Buy Back of Shares and Demerger Under Dividend: Understanding the Income Tax Implications in Indian Law

When a company decides to buy back its own shares, or undergoes a demerger, it has important income tax implications that need to be carefully considered. In this article, we will delve into the details of these transactions and their tax consequences under Indian law.

Buy Back of Shares

What is a Buy Back of Shares?

A buyback of shares refers to the process where a company repurchases its own outstanding shares from the shareholders. This is often done when the company feels that its shares are undervalued, or when it wishes to reduce the number of outstanding shares in the market. The buyback can be made from the open market, through a tender offer, or through a negotiated purchase.

Income Tax Implications of Buy Back of Shares

From an income tax perspective, a buyback of shares is treated as a distribution of the company's accumulated profits. Under Section 77A of the Income Tax Act, 1961, a buyback of shares is considered as a "dividend" and is subject to dividend distribution tax (DDT). The DDT is currently levied at the rate of 15% on the amount of consideration paid by the company for the buyback of shares.

Taxation of Shareholders in a Buy Back

For individual shareholders, the consideration received from the buyback of shares is taxed as "capital gains". The gains are classified as long-term or short-term depending on the holding period of the shares. For long-term capital gains, the tax rate is 20% with indexation benefits, while for short-term gains, the tax rate is as per the individual's income tax slab.

Demerger Under Dividend

Understanding Demerger

A demerger refers to the corporate restructuring process where a company transfers one or more of its undertakings to another company. This can be done for various reasons such as focusing on core businesses, separate management of business units, or restructuring for tax benefits. In a demerger, the shareholders of the demerged company receive shares of the resulting company in proportion to their existing shareholding.

Tax Implications of Demerger

In the case of a demerger, the Income Tax Act provides for tax neutrality for the shareholders of the demerged company. Under Section 47 of the Income Tax Act, any transfer of capital assets or shares by the demerged company to the resulting company is not considered as a transfer for the purposes of capital gains tax. This means that the demerger does not attract any tax liability for the shareholders of the demerged company.

Applicability of Section 2(19AA)

Section 2(19AA) of the Income Tax Act lays down the conditions for recognizing a demerger for tax purposes. One of the key conditions is that the demerger should be carried out for the benefit of the shareholders of the demerged company. Additionally, the resulting company should not be controlled by the demerged company or its shareholders, except for the purpose of the demerger.

Conclusion

In conclusion, both the buyback of shares and demerger under dividend have significant income tax implications that need to be carefully evaluated. It is important for companies and shareholders to be aware of the tax consequences and plan these transactions accordingly. Consulting with tax experts and legal advisors can help in ensuring compliance with the relevant provisions of the Income Tax Act and avoiding any adverse tax implications. By understanding the legal requirements and tax implications, companies and shareholders can effectively navigate these transactions and make informed decisions that are in line with the provisions of Indian law.