Many companies avoided payment of heavy income tax by using the buy back of shares from market avoiding dividend distribution tax thus paying nominal capital gains tax on buy back. Now in the present income tax proposals, Mr. Chidambaram plugged this hole . Please read:
Buyback of shares by an unlisted company will become less attractive after Budget proposed to levy tax on it, while dividend distribution will be more preferred.
A company with distributable reserves has two options to offer the same to its shareholders. It can be done either by paying dividends to shareholders or through buyback of shares. In case of distributing the reserves through dividend, the company has to pay Dividend Distribution Tax (DDT) at 15%, which becomes 17% along with 10% surcharge and 3% education cess. In case of distribution the reserves through share buyback , the company needs to pay no tax under the existing norms.
Under the existing provisions , amount received by shareholders via buyback of shares is not treated as dividend and is taxable as capital gains. The finance ministry noted that unlisted companies, as part of tax avoidance scheme, are resorting to buy back of shares instead of payment of dividends in order to avoid paying Dividend Distribution Tax (DDT), particularly where the capital gains of shareholders are either not chargeable to tax or are taxed at lower rate.
The Budget proposes that a company, which is buying back its shares, has to pay tax at 23% including 10% surcharge and 3% education cess on net consideration (amount) received by shareholders. The net consideration is equal to the value at which the company bought the shares minus the price at which it issued the same to its shareholders .
Executive director of PWC Hemal Uchat said the new proposed tax is like DDT. It is paid by the company over and above the normal tax liability and cannot be claimed as a credit. However , income received by the shareholder with respect to such buyback will be exempt from tax.
Reference: Economic times of India