In the euphoria that has been generated by the ordinance permitting share buyback, many basic points seem to have been ignored. Firstly, Section 100 of the Companies Act provides that a company can reduce its capital if it is not represented by available assets, or when the paid-up capital is in excess of the company's requirements. Hence, this simply means that companies opting for buyback have either diluted equity in excess of the requirements, or equity is not backed by available assets. Neither reflects well on the management.

While the many loopholes in the ordinance have been discussed in detail, the tax impact is still unclear. A view has been taken based on the inclusive definition of dividend in Section 2(22)(d) of the Income Tax Act that share buyback is akin to dividend payout by companies opting for such a buyback. Section 2(22)(d) provides that dividend includes any distribution to its shareholders by a company on the reduction of capital, to the extent to which thecompany posesses accumulated profits, whether such accumulated profits have been capitalised or not.

The payment of dividend necessarily attracts dividend tax, which is covered by Section 115-O of the Income Tax Act. It provides that dividend declared, distributed, and paid will be charged at the rate of 10 per cent. In the case of a buyback, `dividend' is neither declared nor distributed. The payment is for a simple arm's length transaction of buying and selling of shares. Whether a consideration paid for such a transaction be treated as dividend is a moot question.

Section 2(22)(d) of the Income Tax Act states that any distribution to its shareholders by a company on reduction of capital is deemed dividend. In the case of a buyback, no distribution on reduction takes place, and the shareholders are simply being paid a price which is related to the market price for the scrip.

Apart from the definition of share buyback, many more questions have been thrown up by the ordinance as far as the tax angle isconcerned. Some of these are listed below: (a) What if the buyback of shares is from the securities premium account? By no stretch of imagination can securities premium be treated as accumulated profits of the company. Take the example of Grasim, which has a share premium of Rs 640.02 crore, and equity of Rs 72.31 crore. Assuming that Grasim opts to buy back 25 per cent of its equity at Rs 250 a share, the share premium account will be debited only by Rs 451.95 crore. We may take Essel Packaging as another similar case. Free reserves (as at end-March 1998) include a share premium of Rs 97.88 crore. The equity is Rs 15.21 crore. Assuming that 25 per cent of equity is bought back at Rs 250 a share, the share premium will be exhausted. Can the buyback of shares be treated as dividend in such cases?

(b) What if the company opts for buyback through the open market? In this case, the question arises as to whom the `dividend' is being paid. The seller may not be the registered owner of the scrips at all as theshares might not have been sent for transfer by the owner. In such instances, is it possible to believe that the seller has received `dividend' and not made capital gains and/or capital loss? Also, is it possible that the same transaction can be taxed in two different ways? Dividend in the hands of the company and capital gain/loss for the seller of shares? If a buyer has capital gains and wants to set off capital loss (both short-term) resulting from buyback by the company, will it be allowed? In this case, the company opting for buyback does not know the identity of the seller (payment will be made through clearing house), and hence, to whom it is paying `dividend'?

(c) What if the acquisition cost for an investor is Rs 300 a share, and the buyback is at Rs 250 a share? It is a clear case of loss for the shareholder. Does the concept of negative `dividend' exist?

(d) What if on merger, capital reserve (CR) is created? CR is basically a book entry. Subsequently, on transfer of capital asset resulting inprofit, capital reserve is enhanced. The transaction results in CR backed by cash. As per the guidelines for the issue of bonus shares, such CR can be capitalised, but cannot be used to declare dividend. If the buyback is done through this route (as CR is free reserve), where is the question of `dividend'?

Section 46(2) of the Income Tax Act, which provides that the amount received by a shareholder on liquidation of a company can be treated as both deemed dividend and capital gains, is cited as ground to justify the `dividend' treatment. Here, parallel can be drawn between Section 41(2) omitted with effect from April 1988, and the existing Section 46(2). Section 41(2) provided that profit arising out of transfer of depreciable asset being the difference between the sale consideration and written down value should be divided in two parts and taxed under two different heads, profit to the extent of depreciation already allowed was taxable as business income and profit in excess of depreciation alreadyallowed was taxable as capital gains under Section 50.

Just as was the case with Section 41 (2), Section 46(2) is a specific provision, and the portion to be treated on liquidation as deemed dividend and capital gains is specified.

The situation is best summed up by Dinesh Vyas, senior advocate, "The Income Tax Act has no specific provision for buyback, and the act will have to be amended." In all probability, post-amendment, buyback will be treated as capital gain/loss.

Emcee (With contributions from Urmik Chhaya)