Union Budget 2024: IT Company Buybacks may become less attractive

The attractiveness of buybacks from information technology (IT) companies is expected to diminish following the Budget 2023-24 announcement, which states that income from share buybacks will now be taxed as dividends for the recipient investor. Analysts anticipate this change will make buybacks less appealing due to increased compliance burdens and potentially higher taxes.

Under the current system, companies are charged an additional income tax for buybacks. However, starting October 1, 2024, the income from share buybacks will be taxed at applicable rates.

Pareekh Jain, Founder and CEO of EIIRTrend, remarked, “This will impact IT companies from both a tax and compliance standpoint.” Data shows that major IT companies have repurchased shares worth over ₹1 lakh crore across at least 12 buybacks between 2020 and 2024.

Jain also pointed out that the government’s intention appears to be reducing speculative investments, but it might inadvertently affect genuine investors. He explained, "Previously, investors faced no such hurdles; now they must navigate these new implications. Dividend income is taxed at a higher rate compared to capital gains, adding unnecessary complications."

The government justified the move in the Budget memorandum, stating that dividends and buybacks should be treated similarly as both are ways for a company to distribute accumulated reserves.

Currently, investors pay long-term capital gains (LTCG) or short-term capital gains tax (STCG) based on the holding period of shares, with LTCG applying to holdings over 12 months. The Budget has increased the LTCG tax from 10% to 12.5% and the STCG tax from 15% to 20%, effective July 23.

Sanjay Sanghvi, Partner at Khaitan & Co, expressed disappointment over the tax hikes, suggesting they could have been avoided. Sujith Kumar A, founder of CFINANCIO Consulting, noted that while institutional investors can manage the compliance and cash flow challenges, retail investors often struggle with tax compliance due to lack of awareness.

Experts indicated that the IT industry, which significantly contributes to India's exports, might see a reduction in buyback activities as investors cope with the new tax burdens. As analysts and investors adjust to these regulations, the overall impact on the sector is still uncertain.

Shareholders currently pay taxes on dividends at their respective slab rates. The latest Budget proposals have further complicated the tax landscape. Now, any consideration received from the buyback of shares will be classified as dividend income for shareholders, diminishing the appeal of buybacks for investors. Since the new taxation scheme for buybacks takes effect on October 1, companies may rush to complete buyback processes by September 30.

Abhishek Goenka, the founding partner of Aeka Advisors, criticizes the change in taxation for share buybacks, arguing it wasn't well-considered. He states, "Taxing buybacks as dividends while recognizing a capital loss benefits larger investors disproportionately at the expense of smaller ones. Additionally, many buybacks are funded from share premiums, and taxing these as dividends contradicts the principles of dividend taxation."

Puneet Gupta, a partner at EY-India, elaborates that buyback proceeds will be taxed as dividends. Meanwhile, the original cost of the shares will be recognized as a capital loss, which can be offset against other capital gains either within the same financial year or over the next eight years. "The capital loss will be categorized as either long-term or short-term, based on the duration of shareholding prior to the buyback. Shares held for over a year are considered long-term assets, subject to a proposed tax rate of 12.5%," explains Gupta.

If an investor realizes a long-term capital gain from the subsequent sale of remaining shares or other assets, the capital loss from the buyback can be used to offset these gains. Gupta adds, "The effect is twofold: initially, buyback proceeds are taxed as dividends at the applicable slab rate, which for many investors will exceed the long-term capital gains tax rate. Secondly, when assets are sold, the loss from the buyback can only be set off against capital gains, which are taxed at a lower rate. This discrepancy creates an inconsistency in the tax system."

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