By Siddarth M Pai
India’s fiscal history on share buybacks is a tug-of-war between capital formation and aggressive tax enforcement. Buybacks are a process by which a company repurchases it securities from shareholders and extinguishes them. Legally, a buyback checks every box for Capital Gains:(a) An Asset: The share (b) A Transfer: The extinguishment (c) A Gain: The profit. Yet buybacks have seen significant litigation and tinkering due to the department treating them as dividends. Prior to Finance Act, 1999, the department treated such buyback gains as dividend as they viewed it as a distribution of accumulated profits, disregarding the fact that shares were extinguished pursuant to a buyback. To avoid litigation, Section 46A was inserted to treat buyback income as capital gains.
Abuse, avoidance and the 2013 tax shift
However, abuse detected by Mauritius entities and structuring to avoid DDT saw the introduction of measures in 2013 to tax buybacks by unlisted companies at 20% rate plus cess, while making it tax free in the hands of shareholders. This was extended to listed companies in 2019. October 1, 2024, saw the reversal of 25 years of legislation by taxing buybacks as dividend income once again. The irony of the same budget being used to expound “implication of taxation” while introducing convolutions wasn’t lost on the market. The market verdict was brutal: Listed buybacks collapsed from ₹51,143 crore (FY24) to just ₹8,130 crore (FY25).
The reason for this 2024 insertion was to compel companies to invest surplus cash as opposed to distributing it. But this well-intentioned measure failed to account for the intention of companies to only invest in profitable areas and shun experimental forays. Basis finance theory compels companies to distribute excess cash to shareholders so that shareholders may find other profitable investment avenues. Companies often do so when the return on their investment of surplus cash is lower than the return on their stock, or if other ventures are out of their domain of expertise. Forcing companies to hoard cash they cannot efficiently deploy doesn’t just distort the market, it destroys value. Capital flows toward profit, not government mandates.
Budget 2026 finally saw better sense prevail, at least partially. It reinstated buyback income as capital gains but chose to punish promoters and large shareholders with a higher rate. For all shareholders who hold less than 10% or are not promoters, buybacks are capital gains tax. For others, the effectives rates are 22% for domestic companies and 30% for all others, regardless of the holding period.
Relief for employees, pain for founders and investors
The move is beneficial for employees, who can finally enjoy buyback as an exit avenue after being taxed at value at which investors invest in the company. But the pain will be felt by startup founders and financial investors, who suffer the additional tax. Startup investors are especially vulnerable as they have concentrated holdings, often above 10%.
India has solved one problem only to create another. By penalising the very builders of the ecosystem, this regime imposes a ‘success tax’ that directly contradicts the PM’s call to respect wealth creators. It is a bitter pill for the Indian entrepreneur.
(With inputs from TV Mohandas Pai, chairman, Aarin Capital)
The author is Managing partner and CFO, 3one4 Capital
Disclaimer: The views expressed are the author’s own and do not reflect the official policy or position of Financial Express.”