An effective scheme of buy back of shares can increase shareholders’ return and aid in distribution of surplus cash.

Provision for taxability on buy back of shares	Section 115QA of Income Tax Act, 1961
Rate of tax on buy back of shares	20% + surcharge + cess (HEC)
Provision governing buy back of shares	Section 68 of the Companies Act, 2013

Introduction

When a company engages in a share buy back scheme, there are several tax implications to consider which are borne by the company. An announcement for buy back of shares acts like a signal; it conveys the intentions of a company with regards to its future plans and prospects. Properly planning a scheme of buy back of shares is crucial to ensure the optimum result. Let’s understand the essential elements of this concept.

What is buy back of shares?

Buy back of shares refers to the  re-purchase of  its own shares by a company at a price near to or higher than the market value of the shares which results in the reduction of its share capital. A scheme of buy back has to be undertaken as per Section 68, 69 and 70 of the Companies Act, 2013.

Sources of Buy back of shares

The buy back of shares can be done from:

1. Free Reserves; or
2. Security Premium Account;
3. Proceeds of issue of any other security that is specified (other than the type of securities which are being bought back under the scheme of buy back).

It should be noted that no buy-back of securities can me made out of the proceeds of an earlier issue of the same kind of securities.

‘Free Reserves’ refers to reserves, which as per the latest audited balance sheet of the company, can be used for distribution of dividend by such company.

Purpose of Buy back of Shares – How does it help Companies?

When a company goes for a scheme of buy back, it offers an option to its shareholders to tender their shares for the scheme within a specified time limit at a specified price.

The main purpose of buy back of shares is to return the value to the shareholders. It may also be a strategic move by the company to improve financial ratios of the company like earnings per share or to reduce excess cash reserves on the balance sheet, etc. Thus, buy back of shares can serve various purposes:

• To increase value of shares: The buyback of share reduces the number of shares outstanding and increases the company’s earnings per share (EPS), and potentially increase the stock price.
• To return excess cash to investors: If a company has surplus cash on its balance sheet, a share buyback can be a way to distribute the excess cash to investors.
• To prevent a hostile takeover: A company may buy back its shares to prevent hostile takeovers, by reducing the number of shares available to the public. This can make it more difficult and expensive for a potential acquirer to gain a controlling stake in the company.
• Increasing Promoter’s holding: A company can potentially increase the holding of the promoter in the company which will benefit from consolidating their stake in the company.

Practical Insights from the Industry on Buy back of Shares

Company	Purpose of Buy back of shares
Birlasoft Limited	Distribution of cash surplus to equity holders Improve return on earnings and EPS leading to increase in shareholder’s value
Asscher Enterprises Ltd.	Optimizing Capital Structure Return surplus cash to shareholders
Vaibhav Global Limited	Return Cash Surplus Option to shareholder to either sell their share and get cash or not to sell and get higher percentage of holding
Dhanuka Agritech Limited	Enhance overall return to shareholder Reservation of certain shares for ‘small shareholders’
Indian Oil Corporation Limited	Improving return on equity by reducing equity base Increasing Shareholder’s value

 

Buy back of Shares – Relevant provisions of the Company Law, 2013

Stage I: Preparation of scheme of buy back of shares

• Conditions to be complied with for buy back of shares: Under Section 68 of the Companies Act, 2013, a company can draft a scheme for buy back only if it complies with all the following conditions:

1. Authorization by AOA – Buy back must be authorized by the Articles of Association (AOA) of the company
2. Authorization via Special Resolution-Authorization of the scheme through a Special Resolution passed in a general meeting
3. Limit of buy back- Value of shares purchased via buy back should be 25% or less of paid-up capital and free reserves held by the company. (In the case of equity shares, value of buy back of shares shall not be more than 25% of the total paid up equity share capital of the company.)
4. Debt-Equity Ratio- Ratio of secured and unsecured debts, after implementing the scheme of buy back, is less than twice the paid-up share capital and free reserves of the company.
5. Fully paid-up shares- All the shares to be bought back under the scheme of buy back should be fully paid-up.
6. Complying with SEBI Regulations- If buy back pertains to shares listed on the recognized stock exchange, it should be as per the applicable rules and regulations of SEBI.

