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The union budget 2019 proposes to remove the distinction between listed and unlisted companies with respect to taxability of buybacks.
The last few years have seen many listed companies, Indian held and multinational corporations (MNCs), undertake buybacks to reward their shareholders. It is estimated that from 2013 till September 2018, nearly a whopping Rs 100,000 crore was paid out by way of buybacks by listed companies.
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What makes buybacks so popular for listed companies? The reason is the difference in taxation of a buyback by a listed company as against an unlisted company from 2013 onwards. When an unlisted company does a buyback, 20 percent tax is levied on it on the excess of the buyback price over the original issue price of the shares, with no further tax being levied on the shareholder.
However, in case of a buyback by a listed company, shareholders are subject to Capital Gains Tax. Shareholders effectively enjoyed zero tax (till FY2018) or concessional rates of tax of 10-15 percent (insignificant, in view of grandfathering of the market value as on January 31, 2018), since shares were tendered on the stock exchange on which Securities Transaction Tax is paid. This made a buyback by a listed company an attractive proposition, especially since, comparatively, the dividend was subject to Dividend Distribution Tax of over 20 percent ― a prohibitive means of sharing profits with shareholders!
This is now set to change – the union budget 2019 proposes to remove the distinction between listed and unlisted companies with respect to taxability of buybacks, and henceforth, buyback by any company will be taxed at the company’s level. The shareholders’ cost of acquisition, residential status, tax treaty, etc. will not have any bearing on this. Of course, it needs to be seen how this will pan out practically – listed companies will have issued shares at varying points of times at varying prices, and with all the shares being in a dematerialised form, there is no possibility of determining the price at which a share tendered in a buyback was originally issued. This very likely means a FIFO approach will be adopted, resulting in even higher tax outflows for a company.
After the introduction of long-term Capital Gains Tax on sale of listed shares in 2018, this is the latest spanner in the works for the capital market – for all practical purposes, it is unlikely that any listed company will now consider a buyback to reward its shareholders. Clearly, the monsoon budget has rained on the buyback parade!
The union budget 2019 has seen some other interesting changes, some of which seem to be in the nature of clarifications.
It has been clarified that in a demerger, the condition for the resulting company to record assets taken over at book value will not be applicable if this is done in compliance with IND-AS.
For startups, which constituted a clear focus area of the union budget, there has been a relaxation in the rules relating to carry forward and set off of their losses. Now, if their shareholding does not change beyond 49 percent or even if it changes beyond 49 percent, but all the shareholders who held shares in the year in which losses were incurred continue as shareholders, the losses will not lapse.
This apart, the union finance minister indicated that in cases where Angel Tax is sought to be levied by the tax authorities on start-ups, no scrutiny will be conducted on submission of the requisite declarations by the start-ups and their investors.
However, the fine print seems to suggest that if start-ups do not meet the criteria laid down by the Department for Promotion of Industry and Internal Trade (DPIIT) in its circular on February 19, 2019, the entire premium will be taxed in their hands, irrespective of the fair market value of the shares (a leeway available to all other closely held companies). This cannot be the intent of the government, and it is likely that the anomaly will be amended when the Finance Bill is enacted.
Section 50CA, which was inserted in FY2018, seeks to deem the fair market value of closely held shares as the consideration to determine capital gains, where the consideration is lower than the fair value.
On the other hand, Section 56(2)(x) seeks to tax the acquirer on the difference between the fair market value and the consideration in such cases. However, although Section 56(2)(x) contained certain exclusions (such as receipts from relatives or receipts from private trusts), no exceptions were provided in Section 50CA. The Finance Bill has now given the Central Board of Direct Taxes (CBDT) power to notify such exclusions.
There is a glimmer of hope for resolution of the issues faced by distressed companies by recognising the fact that the parties to a resolution do not have control over prices in insolvency cases. It is proposed that the CBDT should be empowered to prescribe transactions for which the deeming provisions relating to the ‘fair market value’ will not be applicable for Section 50CA (the seller) and Section 56(2)(x) (the acquirer).
With the deadline for the Committee’s report on the new Income Tax Act being around the corner, not much change was expected. However, it would have been good to see relief for distressed companies from the provisions of the Minimum Alternate Tax. Moreover, removing the artificial distinction between manufacturing and service companies with respect to carrying forward their losses in the case of mergers is now long overdue. Long- term Capital Gains Tax on listed shares and grandfathering provisions have also given rise to several concerns, especially with respect to shares issued after February 1, 2018, but because the mode of acquisition (mergers, demergers, etc.) are deemed to be held from an earlier date, settling the dust around this also need not have waited for the new code.
Hiten Kotak is Leader and Neelu Jalan id Director, M&A Tax, PwC India.