Buy Back of Shares and Demerger Under Dividend

In the realm of income tax law in India, the concepts of buyback of shares and demerger under dividend have significant implications for businesses and shareholders. Understanding the tax implications and legal provisions related to buyback of shares and demerger under dividend is crucial for businesses to make informed decisions and ensure compliance with the law.

Buy Back of Shares

The buyback of shares refers to the process through which a company repurchases its own shares from existing shareholders. This can be done either through the open market or by directly purchasing shares from the shareholders. The buyback of shares can be a strategic move by the company to deploy its surplus cash, to optimize its capital structure, or to return excess cash to shareholders.

Under the Income Tax Act, 1961, the tax implications of buyback of shares are governed by Section 115QA. According to this provision, any distributed income arising from the buyback of shares by an unlisted company is subject to a tax at the rate of 23.296% (including surcharge and cess). The distributed income is calculated as the consideration paid on buyback of shares in excess of the sum received by the company for issue of such shares. However, the tax on buyback of shares is not applicable if the buyback is undertaken by a listed company in accordance with the Securities and Exchange Board of India (Buy-Back of Securities) Regulations, 2018.

From a legal perspective, it is essential for companies to adhere to the relevant provisions of the Companies Act, 2013, and the SEBI regulations while conducting a buyback of shares. Any non-compliance with these provisions can lead to legal repercussions and penalties.

Demerger Under Dividend

A demerger is a corporate restructuring process wherein a company transfers one or more of its undertakings to another company. In the context of income tax, demerger under dividend refers to the distribution of shares in the resulting company to the shareholders of the demerged company. This distribution of shares is treated as a dividend under the Income Tax Act.

The tax implications of demerger under dividend are governed by Section 2(22)(d) and Section 115-O of the Income Tax Act, 1961. As per Section 2(22)(d), any distribution by a company of accumulated profits to its shareholders in the form of a debenture, bonus issue of shares, or free shares is deemed to be a dividend. Additionally, Section 115-O imposes a dividend distribution tax (DDT) on the distribution of dividends by companies. However, the Finance Act, 2020 has exempted the dividend received by an Indian company from its foreign subsidiary.

From a legal standpoint, companies undertaking a demerger under dividend must ensure compliance with the provisions of the Companies Act, 2013, as well as any other relevant regulations and guidelines issued by regulatory authorities.

Key Considerations for Businesses

When considering a buyback of shares or a demerger under dividend, businesses need to take into account various legal and tax considerations to ensure compliance with the law and mitigate any potential risks. Some key considerations include:

Legal Compliance: Businesses must ensure compliance with the relevant provisions of the Companies Act, 2013, and any other regulations governing buyback of shares and demerger under dividend.
Tax Planning: It is imperative for businesses to engage in tax planning to optimize the tax implications of buyback of shares and demerger under dividend. This may involve structuring the transactions in a tax-efficient manner and considering the impact on the company’s overall tax liability.
Shareholder Communication: Transparent communication with shareholders is essential when undertaking a buyback of shares or a demerger under dividend. Shareholders should be provided with clear information about the implications of these transactions on their shareholding and tax obligations.
Regulatory Framework: Businesses need to stay abreast of any changes in the regulatory framework governing buyback of shares and demerger under dividend, as non-compliance can lead to legal and financial consequences.

Legal Proceedings and Litigation

In the event of non-compliance with the provisions related to buyback of shares and demerger under dividend, businesses may face legal proceedings and litigation. This can arise due to challenges from shareholders, regulatory authorities, or other stakeholders affected by the transactions.

Legal proceedings related to buyback of shares and demerger under dividend may involve issues such as:

Breach of Legal Provisions: Non-compliance with the provisions of the Companies Act, 2013, and the Income Tax Act, 1961, can give rise to legal challenges and accusations of breach of statutory obligations.
Shareholder Disputes: Shareholders may raise concerns about the fairness of the buyback of shares or the demerger under dividend, especially if they believe that their interests have been prejudiced.
Tax Disputes: Disputes with the tax authorities may arise if there are disagreements regarding the calculation and payment of taxes arising from the buyback of shares and demerger under dividend.
Regulatory Sanctions: Non-compliance with regulatory requirements can lead to sanctions and penalties imposed by regulatory authorities, which can have financial and reputational implications for the business.

Conclusion

The buyback of shares and demerger under dividend are important corporate actions that have significant implications for income tax and business operations. It is crucial for businesses to navigate these transactions with a thorough understanding of the legal and tax implications, and to ensure compliance with the relevant provisions of the law. By engaging in proactive tax planning, legal compliance, and transparent communication with stakeholders, businesses can mitigate risks and optimize the outcomes of buyback of shares and demerger under dividend.