Budget 2013-ADDITIONAL TAX ON COMPANY ON BUY BACK OF UNLISTED SHARES.

[CA DEV KUMAR KOTHARI]

Proposal in the Finance Bill 2013:

A new Chapter titled “Chapter XII-DA Special Provisions Relating to Tax on Distributed Income of Domestic Company for Buy-Back of Shares” is proposed to be inserted to impose tax in hands of company by deeming excess of buy-back price over issue price as income distributed. The company will have to pay tax on such excess. As a consequence, the shareholder will get the income on buy-back as tax free and will not be required to pay capital gain tax or tax on business income, as the case may be.

Present provision vis a vis proposed provision:

Under present provision the shareholder of an unlisted share is required to pay tax on capital gains. He can take advantage of cost inflation index and the tax rate is 20% on excess of consideration received above cost inflated cost. Therefore, many times there in no taxable capital gains or the rate of tax on excess of consideration above cost is much lower depending on the period of holding in case of long-term holding (above one year).

After the proposed amendment, the income in hands of shareholder will be exempt. However, the company will have to pay tax. The basis for computation of chargeable income in hands of company is buy-back price paid minus issue price of share. Therefore, company will not get benefit of cost inflation index. Furthermore, irrespective of price paid by shareholder at the time of acquisition from any other shareholder (that is not by way of allotment), the deduction allowable in hands of company is fixed at the issue price.

Unlisted shares are generally held by a close group of share holders, therefore, for taking a decision one has to consider the tax in case of sale of shares and in case of buy-back of shares.

 Amendment of section 10.

 (V) after clause (34), the following clause shall be inserted with effect from the 1st day of April, 2014, namely:—

 “(34A) any income arising to an assessee, being a shareholder, on account of buy back of shares

(not being listed on a recognised stock exchange) by the company as referred to in section 115QA;”;

 As discussed above this exemption is consequential to imposition of tax on company and not in other cases.

 New Chapter titled “Chapter XII-DA Special Provisions Relating to Tax on Distributed Income of Domestic Company for Buy-Back of Shares”

The Chapter vide section 115QA start with words “Notwithstanding anything contained in any other provision of this Act…..,” Therefore, an exception is provided and the chapter can be considered as a self contained   code. This Chapter provide for charging and computation provision both.

The tax is in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment. Even if company has no chargeable income and tax payable thereon, the tax on distributed income by way of buy-back of unlisted shares is payable – vide sub-section (2).

Tax is payable on amount of distributed income by the company on buy-back of shares (not being shares listed on a recognised stock exchange) from a shareholder shall be charged to tax – thus buy-back out of any capital reserves

Or buy back, which is to the extent of capital reserves may not be taxable under this charging provision.

In case o company has listed shares as well as unlisted shares, this clause will apply only to buy-back of unlisted shares.

Additional income-tax will be at the rate of twenty per cent. on the distributed income – that means not on the portion of distributed capital receipts and capital reserves. Therefore, a buy-back out of share premium will not be taxable.

The provision apply when amount is distributed to a shareholder, and not a person who is not a shareholder.

Meanings:

By way of explanations certain definite meanings have been provided. These include meaning for “buy-back” and distributed income.

The meaning of distributed income is provided as follows:

          (ii) “distributed income” means the consideration paid by the company on buy-back of shares as reduced by the amount which was received by the company for issue of such shares.

According to this meaning price paid by company minus issue price (including premium) shall be considered as “distributed income”.

This meaning by way of an explanation is against the basic principal of distributed income underlying the charging section. By this meaning even capital receipts are deemed to be income distributed if capital receipts are used to pay buy-back price. According to this meaning, irrespective of purchase price paid by the shareholder who bought shares after issue by company, the Company will have to pay tax on excess of buy-back price over issue price which need to be ascertained in respect of all shares.

