Finance Bill, 2026 proposes to amend buyback tax. Yet again. The proposed amendment simultaneously simplifies and complicates buyback tax. Latter because of the proposal to create a separate tax slab for promoters of companies who participate in buyback of shares. Former because shareholders will be liable for capital gains instead of paying tax on the entire amount received on buyback. Too early to say if a separate tax slab for promoters is warranted, but the added layer of complexity neatly ties into chequered history of buyback tax, as depicted here.
A simple conception of buyback tax would be – taxable amount is the difference between amount received by a shareholder on buyback and issue price of shares. And the amount is taxable in hands of shareholder as capital gains. But, akin to love, Indian tax policy on buybacks has rarely followed a straight path. In this article I provide a descriptive account of the origin and subsequent evolution of buyback tax in India upto its latest modification. I conclude that buyback tax is an example of how the Revenue, in its attempt to plug tax avoidance, unduly complicated the provisions of Income Tax Act, 1961 (‘IT Act, 1961’) in relation to buyback tax.
Origin of Buyback Tax – Tied to Dividend Distribution Tax
India introduced Dividend Distribution Tax (‘DDT’) in 1997 and made companies liable for tax on dividends. The Budget Speech of 1997 – by then Finance Minister P. Chidambaram – reasoned that introduction of DDT was to enable efficient collection of tax on dividend. It was easier to collect tax on dividends at the company level instead of tracking multiple shareholders. Also, DDT was introduced to discourage companies from distributing ‘exorbitant dividends’ to shareholders and instead further invest their profits. Consequent to introduction of DDT, companies started pursuing buyback of shares as an avenue to avoid payment of DDT. If a company was profitable, buyback of shares achieved the same objective as payment of dividends, i.e., sharing profits with shareholders.
To prevent companies from circumventing their DDT obligations, buyback tax was introduced in 2013. Section 115QA, Income Tax Act, 1961 levied tax on ‘amount of distributed income’ by the company on buyback of shares. And distributed income was defined as the difference between consideration paid by a company for buyback and amount received by it on issue of shares. Buyback tax was a convoluted tax since its inception. A company which was paying money to buy shares from its shareholders was made liable for buyback tax instead of the shareholders who received the money. But the original convoluted version of buyback tax can be explained in the context of DDT.
DDT imposed tax liability on companies if they distributed dividends and buyback tax was introduced to prevent them from using buyback route to avoid payment of DDT. Imposing the burden of buyback tax on companies ensured that dividend distribution and buyback of shares attracted similar tax liabilities for companies. And companies did not use the latter for mitigating their DDT liability. In fact, the Memorandum to Finance Act, 2013 clearly stated that buyback was an anti-abuse measure. And the tax rates of DDT and buyback tax were also similar to prevent one being a more attractive option vis-à-vis the other. Buyback tax received the label of a tax but was, in effect, a backstop to prevent companies from circumventing their DDT obligations.
Dividend Distribution Tax Laid to Rest
In 2020, India abolished DDT and reverted to the classical system of dividend taxation where dividends are viewed as income in hands of shareholders. From 2020 onwards, tax liability for dividends is imposed on shareholders receiving dividends instead of companies distributing the dividends. DDT, the Union realized, was cumbersome and unnecessarily added to compliance obligations of companies. And presumably the original reason of discouraging companies from declaring exorbitant dividends was also a redundant policy. Nonetheless, the abolition of DDT removed the original incentive of companies to indulge in buyback of shares. And from here on we enter an even more confused – and difficult to fathom – domain of Indian tax policy in relation to buyback tax.
Buyback tax was an anti-abuse measure for DDT and removal of latter demanded a simultaneous modification of the former. Ideally a removal of buyback tax altogether. But Indian tax policy doesn’t inhabit an ideal world. Far from it.
Buyback Tax Complicated via Finance Act, 2024
In the period of 2020-2024, there remained a dissonance between dividend taxation and buyback tax. The burden of tax of the former was on shareholders while that of latter continued to be on companies. To correct this anomaly, there were two possible modifications for buyback tax:
First, altogether remove it from the IT Act, 1961 since the original reason for its introduction, i.e., DDT ceased to exist.
Second, by way of abundant caution shift the tax liability of buyback shares to shareholders aligning it with the classical system of dividend taxation implemented in 2020. Such a modification would have maintained tax parity between distribution of dividends and buyback of shares.
Instead, Finance Act, 2024 propelled buyback tax to a complicated territory. Section 115QA of the IT Act, 1961 was amended to state that buyback tax shall not apply to buyback of shares that took place on after 1 October 2024. Effectively, ending the original avatar of buyback tax.
