There was lot of controversy whether buy-back of shares could be treated as dividend taxable u/s.115-0 of IT Act. It was generally felt that distribution of dividend amounts to payment to all the shareholders of company. On the other hand buy-back could be to a few shareholders, therefore there is no real distribution as contemplated u/s.2(22) of IT Act.

The finance minister in his budget speech announced that no additional tax on buy back will be paid by the corporates on the buy-back transactions. In the end result only the shareholder shall be subject to capital gain tax.

So as to do that the Finance Bill is being amended. The new sub-section under section 2(22) clause (d) would mean that the Finance Bill proposes to provide that the dividend does not include any payment made by the company on purchase of its own shares, if the provision u/s.77A of The Companies Act, 1956 are complied with. With this clarification the doubt is removed out of the mind of the corporates and the shareholderswith regard to the mandatory provision of payment of additional tax at 10 per cent on dividend distributed u/s.115-O of the IT Act. Hitherto before, there was lot of hesitation on the part of company to pay the said additional tax.

The sub-section 46A proposed with effect from 1st April, 2000, would mean that any consideration received by the shareholder or a holder of specified securities from any company on purchase of its own shares or the specified securities to the extent of difference between the cost of acquisition and the value of consideration so received shall be deemed to be the capital gain (subject to covenants u/s.48).

However, the bill is silent as to the provisions of indexation benefits. The whole rationale of the finance minister as it appears, stems from the ruling given by the Supreme Court in the case of A Sarabhai vs CIT (224 ITR 422) where it was held that "the redemption of preference shares results in transfer of capital assets and giving rise to capital gains."

The SupremeCourt has observed in the case of A Sarabhai vs CIT that the amount paid as buy-back does amount transfer of capital asset by shareholder the surplus which is taxable as long-term or short-term capital gain. The court further noted that redemption of preference shares was not reduction of capital in view of section 80(3). Thus the redemption of preference shares is not taxable as dividend u/s.2(22)(d) of the Act. The tax treatment of buy-back of shares could depend upon the facts of each case. The budget speech of the finance minister thus has put to rest the controversy.

As regards expenses on buy-back e.g., legal expenses, fees to advisors etc. it is felt that the tax treatment could vary from case to case and in particular could depend on nature of transaction, manner in which buy-back is carried out.

Judicial precedents on buy-back of shares and its tax implication:The Supreme Court in the case of Punjab Distilling Industries Ltd vs CIT observed that a company under cloak of reducing its capital couldutilise the accumulated profits for making payment to shareholder. This could undoubtedly lead to tax evasion, because the shareholder could be receiving `dividend'. The court thus gave a wider meaning to the definition of term `dividend' so as to include buy-back.

KG Saraf is a Mumbai-based company secretary