DEEMED INCOME AND TAX ON BUY BACK OF SHARES - ULTRA VIRSE

[CA DEV KUMAR KOTHARI]

Tax on companies in event of buy back of own shares- provision is not to impose tax on income , the provision is ultravirse the Constitution of India and the purposes of the Income-tax Act, 1961.

Links and references:

Statutory provisions:

The Constitution of India Article 246 read with Union List entries 82 and 85 , Article 366 clauses –1, 6, 8, 28 and 29.

Sections 2 (24 (x) , 4, 115QA , 115QB and 115QC (Chapter XII-DA) of the Income-tax Act, 1961.

Other article on related subject:

SPECIAL PROVISIONS RELATING TO TAX ON DISTRIBUTION OF INCOME written by Shri Mr. M. GOVINDARAJAN

In earlier article referred to above Learned author Mr. M. GOVINDARAJAN has analyzed provisions in an easy to understand manner. The new provisions in sections 115QA - 115QC are about assumed income in case of  Buy-back of own shares by unlisted companies.

Vide the Finance Act 2013 sections 115QA , 115QB and 115QC were inserted with effect from the 1st day of June, 2013. These sections are reproduced below with highlights added for an analysis, catch words for easy to understand:

   115QA. Tax on distributed income to shareholders.—

(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 companyfor 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 (1 of 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. Interest payable for non-payment of tax by company.— 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 subsection (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. When company is deemed to be assessee in default.—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.]

 In addition to analysis made by Shri Govindrajan, and analysis made by highlighting , the following points are emphasized:

As per standard practice the charging section 115QA has been started with words ‘not withstanding….’

The tax is imposed on company as additional tax on deemed distributed income irrespective of source of amount distributed to buy-back shares.

The tax is levied as a final payment for which no credit or deduction shall be allowed either to the company or to the share holder.

The tax has been levied only on buy-back of unlisted shares of companies.

The tax is on assumed income will be assessed in hands of company.

These provisions have come into force w.e.f.01.06.2013.

Whether a payment made by one person to other can be considered as income of payer:

In the situation of buy-back of own shares, company pays to shareholders. The company does not receive any payment, therefore there is no question of any income in hands of company./

The shareholders who receive money on buy-back of shares may have some profit on relinquishment of shares bought back by company or they may not have income rather they may have suffered loss. Thus, if at all income can accrue, it can only be in hands of shareholder and not in hands of company.

In such situation, how the amount paid by company can be considered as income of company or distributed income.

Such payment cannot be considered income at all and in any hands. Unless a proper computation is made.

How the amount paid for buy-back minus amount received at the time of issue of issue of shares can be considered income of company or share holder?

Sale of shares vs. relinquishment of shares:

In case shareholder sells shares he will make computation as ‘capital gains’ or business income as may be applicable in his case. In case of sale shares remain and ownership is changed.

In case he surrender shares in a buy-back offer by company, his shares are extinguished on cancellation and he get consideration from company for transfer of shares in buy-back. The company is not receiving any money, there is no profit or income in hands of company, then how company can be made liable to pay tax.

Example: For example suppose a company issued shares of Rs. one crore and thereater over a period issued bonus shares from time to time and at present share capital is Rs. ten crore consisting of Rs. one crore as initially issued shares agaisn tcash and Rs. 14 crore as shares issued as bonus shares..

Now suppose company buyback shares of paid up value of Rs. five crore (including Rs. one crore against original shares) and pay Rs. fifteen crore to share holders.

As per provisions, company will have to pay tax on Rs. 14 crore. That is 15 crore minus 1 crore received by company on original shares.

The sum of Rs. 14 crore cannot be called income in hands of company;

The sum of Rs.15 crore cannot be called income in hands of shareholders because the amount represents realization of capital. If at all it can be taxed as capital gains in hands of shareholders because generally shares of unlisted company are investments and not stock-in-trade. 

Therefore, the levy of tax on Rs.14 crore is not at all tax on income of company (or share holder). Merely including any sum of money in definition of income or deeming any sum of money as income cannot be basis of imposition of tax. There should be income in fact and not by fiction.

Constitution of India (COI):

As per COI , tax on income can be levied by the UOI.

As discussed above amount paid on buy-back of shares is not income in hands of company.

Even if we consider it as ‘income distributed’, a tax cannot be imposed because ‘income distributed’ is not ‘income’. By very nature tax on income is a tax to be imposed on income of person who has earned income and not a person who has paid any sum which may include some income earned by the receiver.

If tax on income can be imposed on the person who pays then we should not be shocked if at some time tax is imposed in hands of employer who pay or distributes income by way of salary of his employees.

Therefore, the moot question for consideration is whether these provisions are valid or ultra virse the Constitution of India (COI).

The Central Government or UOI is authorized levy tax on income and corporation tax the relevant entries are as follows:

List I - Union List

82. Taxes on income other than agricultural income

85. Corporation tax.

Definitions in COI:

The meaning of ‘agricultural income’ and other related words are found in the Article 366 of the COI. Related definitions are reproduced below:

Article 366 in The Constitution Of India 1949

366. Definition In this Constitution, unless the context otherwise requires, the following expressions have, the meanings hereby respectively assigned to them, that is to say

(1) agricultural income means agricultural income as defined for the purposes of the enactments relating to Indian income tax;

(6) “corporation tax” means any tax on income, so far as that tax is payable by companies and is a tax in the case of which the following conditions are fulfilled:—

(a) that it is not chargeable in respect of agricultural income;

(b) that no deduction in respect of the tax paid by companies is, by any enactments which may apply to the tax, authorised to be made from dividends payable by the companies to individuals;

(c) that no provision exists for taking the tax so paid into account in computing for the purposes of Indian income-tax the total income of individuals receiving such dividends, or in computing the Indian income-tax payable by, or refundable to, such individuals; (8) “debt” includes any liability in respect of any obligation to repay capital sums by way of annuities and any liability under any guarantee, and “debt charges” shall be construed accordingly;

 (28) taxation includes the imposition of any tax or impost, whether general or local or special, and tax shall be construed accordingly;

(29) tax on income includes a tax in the nature of an excess profits tax;

The Central Government or the UOI is empowered to levy tax on income other than agricultural income.

Therefore, ‘tax’ in nature of tax on income can be either a tax or an impost on the following type of incomes:

1. tax or impost on ‘agricultural income’ , which can be levied by a State Government only,
2. tax or impost on ‘income’ , which can be levied by the central Government,
3. tax or impost on ‘excess profits’ , which can be levied by the central Government,
4. tax or impost on income of companies as ‘corporations tax’ as defined in Article 366 (6).

Amount paid on buy-back of shares is not even a receipt by company, the amount paid is not in nature of ‘income’ or ‘excess profits’ of company, the tax so imposed is also not in nature of ‘corporation tax’. Therefore, levy of tax as per section 115QA is not within the authority or power provided in the Constitution of India and in considered view of the author the levy is ultravirse the COI and it can be challenged by way of Writ Petition in any High Court in India.