However, the Finance Act, 2024 also simultaneously expanded the definition of dividend under Section 2(22) of the IT Act, 1961. Clause (f) was added which stated that dividend includes:
any payment by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 68 of the Companies Act, 2013 (18 of 2013);
The above expansion of dividend simply meant that any amount received by a shareholder as part of buyback of shares would be taxed as dividends. This was an opportunity to simplify the buyback tax. The Revenue could have chosen to levy income tax on shareholders on the difference price received on their shares and their cost of acquisition of such shares. The difference would have been classified as capital gains in hands of the shareholders. Instead gains from buybacks were clubbed with dividends. And to complicate the scenario further, Finance Act, 2024 also amended Section 46A of the IT Act, 1961 by adding the following Proviso:
Provided that where the shareholder receives any consideration of the nature referred to in sub-clause (f) of clause (22) of section 2 from any company, in respect of any buy-back of shares, that takes place on or after the 1st day of October, 2024, then for the purposes of this section, the value of consideration received by the shareholder shall be deemed to be nil.
Cumulative effect of both amendments was that the entire amount received on buyback of shares was taxable as dividends in hands of the shareholders under the head ‘income from other sources’. The more obvious choice of charging capital gains tax to shareholders on difference in cost of acquisition and consideration on sale of shares was bypassed. Instead, the cost of acquisition of shares was treated as capital loss because it was reasoned that shares were extinguished due to buyback. The Memorandum accompanying the Finance Bill, 2024 stated that:
Therefore when the shareholder has any other capital gain from sale of shares or otherwise subsequently, he would be entitled to claim his original cost of acquisition of all the shares (i.e. the shares earlier bought back plus shares finally sold). (emphasis added)
The tax liability on buyback after Finance Act, 2024 can be explained through this example: A shareholder acquired a share for Rs 100, sold it for Rs 150 during buyback. As per the above provisions the shareholder was liable to pay tax on the entire Rs 150. The amount of Rs 150 would be treated as dividend and taxable under the head ‘income from other sources’. To offset the taxation on entire consideration, shareholder was entitled to claim Rs 100 as a capital loss in the subsequent years and offset it against any potential capital gains earned in subsequent years. Apart from the complicated mechanism, an obvious flaw in this version of buyback tax was that capital loss could be offset ‘if’ a capital gain is earned in subsequent years. In the absence of a capital gain against which to offset capital loss the taxpayer could suffer an onerous tax burden.
Speculation – and informed guesses – suggest that the above version of buyback tax was adopted in 2024 to prevent taxpayers from taking advantage of lower tax rates of capital gains. And instead tax was levied on entire consideration under the head of ‘income from other sources’. There is some credibility to this guess but it doesn’t reveal a sound tax policy. There is little debate as to whether shares constitute capital assets. Any gains earned on their sale are, in their true nature, classifiable as capital gains. Whether the sale happened as part of a buyback or in course of normal alienation of shares should be immaterial. To gain marginally more revenue, provisions were amended and complicated to classify the gains under another head of income. In simple terms, the modification of buyback tax in 2024 sacrificed simplicity and unduly complicated the relevant provisions of IT Act, 1961.
Proposed Amendment in Finance Bill, 2026
Realizing the complications created by amendments of 2024, the Memorandum accompanying Finance Bill, 2026 states the reasons for new set of amendments as:
It is proposed to rationalise the taxation of share buy-backs by providing that consideration received on buy-back shall be chargeable to tax under the head “Capital gains” instead of being treated as dividend income. (emphasis added)
The Union complicated buyback tax in 2024 and in 2026 the Union proposes to ‘rationalise’ it. How? By doing what it should have done in the first place: treat the consideration received during buyback of shares as capital gains and not dividend.
But since this buyback tax, even in 2026 it has not outgrown its convoluted origins. The Finance Bill, 2026 proposes to levy buyback tax on promoters at a special tax rate because they hold a distinct position and exercise influence on corporate decision-making particularly buyback of shares. Accordingly the reason for special tax rate was in following words:
it is proposed that, in the case of promoters, the effective tax liability on gains arising from buy-back shall be thirty per cent, comprising tax payable at the applicable rates together with an additional tax. In case of promoter companies, the effective tax liability will be 22%.
Treating promoters distinctly seems to flow from the suggested rationale of 2024 amendments. Levying buyback tax at a higher rate. While the 2024 amendments tried to sweep all shareholders in the higher tax rate, the 2026 amendments have limited the high tax rates to only promoters of companies. Though whether this will lead to a differential tax burdens for resident and non-resident promoters maybe worth examining, but maybe in a separate article. Here, it may suffice to say that time will reveal the durability of this version of buyback tax.
Conclusion
The lifecycle of buyback tax can be summarised as a journey from an anti-abuse measure to an enduring revenue source. Buyback tax was not conceived as a tax per se. Originally, buyback tax was an anti-abuse measure to prevent companies from using it as means to avoid payment of DDT. While the original avatar of buyback tax – introduced via Section 115QA of the IT Act, 1961 – was convoluted, but it could be understood in the context of DDT. However, the removal of DDT left little reason to continue with buyback tax in its original version. But the amended version introduced in 2024 morphed buyback from an anti-abuse measure to a revenue source. And complicated buyback tax that it betrayed some basic principles of taxability. Devoid of the context of DDT, buyback tax from 2020 onwards has been a site of confused – and may I dare say – Revenue’s greedy tax policy. Nonetheless, the complications introduced in 2024 have been reckoned with via the Finance Bill, 2026. Though promoters of companies are unlikely to be too relieved at the latest proposed modification in buyback tax.