Therefore, suppose a company buy-back shares which include shares issued at par say Re. 1 per share , at premium of say Rs. 5, Rs.15 and Rs.100 per share from time to time. In such a situation chargeable distributed income will be different in all cases.

The question will arise as to buy-back of bonus shares. In case of bonus share any price is not received at the time of issue. Therefore, on buy-back of bonus shares, any distributed income cannot be computed. The price paid on buy-back minus nil will remain price paid and not the difference which alone can be called income.

Income cannot include capital:

Distributed income cannot include share premium or other capital receipts like subsidy or loans of new share capital issued etc. However, by deeming provision, an attempt is made to include such receipts also as forming part of distributed income if such receipts are used to buy-back unlisted shares.

It is worth to mention that as per Section 77A of the Companies Act, 1956 a company can buy-back its shares or other securities out of specified resources. The sub-section (1) readsa as follows:

Power of company to purchase its own securities^[3].

^[1][77A.  (1) Notwithstanding anything contained in this Act, but subject to the provisions of sub-section (2) of this section and section 77B, a company may purchase its own shares or other specified securities (hereinafter referred to as "buy-back") out of^___

     (i) its free reserves; or

     (ii) the securities premium account; or

     (iii) the proceeds of any shares or other specified securities:

Provided that no buy-back of any kind of shares or other specified securities shall be made out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.

Therefore, the proposed provision may not be valid to the extent it tries to impose tax on distribution of capital receipts.

Buy-back can be from open market also:

As per sub-section (5) of section 77A of the Companies Act, 1956 a buy-back can be of shares held in different manner. The sub-section reads as follows:

(5) The buy-back under sub-section (1) may be

     (a) from the existing security holders on a proportionate basis; or

     (b) from the open market; or

     (c) from odd lots, that is to say, where the lot of securities of a public company whose shares are listed on a recognised stock exchange, is smaller than such marketable lot, as may be specified by the stock exchange; or

     (d) by purchasing the securities issued to employees of the company pursuant to a scheme of stock option or sweat equity.

From open market- the person tendering not being a shareholder:

When securities are purchased from an open market, in case of unlisted shares the securities are available in market with blank transfer deed. In case of blank transfer deeds, the person who tender such unregistered shares will be paid the buy-back consideration. The holder of share certificate with blank transfer deed may not be regarded a ‘shareholder’ of company, in absence of specific provision in this regard. Therefore the proposed provision may not apply to cases of buy-back of own shares from open market in which person tendering shares is not a shareholder of the company.

Effective date- the amendment is operative from 1^st June 2013.- general perception is that this provision will apply to buy-back which take place on or after 01.06.2013.

However, a possible view is that the provision will apply to a previous year which begins on or after 01.06.2013. Therefore, this provision will apply to previous year beginning from 01.04.2014.

Tax rate:

The rate of tax is 20% Plus a surcharge (@ 10%) and education cess (@3%) resulting in an effective rate of tax (22.66%).

Other proposed provisions:

Other provisions are on same lines as relating to dividend distribution tax on companies and mutual funds.

Other provisions relating to finality of tax collected, non allowability of income by way of buy-back and tax thereon, collection of tax, time within which tax is to be deposited, inter in case of delay in deposit, consideration of assessee and officers of assessee in default are similar to those found in relation to tax on distribution of profit by way of dividend by companies.

Deemed dividend:

In case a buy-back falls under category of dividend u/s 2(22), then the shareholder will be taxed on such dividend income and the proposed provision will not apply. This is clear because new proposed provision apply only to cases of buy-back in terms of section 77A of the companies act, 1956. Payment on such buy-back are not considered as dividend as per exclusion provided under the heading “dividend does not include” in section 2(22).

The proposed provisions are reproduced below with highlights provided by red colour:

28. After Chapter XII-D of the Income-tax Act, the following Chapter shall be inserted with effect from the 1st day of June, 2013, namely:—

‘CHAPTER XII-DA SPECIAL PROVISIONS RELATING TO TAX ON DISTRIBUTED INCOME OF DOMESTIC COMPANY FOR BUY-BACK OF SHARES

Tax on distributed income to shareholders.

