Oct 09, 2023

Consideration Paid for Buyback of Shares Under Court Approved Scheme Prior to Amendment of Section 115QA – Taxable as Deemed Dividend?

Buy back of shares has always been a preferred method for companies in India to distribute accumulated profits among its shareholders, and resultantly the same has become a subject matter of scrutiny for various Income Tax Authorities (‘ITA’). Under the erstwhile Companies Act, 1956 (‘CA 56’), companies were allowed to buy back their shares via both automatic and approval route. Section 77A of CA 56[1] allowed the companies to buy back their shares through automatic route while imposing a condition that the capital reduction through such buyback cannot exceed 25% of the company’s total paid-up capital and free reserves. In case a company wished to reduce its capital by more than 25%, the same would necessitate a court approval, under Sections 391 to 394 of CA 56 and, consequently, buyback could be undertaken only in terms of methods of capital reduction provided under Sections 101 to 104 of CA 56.[2]

Additionally, the consideration paid to shareholders as against the buyback of shares was not specifically taxable under any provision of the IT Act, unless the same constituted deemed dividend under Section 2(22) of the IT Act, which was subject to levy of tax under Section 115O of the IT Act in the hands of the company undertaking such buyback. However, the Government by way of the Finance Act of 2013, introduced Section 115QA seeking to levy tax on the company undertaking buy back of shares through automatic route, i.e., under Section 77A of CA 56, and the said provision was further amended w.e.f. June 01, 2016, to also cover all kinds of buyback under its ambit.

Interestingly, the Chennai Bench of Income Tax Appellate Tribunal (‘Tribunal’) in a recent case[3], while examining a transaction of buy back of shares undertaken post introduction of Section 115QA, but prior to amendment in such provision, has affirmed the levy of dividend distribution tax (‘DDT’) on the consideration amounting to INR 19,080.26 crores paid by the assessee for buy back of shares from its non-resident shareholders, in pursuance of a court approved scheme, which did not constitute a buy back under Section 77A of CA 56. The Tribunal upon noting the sequence of events prior to sanction of the impugned scheme observed that as the proposal of amendment of Section 115QA w.e.f. June 01, 2016, was in public domain since February 2016, the assessee moved the entire scheme in a hurried manner to circumvent the levy of additional tax, under the amended provisions of Section 115QA of the IT Act, and thus accordingly found such scheme to be a colourable device.

Further, the Tribunal while noting the fact that paid-up share capital, general reserves and retained earnings were utilized to make payments to the shareholders, took a view that the same has resulted in reduction of 54.70% of the share capital and distribution of accumulated profits of the assessee, and accordingly proceeded to characterize such payment as ‘deemed dividend’ under Section 2(22) of the IT Act. Lastly, the Tribunal also reiterated the cardinal principle that sanction of a scheme by a competent court would not prevent the assessing officer to re-examine the taxability of a transaction undertaken in a scheme.[4]

It is, however, relevant to highlight here that post amendment under Section 115QA w.e.f. June 01, 2016, the aforesaid transaction is anyways exigible to additional levy of tax and hence, the judgement rendered by the Tribunal would have limited relevance qua any buy back undertaken post such period. However, it is highly plausible that based on the findings rendered by the Tribunal qua timing of sanction of the scheme placed before them, ITAs may challenge all the similar court approved schemes of buy back of shares which were sanctioned between February 2016 and May 2016, and thus the risk of prospective litigation in this regard cannot be ruled out.

[1] See section 68 of the Companies Act, 2013.

[2] The procedure for reduction of share capital is now prescribed under Section 66 of the Companies Act 2013.

[3] Cognizant Technology Solutions India Pvt. Ltd. v. ACIT (Order dated 13.09.2023 in ITA No. 269/Chny/2022, Chennai Tribunal).

[4] Similar view has been taken by the Mumbai bench of Income Tax Appellate Tribunal in the case of DCIT v. Grasim Industries Limited, [2023] 151 taxmann.com 196 (Mumbai Tribunal).




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