Tax on Buyback of Shares — Post October 2024 Deemed Dividend Treatment

Prior to 1 October 2024, share buybacks by Indian companies were governed by Section 115QA, which imposed a buyback tax of 20% (plus surcharge and cess) on the distributed income — the difference between the consideration paid in the buyback and the amount received by the company at the time of original issue of those shares. This tax was paid by the company, and proceeds received by shareholders were exempt in their hands under Section 10(34A). This made the buyback route attractive to promoters and institutional shareholders who could receive cash without any personal tax liability.

The Finance (No. 2) Act 2024 fundamentally restructured this framework effective 1 October 2024. Section 115QA was amended to apply only to buybacks in respect of which public announcements were made prior to 1 October 2024. For all buybacks announced on or after that date, the proceeds received by shareholders were brought within the ambit of deemed dividends under a new clause (f) inserted in Section 2(22) of the Income Tax Act. As deemed dividends, the entire consideration received by the shareholder in a buyback (not just the profit component) was treated as dividend income and taxable at the shareholder's normal slab rate — up to 30% plus surcharge and cess for individuals in the highest bracket or at the applicable corporate rate for corporate shareholders.

Simultaneously, an offset mechanism was introduced. Since the shareholder was now taxed on the full buyback consideration as dividend, the original cost of the shares bought back would generate a capital loss equal to the full acquisition cost. This capital loss could be set off against capital gains from other transactions. For a taxpayer who purchased shares at Rs 100 and received Rs 150 in a buyback, the Rs 150 was treated as dividend income while the Rs 100 acquisition cost became a capital loss. The net economic outcome — a Rs 50 gain — would be taxed as dividend income, but the timing of the capital loss utilisation depended on whether the taxpayer had available capital gains in the same or subsequent years.

The impact of this change was most significant for corporate shareholders and high-net-worth individuals (HNIs) who had historically used buybacks as a tax-efficient alternative to dividends. A promoter holding shares in a company with a book cost of near zero would now receive buyback proceeds that were almost entirely treated as taxable dividend income. The capital loss from the near-zero cost shares would be negligible. Effective tax rates for such shareholders in buybacks jumped from near zero to potentially 35-40% including surcharge.

For resident retail investors holding shares in a buyback at moderate holding gains, the change reduced post-tax returns compared to the earlier regime. However, for investors who had purchased at prices close to the buyback price — particularly recent investors in a company announcing a buyback at a modest premium — the deemed dividend on full consideration without a meaningful capital gain offset resulted in a tax cost that exceeded the actual economic gain from the transaction.

Mutual funds holding shares in a buyback saw the buyback proceeds treated as dividend income at the fund level, which was then passed through to investors as income distribution or reflected in NAV. Debt mutual funds and balanced funds with equity components were affected depending on their specific holdings and buyback participation.