Share Buyback Tax (Detailed)

The taxation of share buybacks in India underwent a fundamental regime change with effect from 1 October 2024, when the Finance Act 2024 amended the Income Tax Act to abolish the company-level buyback tax and replace it with shareholder-level taxation, aligning India's buyback tax framework more closely with international norms.

Under the pre-October 2024 regime established by Section 115QA, a domestic company was required to pay an additional income tax — commonly called buyback tax or buy-back distribution tax — on the distributed income at the rate of twenty percent. With surcharge and health and education cess, the effective rate came to approximately 23.296%. The distributed income was defined as the consideration paid to shareholders less the amount received by the company at the time of the original issue of those shares. Crucially, the tax was paid by the company; in the hands of the recipient shareholders, the proceeds from a buyback were exempt from tax under Section 10(34A). This treatment effectively meant buyback proceeds were more tax-efficient than dividends in the hands of high-net-worth individuals in high income tax slabs, since dividend income was taxable at the slab rate post the 2020 DDT abolition.

This asymmetry created a strong incentive for companies to route capital returns through buybacks rather than dividends, particularly benefiting promoters and high-income shareholders who would otherwise face high marginal rates on dividend income. The government, recognising this arbitrage, amended the framework through the Finance Act 2024.

Under the post-October 2024 regime, Section 115QA was effectively repealed for buybacks undertaken after the effective date. Instead, buyback proceeds received by shareholders are treated as deemed dividends under Section 2(22)(f) of the Income Tax Act, taxable in the hands of shareholders at the applicable income tax rate (slab rate for individuals and resident entities, treaty rate for foreign investors subject to applicable DTAA provisions). The company making the buyback withholds tax at source under Section 194, as it would for dividends.

The change substantially levelled the playing field between buybacks and dividends from a tax perspective for resident individual shareholders. For institutional shareholders — both domestic and foreign — the after-tax impact depends on their specific tax profile, treaty benefits, and holding period. FPIs from treaty-favourable jurisdictions may find that buyback proceeds now qualify for reduced withholding tax rates under DTAA provisions applicable to dividends, potentially making the post-2024 regime tax-efficient for certain foreign holders relative to the 23.296% company-level tax that had no DTAA mitigation.

For corporate finance analysis, the regime change requires reassessment of the relative merits of buybacks versus dividends for different shareholder classes. Companies structuring capital return policies post-October 2024 must weigh the tax implications for their dominant shareholder groups and model the after-tax yield under both mechanisms to determine the most efficient form of distribution.