115QA. (1) Notwithstanding anything contained in any other provision of this Act, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount of distributed income by the company on buy-back of shares (not being shares listed on a recognised stock exchange) from a shareholder shall be charged to tax and such company shall be liable to pay additional income-tax at the rate of twenty per cent. on the distributed income.

Explanation.—For the purposes of this section,—

(i) “buy-back” means purchase by a company of its own shares in accordance with the provisions of section 77A of the Companies Act, 1956;

(ii) “distributed income” means the consideration paid by the company on buy-back of shares as reduced by the amount which was received by the company for issue of such shares.

(2) Notwithstanding that no income-tax is payable by a domestic company on its total income computed in accordance with the provisions of this Act, the tax on the distributed income under sub-section (1) shall be payable by such company.

(3) The principal officer of the domestic company and the company shall be liable to pay the tax to the credit of the Central Government within fourteen days from the date of payment of any consideration to the shareholder on buy-back of shares referred to in sub-section (1).

(4) The tax on the distributed income by the company shall be treated as the final payment of tax in respect of the said income and no further credit therefor shall be claimed by the company or by any other person in respect of the amount of tax so paid. (5) No deduction under any other provision of this Act shall be allowed to the company or a

shareholder in respect of the income which has been charged to tax under sub-section (1) or the tax thereon.

115QB. Where the principal officer of the domestic company and the company fails to pay the whole or any part of the tax on the distributed income referred to in sub-section (1) of section 115QA, within the time allowed under sub-section (3) of that section, he or it shall be liable to pay simple interest at the rate of one per cent. for every month or part thereof on the amount of such tax for the period beginning on the date immediately after the last date on which such tax was payable and ending with the date on which the tax is actually paid. 115QC. If any principal officer of a domestic company and the company does not pay tax on distributed income in accordance with the provisions of section 115QA, then, he or it shall be deemed to be an assessee in default in respect of the amount of tax payable by him or it and all the provisions of this Act for the collection and recovery of income-tax shall apply.’.

 Section 77A of the Companies Act which is relevant is reproduced with highlights:

^[2]Power of company to purchase its own securities^[3].

^[1][77A.      (1) Notwithstanding anything contained in this Act, but subject to the provisions of sub-section (2) of this section and section 77B, a company may purchase its own shares or other specified securities (hereinafter referred to as "buy-back") out of^___

     (i) its free reserves; or

     (ii) the securities premium account; or

     (iii) the proceeds of any shares or other specified securities:

Provided that no buy-back of any kind of shares or other specified securities shall be made out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.

     (2) No company shall purchase its own shares or other specified securities under sub-section (1) unless^___

     (a) the buy-back is authorised by its articles;

     (b) a special resolution has been passed in general meeting of the company authorising the buy-back:

^[4][Provided that nothing contained in this clause shall apply in any case where

     (A) the buy-back is or less than ten per cent of the total paid-up equity capital and free reserves of the company; and

     (B) such buy-back has been authorised by the Board by means of a resolution passed at its meeting:

Provided further that no offer of buy-back shall be made within a period of three hundred and sixty-five days reckoned from the date of the preceding offer of buy-back, if any.

Explanation. For the purposes of this clause, the expression "offer of buy-back" means the offer of such buy-back made in pursuance of the resolution of the Board referred to in the first proviso;]

     (c) the buy-back is or less than twenty-five per cent of the total paid-up capital and free reserves of the company:

Provided that the buy-back of equity shares in any financial year shall not exceed twenty-five per cent of its total paid-up equity capital in that financial year;

     (d) the ratio of the debt owed by the company is not more than twice the capital and its free reserves after such buy-back:

Provided that the Central Government^[5] may prescribe a higher ratio of the debt than that specified under this clause for a class or classes of companies.

