermissible arrangement in substance and eliminate that part of the arrangement which is considered to be giving rise to undue tax benefit. An arrangement may be disregarded in its entirety or the same may even be re-characterized. Further, if part of an arrangement is declared impermissible, the consequences under Section 98 shall be determined with reference to such part only. In the present case, if the price determined for buy back is considered to be impermissible, then revenue authorities shall have the power under Chapter XA, to re-characterize the transaction and to consider the surplus distributed to the shareholders over and above the FMV of the shares to be in the nature of dividend and determine the additional tax accordingly.

10.13 On the other hand, if the price of the shares determined for the purpose of buy back is less than the FMV, then there may not be any applicability of GAAR. The reason for this is that the primary condition to be fulfilled is there should be some tax benefit arising out of taxable income. As discussed hereinbefore, Section 56(2)(x) is not applicable in the hands of the company carrying out buy back. Thus, at the company level there cannot be any income arising out of buy back of shares. For GAAR to apply there has to be some income arising out of the transaction for the parties, however, where there is no income, GAAR provisions cannot be invoked. From the point of view of the shareholder, also there would not be any additional tax benefit as there cannot be any allegation of payment of surplus to shareholders, through buy back, instead of declaration of dividend. 

10.14 Lastly, as per Rule 10U of the ITR, threshold is specified so that GAAR is not invoked where tax benefit arising in the relevant assessment year to all the parties to the arrangement does not exceed INR 3 crores. Thus, any tax benefit arising out of determination of the price on which buy back is to be done is less than INR 3 crores, there shall not be any applicability of GAAR. However, still the ratio as laid down by the ITAT Bangalore Bench in Fidelity Business Services India (P.) Ltd. (Supra) may apply if the relationship between the shareholder and company, as provided under section 2(22)(e) is satisfied.

11. NON-RESIDENT SHAREHOLDERS

11.1. As per Section 195 of the ITA, “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.

11.2. Thus, withholding of tax under Section 195 is only required in case the payment made to non-resident is taxable in India. If in case, such payment is not taxable in India then there is no requirement to deduct tax at source under Section 195.

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

12. STAMP DUTY ON BUY BACK

12.1. Transfer of shares of unlisted companies was subject to Stamp Duty at the rate of 0.25% of the value of shares, in accordance with Indian Stamp Act, 1899 (Article 62, Schedule I). However, the stamp duty payable on such transfer after 1st April, 2020 has been reduced to 0.015% of the sale consideration.

12.2. One may argue that buy-back of shares by a company is not a transfer as the share bought back by the company have to be statutorily extinguished within seven days from the completion of buy back, in accordance with sub-section (7) of Section 68. Further, no registration of such shares takes place in the name of the company.

12.3. As a result, there is liability apropos payment of stamp duty on the buyback of shares undertaken by the company.