Under the Indian tax laws, a company is liable to pay ‘buyback tax’ at the rate of 20% of the distributed income to the shareholders on account of buyback of unlisted shares. To determine distributed income, the ‘amount received’ on issue of shares is reduced from the consideration paid for the buyback. Based on the experience gained during the initial years of operation of the buyback tax (introduced in 2013); Finance Act, 2016 amended the law to provide that the ’amount received’ by the company with reference to shares being bought back shall be determined in the prescribed manner.
In July this year, the Central Board of Direct Taxes (CBDT) issued draft rules prescribing the methodology for determination of ’amount received’ by the companies under various scenarios of shares issued including regular share subscription, amalgamation, demerger, conversion of bonds/debentures and issue of shares without consideration. A residuary provision provided that in respect of cases not dealt with specifically in such draft rules, the face value of the shares would be the available cost base.
The CBDT invited comments from stakeholders on such draft rules. Various representations were made by industry and professional bodies since certain cases of share issue such as shares held in a dematerialised form, shares issued under ESOP scheme, share issuance for consideration other than cash were not specifically covered by the draft rules. In absence of specific rules in this regard, most of such cases would fall under the face value rule as per the residuary provisions which could cause significant hardship to the assessees.
The CBDT on 17 October 2016 notified the final rules (to be effective retrospectively from 1 June 2016) after taking into account most of the suggestions received from the stakeholders and specific share issue scenarios not addressed earlier have now been incorporated in the final rules.
The final rules now provide that for shares which have been issued under an ESOP scheme or as part of sweat equity shares, the perquisite amount (i.e. fair market value of the share as determined by a merchant banker) on which an employee has been charged to tax would be considered as the ‘amount received’ and hence, deductible as a cost base for computing buyback tax.
In cases where shares are issued by a company on succession or conversion of a sole proprietorship or a firm/LLP into a company, a formula based on the net book value has been provided to compute the ‘amount received’ on such issue. The formula is drawn on similar lines as in Rule 11UA of the Income Tax Rules. For shares held in a dematerialised form which cannot be distinctly identified, the first-in-first-out method has been prescribed.
A specific rule has now been included to provide for situations where shares are issued in consideration of acquisition of any asset or settlement of any liability. The rule provides that in such situations the lower of the Fair Market Value of the asset, as determined by a merchant banker, or the amount recorded in the books of the company as share capital and premium would be considered to be the ‘amount received’. It also caters to a situation where the discharge of consideration for the assets is partly by shares and partly in cash.
Under the draft rules, it was provided that where the company had, prior to buyback of the share, returned any sum out of the amount received in respect of such share, the ‘amount received’ shall be reduced by the sum so returned. The final rules have included a proviso to the above rule clarifying that such sum returned shall not be so reduced if it has been charged to Dividend Distribution Tax (DDT) under Section 115-O of the Income Tax Act. This will ensure that there is no double taxation on the company in a situation where a capital reduction and repayment prior to a buyback had been treated as dividend and charged to DDT. Though the provision is not eloquently worded, however logically, the reduction mentioned herein is of the original cost (i.e. amount received) of the shares bought back earlier and not of the consideration paid on such earlier buyback.
Though the draft rules provided for a situation where shares had been issued upon conversion of another instrument, the rules did not specifically cover convertible preference shares which has now been included. A case of conversion of a loan into equity shares is still not specifically covered.
The rules around shares issued on amalgamation, demerger, bonus issue, among others, have not undergone any change and have been notified as originally proposed.
Overall, these final rules as notified by CBDT certainly address major areas of concern, assist in correct interpretation of stated provisions and provide clarity on the prescribed mechanism for computing buyback tax. The final rules are in line with the government’s efforts towards bringing transparency in tax laws to reduce litigation and depicts its commitment towards a two-way consultative approach to tax policy formulation.
The author is Partner, Deal Advisory – M&A Tax, KPMG in India. The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG in India.
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