Share Buyback Regulation Rules from October 2024 – Who will benefit from the changes?

With the implementation of new regulations controlling share buybacks on October 1st, 2024, India’s tax system will undergo a major transformation. The tax liability will shift from corporations to shareholders as a result of these modifications, greatly impacting the patterns of capital allocation and investment plans. Let’s examine who stands to gain from these changes and dissect them.

Understanding Tax Shift

The buyback proceeds will now be taxed as “dividend” income rather than “capital gains” under the new legislation. There are significant implications for this seemingly straightforward designation. Buybacks were tax-free for companies under the prior regulations; under the new ones, shareholders’ income from buybacks will be subject to taxation.

Effects on Equity Distribution

It is anticipated that this change would significantly affect how companies decide to allocate cash. A popular way for businesses to give back excess money to shareholders in the past has been through buybacks. However, businesses might be compelled to reevaluate buybacks as a feasible option given the increased tax burden placed on shareholders. A rise in dividends or other capital distribution strategies that might be lower in taxation for shareholders may be observed instead.

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Tax Implications for Buyback Proceeds

The shareholders’ tax reporting of repurchase proceeds will need to be adjusted due to its categorisation as dividend income. The shift aims to create a more equitable tax system by levelling the playing field between dividends and buybacks. For shareholders, this could mean higher tax liabilities depending on their income tax bracket, making it essential for investors to rethink their strategies.

Utilisation of Capital Losses

One of the critical aspects of the new regulations is how capital losses from buybacks will be treated. Shareholders will be able to treat the cost of acquiring shares that are tendered in a buyback as a capital loss. This loss can then be used to offset other capital gains or carried forward for up to eight years. While this offers some potential tax relief, the benefit is deferred and may not immediately ease the financial burden for those without significant future capital gains.

Adjustments to the Holding Period

The holding periods used to calculate both long- and short-term gains on capital will also vary as a result of the new regulations. These changes will affect how gains are taxed and classified and are required to be in line with the new tax structure. To maximise their tax results, investors will have to be mindful of these developments.

Who Will Gain from This?

The new regulations provide opportunities for certain investor groups even as they impose higher tax costs. For instance, mutual funds stand to gain from the lessened tax arbitrage between buybacks and dividends. Under the new system, mutual funds may benefit because they frequently receive tax exemptions.

Impact on Non-resident Shareholders

Another group that may benefit from the new rules are non-resident shareholders. Non-resident investors could be eligible for lower tax rates on dividend income because of tax treaties that exist with India and other nations, like the India-UK or the India-Mauritius treaties. The tax treaty between India and the UK, for example, allows UK-based shareholders to have their dividend tax rate lowered to as low as 5% to 15%, which represents a significant tax relief over the previous scheme.

Potential drawbacks

The new regulations have some significant disadvantages, despite these advantages. There will probably be more taxes to pay for resident stockholders, particularly for those who fall into higher tax categories. In light of this, buybacks might be less desirable, especially for high-net-worth individuals whose tax obligations might rise significantly. Moreover, individuals without substantial near-term capital gains may find it difficult to take advantage of the delayed tax relief on capital losses due to its potential lack of immediate benefits.

Financial Market Impact

It is impossible to ignore how the proposed buyback tax laws would affect financial markets more broadly. Given that buybacks might become less enticing, companies would want to reconsider how they distribute money. It may result in higher compliance costs and a decline in market liquidity as companies adjust to the new tax environment. To maximise profits and guarantee adherence to the new rules, both companies and investors will need to adjust to these changes.

In summary, a major change in the taxation of corporate capital returns in India will occur with the implementation of new buyback tax regulations starting in October 2024. The modifications provide new difficulties and factors to consider for businesses as well as shareholders, even if their main goals are to increase equity and lessen tax arbitrage. It will be essential for all parties involved to reevaluate their plans as the date for implementation draws near in order to thrive in this changing tax environment.

(By Garima Tripathi, Partner, V Sahai and Co, Chartered Accountants)

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