By Mehul Bheda
The taxation of buyback of shares under the Income Tax Act, 1961, has undergone multiple shifts, reflecting the overall thinking at the government level on how to tax return of capital and distribution of profits as well as the government’s response to tax arbitrage.
Finance Bill 2026 signals a return to capital gains
Initially, buybacks were taxed as capital gains, which encouraged companies—especially promoter-driven ones—to prefer them over dividends. This was driven by lower tax rates on capital gains vs dividends, and was especially preferred by foreign-owned companies, where the overseas parents could also take benefit of tax treaties. To curb this, the Finance Act, 2013, introduced a buyback distribution tax under Section 115QA for unlisted shares, taxing the company instead of the shareholder. The tax rate was 20% on the buyback proceeds but the amount invested in the company was available as deduction. This seemed to be a balanced way of taxing buybacks, although a basis on the shares was a permanent loss not available for tax purposes if the shares were purchased from other shareholders (secondary purchase). This regime was extended to listed shares in 2019, effectively equating buybacks with dividend distributions. Shareholders were granted exemption, and capital gains provisions were overridden. However, bringing this regime to widely held listed companies led to several practical challenges, especially around the cost deduction.
In the meantime, the taxation of dividends in India underwent several flip-flops, between taxation at the company (as dividend distribution tax or DDT) and the shareholder level. Despite the abolition of DDT in 2020 and a return to shareholder-level taxation of dividends, Section 115QA was retained, creating asymmetry between dividends and buybacks.
This asymmetry, not entirely undesirable, was addressed by the Finance Act, 2024, effective October 1, 2024. The buyback tax under Section 115QA was abolished for buybacks on or after this date. Instead, the entire buyback consideration is now taxable as “dividend” in the hands of shareholders while the cost of acquisition is treated as a capital loss, allowable subject to general set-off rules. While this provided uniformity in taxation, it also lead to companies shying away from using this important tool, especially in genuine cases of return of capital.
From distribution tax to dividend treatment
The tax fraternity thought that the final word on buyback taxation has been said (at least for a few years), but Finance Bill, 2026, has made a pivot again. This was partially to address a genuine concern of the small/minority shareholders who were taxed on buybacks at the dividend slab rates but may not benefit from the cost of acquisition converted into a capital loss. The proposed provision seeks to tax buybacks (both listed and unlisted) as capital gains, thus restoring the pre-2013 position. This comes with a twist, though. To prevent tax arbitrage by promoters for distribution of profits, they will pay an additional tax on the capital gains, increasing the tax rate to 22% for domestic companies and 30% for promoters who are not domestic companies. The definition of “promoter” is drawn from the Securities and Exchange Board of India buyback regulations for listed companies. For unlisted companies, the definition is more comprehensive. It refers to the definition under Section 2(69) of the Companies Act, 2013, which covers any person who is in the control of the company or named in the annual return/prospectus as a promoter. Again, to curb misuse, the definition includes any shareholder holding more than 10% shares in the company directly or indirectly.
This proposed change is generally positive as it provides capital gains certainty with a built-in tool to prevent tax arbitrage by dominant shareholders. However, it does raise a few points for consideration. One important benefit from when buybacks were taxed as dividends was that both business losses/unabsorbed depreciation as well as deductions such as Section 80M (for onward dividend distribution) were available. These offset opportunities maybe significantly restricted in a capital gains scenario. The 10% shareholder rule could impact private equity funds/pooling vehicles, alternative investment funds, etc., and there could be ambiguity especially for tax-transparent vehicles.
The tax law on buybacks has come full circle. One does hope that going forward, these provisions are not tinkered with. In the current times of global uncertainty, investors, especially foreign ones, do look for tax certainty and policy continuity. Buyback taxation definitely qualifies for the same. It is also impossible to curb tax planning entirely as smart promoters/investors do aim for tax efficiency, and the government may be well served to fall back on the General Anti-Avoidance Rule or similar anti-abuse tools in case of genuine misuse of tax arbitrage, instead of changing tax policy.
The author is partner at Partner, Dhruva Advisors
Disclaimer: The views expressed are the author’s own and do not reflect the official policy or position of Financial Express.”