Explanation. For the purposes of this clause, the expression "debt" includes all amounts of unsecured and secured debts;

     (e) all the shares or other specified securities for buy-back are fully paid-up;

     (f) the buy-back of the shares or other specified securities listed on any recognised stock exchange is in accordance with the regulations^[6] made by the Securities and Exchange Board of India in this behalf;

     (g) the buy-back in respect of shares or other specified securities other than those specified in clause (f) is in accordance with the guidelines as may be prescribed.

(3) The notice of the meeting at which special resolution is proposed to be passed shall be accompanied by an explanatory statement stating^___

     (a) a full and complete disclosure of all material facts;

     (b) the necessity for the buy-back;

     (c) the class of security intended to be purchased under the buy-back;

     (d) the amount to be invested under the buy-back; and

     (e) the time limit for completion of buy-back.

(4) Every buy-back shall be completed within twelve months from the date of passing the special resolution ^[7][or a resolution passed by the board] under clause (b) of sub-section (2).

(5) The buy-back under sub-section (1) may be

     (a) from the existing security holders on a proportionate basis; or

     (b) from the open market; or

     (c) from odd lots, that is to say, where the lot of securities of a public company whose shares are listed on a recognised stock exchange, is smaller than such marketable lot, as may be specified by the stock exchange; or

     (d) by purchasing the securities issued to employees of the company pursuant to a scheme of stock option or sweat equity.

(6) Where a company has passed a special resolution under clause (b) of sub-section (2) ^[8][or the Board has passed a resolution under the first proviso to clause (b) of that sub-section] to buy-back its own shares or other securities under this section, it shall, before making such buy-back, file with the Registrar and the Securities and Exchange Board of India a declaration of solvency in the form as may be prescribed,^[9] and verified by an affidavit to the effect that the Board has made a full inquiry into the affairs of the company as a result of which they have formed an opinion that it is capable of meeting its liabilities and will not be rendered insolvent within a period of one year of the date of declaration adopted by the Board, and signed by at least two directors of the company, one of whom shall be the managing director, if any:

Provided that no declaration of solvency shall be filed with the Securities and Exchange Board of India by a company whose shares are not listed on any recognised stock exchange.

(7) Where a company buys-back its own securities, it shall extinguish and physically destroy the securities so bought-back within seven days of the last date of completion of buy-back.

(8) Where a company completes a buy-back of its shares or other specified securities under this section, it shall not make further issue of the same kind of shares (including allotment of further shares under clause (a) of sub-section (1) of section 81) or other specified securities within a period of ^[10][six] months except by way of bonus issue or in the discharge of subsisting obligations such as conversion of warrants, stock option schemes, sweat equity or conversion of preference shares or debentures into equity shares.

(9) Where a company buys-back its securities under this section, it shall maintain a register^[11] of the securities so bought, the consideration paid for the securities bought-back, the date of cancellation of securities, the date of extinguishing and physically destroying of securities and such other particulars as may be prescribed.

(10) A company shall, after the completion of the buy-back under this section, file with the Registrar and the Securities and Exchange Board of India, a return^[12] containing such particulars relating to the buy-back within thirty days of such completion, as may be prescribed:

Provided that no return shall be filed with the Securities and Exchange Board of India by a company whose shares are not listed on any recognised stock exchange.

(11) If a company makes default in complying with the provisions of this section or any rules made thereunder, or any regulations made under clause (f) of sub-section (2), the company or any officer of the company who is in default shall be punishable with imprisonment for a term which may extend to two years, or with fine which may extend to fifty thousand rupees, or with both.

Explanation. For the purposes of this section,

     (a) "specified securities" includes employees' stock option or other securities as may be notified by the Central Government from time to time;

     (b) "free reserves" shall have the meaning assigned to it in clause (b) of Explanation to section 372A.