With a  new buyback tax regime kicking in from October 1, both listed and private companies in India are trying to meet the deadline and complete their share buybacks.

Significant changes to the buyback tax regime will come into effect after the new rule comes into effect. This change, which shifts the tax burden from companies to shareholders, is prompting firms to rethink their strategies for distributing excess capital to shareholders, industry experts told Moneycontrol.

What does the new rule say?

Under the earlier regulations, buybacks are taxed in the hands of the company at 20 per cent rate and investors were not required to pay any additional tax for such income. The new regulations will shift the tax liability from corporations to shareholders. The new rule stipulates that the buyback proceeds will be taxed as ‘dividend’ income rather than ‘capital gains’.  Buybacks have been a popular method for companies to give back excess money to shareholders.

As the deadline looms large, the rush to complete buybacks highlights the significant impact of the new tax regime on corporate financial strategies. While companies scramble to adjust, experts believe that the landscape for capital returns will look markedly different in the months ahead.

“The companies are likely to change their buyback strategies after October 1. The listed companies may opt for options such as issuing bonus preference shares or debentures to its shareholders. However, unlisted companies can explore alternative strategies such as restructuring their holding structures or opting for LLPs (limited liability partnerships) as a business vehicle instead of conventional company structures. Dividends may not be more tax-efficient than buybacks,” Bhavin Vora, Executive Director at corporate law firm Khaitan & Co, told Moneycontrol.

The current tax framework imposes a 20 per cent tax on net distributable income, which is paid by the companies. However, under the new rule, announced in the Union Budget 2024-25 on July 23, shareholders will be taxed on buyback proceeds as dividend income, in accordance with their tax slabs. This shift in the tax burden could discourage companies from using buybacks as a primary method for capital returns, especially for listed firms. Experts believe the new regime is designed to bring the tax treatment of buybacks in line with dividends.

"Both listed and unlisted companies are expediting their buyback plans ahead of the tax changes to mitigate the additional tax burden on shareholders," Vora said. "Over 15 listed companies have already announced buybacks, while unlisted firms are also accelerating efforts to repatriate surplus funds before the deadline expires," he added.

Vora also noted that companies may turn to dividends as an alternative, though there is ambiguity in Double Taxation Avoidance Agreements (DTAA) regarding non-resident shareholders and whether buyback proceeds would be treated as dividends or capital gains.

“We are running on fast timelines. It's driven by corporate law, and companies have to inform stock exchanges. The buyback has to be implemented before October 1, which is a challenging task," Lokesh Shah, Partner at IndusLaw, told Moneycontrol. He explained that companies are working rapidly to finalise buybacks before the new tax laws come into effect. He also pointed out that after the deadline, companies will have fewer options for distributing excess cash to shareholders in a tax-efficient manner.

For listed companies, the tax change means rethinking strategies for rewarding shareholders. "Companies listed on the stock market often buy back their shares at a premium above the market price. This tax burden will shift to shareholders, with buyback proceeds treated as dividend income," Amit Maheshwari, Partner at accounting firm AKM Global, told Moneycontrol. He added that while companies with high-growth potential may continue to prefer buybacks to boost expansion, mature firms with stable cash flows are likely to opt for dividends, signaling profitability to investors.

Several well-known listed companies, including CERA Sanitaryware, Symphony, AIA Engineering, and Mayur Uniquoters, are among those that have already initiated or announced buybacks ahead of the deadline. "One of the reasons for listed companies to engage in buybacks before October 1 is to utilise excess cash and reward shareholders while minimising their tax exposure," Maheshwari noted.

The upcoming change aims to create parity between the taxation of buybacks and dividends. "The treatment of buyback proceeds will be the same as dividends for shareholders after the new rule is implemented. So, companies will no longer bear the tax burden," Om Rajpurohit, Director at tax consultancy firm Moore-Singhi, told Moneycontrol.