The 2024 Union Budget has completely changed the tax landscape for share buybacks in India, a move that directly impacts investors’ financial strategies. Effective October 1, 2024, the tax liability for buybacks has shifted from the company to the individual shareholder. This fundamental change requires investors to reassess their portfolios and tax planning.
What Has Changed?
Previously, companies paid a tax of about 23.3% on buybacks, and the proceeds received by shareholders were tax-free. Now, that company-level tax is gone. Instead, the entire buyback amount is considered a “deemed dividend” and is taxable in the hands of the shareholder at their individual income tax slab rate. This means that high-net-worth individuals (HNIs) could see their tax on buyback proceeds jump as high as 35.88%.
A significant disadvantage for investors is that the cost of acquiring the shares cannot be deducted from this deemed dividend income. This cost is now treated as a notional capital loss, which can only be set off against future capital gains or carried forward for up to eight years. This is far less efficient, as capital gains are typically taxed at much lower rates (12.5% for long-term gains) than the high slab rates applied to the buyback income.
What Does This Mean for Investors?
The new rules significantly reduce the tax efficiency of buybacks, making them a less attractive way for companies to return capital to investors. This shift is expected to have a few key effects:
- Dividends May Reclaim Favor: With the tax advantage of buybacks gone, dividends are likely to become the preferred method for companies to distribute profits. For foreign investors, dividends often come with lower tax rates under DTAAs, and the ability to claim a foreign tax credit against home-country taxes further enhances their appeal.
- Focus on Long-Term Investing: The new tax structure encourages investors to hold onto their shares for longer periods. The long-term capital gains tax on listed shares is 12.5%, which is a much more favorable rate than the high slab rates now applied to buyback proceeds. This may push investors to focus on long-term appreciation rather than short-term gains from buyback schemes.
Impact on Global Competitiveness
Despite these major changes, experts believe the new policy will have minimal impact on India’s global competitiveness. India’s corporate tax rates remain attractive, and its treatment of dividends aligns with global norms, benefiting foreign investors through DTAAs. The reform ultimately aims to enhance tax compliance and bring India’s regulations in line with international standards, even as it adds a new layer of complexity for investors to navigate.