• When buy back of shares is not more than 10%:

  In such a case, there will be no need for passing a special resolution for authorizing the scheme of buy back. The buy back can take place simply with the passing of a Board Resolution.

• Can a company buy back shares beyond the limit of 25% set under Section 68 of the Companies Act, 2013?

Section 68 of the Companies Act, 2013 allows for buy back of shares up to 25% or less of paid-up capital and free reserves held by the company. In case a company wants to buy back more than 25%, it cannot be done under a scheme of buy back (Section 68). It would instead be governed by the provisions of Section 66 of the Companies Act i.e., any buy back of shares beyond 25% shall be considered as ‘capital reduction’. The company would have to approach the NCLT under a Court Scheme for seeking authorization for such share capital reduction. For understanding the practical implications of share capital reduction scheme- Contact us today.

• Important documents for undertaking a Scheme of Buy Back

  • Notification of alteration in AOA for buy back of shares: Where a company alters its AOA under Section 14 of the Companies Act, 2013 through special resolution, it shall inform the Registrar of the Company within 30 days through Form MGT-14.

• • Letter of Offer: The company will file Letter of Offer in Form SH-8 with the ROC and applicable fees, after which it shall dispatch the Letter to the shareholders.

• • Declaration of Insolvency: A declaration of insolvency is to be filed under Form SH-9 with ROC and SEBI (in case of listed company) which will be:

1. 1. Signed by 2 Directors, one of whom will be Managing Director
   2. Verified through Affidavit

Stage II: Implementing the scheme of buy back of shares

• Method of buy back of shares:
  • For unlisted and private companies: The buy back of shares can take place:

1. 1. Through open market operations (OMO)
   2. Purchasing of securities from employees of the company through a scheme of stock option or sweat equity shares
   3. Purchasing of securities, on a proportionate basis, from existing shareholders or security holders

• • For listed companies: The buy back of shares can take place via any of the following methods:

1. 1. Tender Offer made to existing shareholders for purchase of shares on a proportionate basis
   2. Through open market operations (OMO)- This can be done via Stock Exchange or Book Building Process.

However, as per 2023 amendment of the SEBI (Buy Back of Securities) Regulations, 2018, buy back of securities from the open market via stock exchange cannot be done from April 1, 2025.

• Time Limit for Completion of buy back: The buy back of securities will have to be completed within a time period 1 year of passing of special resolution or board resolution (as per the situation).

• Extinguishment of share certificates: This is to be done within 7 days of completion of buy back.

 Stage III- Post scheme of buy back of shares

• Register for buy back of shares to be maintained: The register is to be maintained in Form SH-10 at the registered office of the company by the secretary of the company.

• Return to be filed after buy back of shares: The return of buy back of shares is required to be filed under Form SH-11 with the ROC and SEBI (in case of listed company) within 30 days of completion of buy back of shares. The company shall also file a certificate as per Form SH-15.

• Transfer to Capital Redemption Reserve Account: Under Section 69 of the Companies Act, 2013, where the buy back of shares takes place through free reserves or Securities Premium Account, a sum equal to the amount of buy back shall be transferred to the Capital Redemption Reserve Account and disclosed in the balance sheet.

• Restriction on further issue for 6 months-  After completion of the buy back scheme, no further issue of the same kind of securities is allowed for a time period of 6 months. Furthermore, it cannot allot new shares or other specified securities for the 6-month period except by way of:
  • A bonus issue or;
  • Discharge of subsisting obligations with regards to conversion of ESOPs, sweat equity shares, preference shares, stock option schemes or debentures into equity shares.

Restriction on Buy Back of Shares

Under Section 70 of the Companies Act, 2013, the buy back of shares by the company will not take place in these circumstances:

1. Buy back through a subsidiary company (including its own subsidiary);
2. Through an investment company or a group of investment companies;
3. Where the company has failed to comply with any of the following provisions:
   • Section 92 – Annual Return,
   • Section 123 – Declaration and Payment of Dividend,
   • Section 127 – Failure to pay Dividend and
   • Section 129 – Failure to give true and fair Statement
4. Company defaults in:

• • Repayment of deposit or interest,
  • Redemption of preference share or debenture,
  • Payment of dividends to shareholders
  • Repayment of term loan or interest to financial institutions or banking company

Note: There will be no prohibition on buy back of shares if:

1. The default is remedied, and
2. 3 years have elapsed since such remedy 

Penalty for not complying with Section 68 of Companies Act, 2013 or SEBI Regulations

• Penalty for Company: Where the company does not comply with specified provisions and regulations, the penalty levied shall be minimum of Rs. 1 Lakh and maximum of Rs. 3 Lakhs.
• Penalty of Officer of Company: Where the officer of the company is in default, he shall be the penalty levied shall be minimum of Rs. 1 Lakh and maximum of Rs. 3 Lakhs.

Income Tax Implications on Buy back of Shares

The buyback of shares are considered as “transfer” as per Section 2(47) of the Income Tax Act, 1961. As per Section 10 (34A) of the Income Tax Act, 1961, where the shareholder has earned income on the buy back of the shares, it will be exempt in the hands of the shareholder.

Under Section 115QA of the Income Tax Act, 1961, the company (whether listed or unlisted) has to pay additional income tax on the amount of the distributed income which shall be:

1. 20% tax on the distributed income
2. Surcharge and cess (HEC)

Thus the total amount of tax on the distributed income would be 23.3%.

Meaning of ‘Distributed income’ for the purposes of buy back of shares

Distributed income is the difference of the amount received by the company and the amount paid by the company for the buy back of the shares.

Note: If there is a situation where the Indian company is not liable to pay  income tax on its total income, even in such a case, the company shall be liable to pay income tax on distributed income from such buy back of shares.

• Determination of ‘Distributed Income’ for Buy Back of Shares

Rule 40BB of the Income Tax Rules, 1962 governs the calculation of the amount received on issuance of shares for determining the distributed income earned from the buy back of shares.

Method of issuance of shares	Determination of ‘amount received’ on issuance of shares
1.    Issue of share on subscription	Sum which is actually received + premium
2.    Amount returned by the company, before buyback of shares	Sum after reduction of ‘returned amount’ But, if company has paid additional tax under Section 115O, then the ‘returned amount’ will not be deducted.
3.    Issue of share on Employee Stock Option Plan (ESOP) or Sweat Equity Shares	On fair market value of share as per the calculation under Rule 3(8)
4.    Shares issued without consideration, due to an existing shareholder – Bonus Shares	Consideration will be Nil
5.    Issue of Shares by Amalgamated Company	Sum received in respect of such shares
6.    Amount received by company resulting from demerger 7.    Amount received by demerged company	Amount received in respect of original shares in proportion of net book value of the assets transferred
8.    Shares issued on conversion of preference shares, debentures, etc.	Sum received on such conversion

• Are there Capital Gains on a scheme of Buy back of Shares?

No capital gains would arise to the shareholder on the transfer of shares in a scheme of buy back. However, distributed income shall be subject to additional income tax. 

• Can the company claim credit of additional income tax paid on buy back of shares?

As per Section 115QA, tax on the buy back of shares will be treated as final payment of tax and no credit can be claimed by the company or any other person.

• Tax Deduction of additional income tax paid on buy back of shares

No deductions can be claimed under any of the provisions of the Income Tax Act, 1961 against payment of additional income tax on distributed income under Section 115QA(1), by either the company or the shareholder.

Want to understand the tax implications of a buy back scheme? Contact us today 

FEMA implications on Buy Back of Shares

The provisions of the Foreign Exchange Management Act, 1999 (FEMA) click in when there is a buy back of shares by the company from:

1. Foreign Shareholders
2. Non-Resident Indians (NRIs)
3. Foreign Institutional Investors (FIIs), etc.

• Automatic Route: A company can buy back its shares under the ‘Automatic Route’ prescribed by the Reserve Bank of India. Thus, a company does not require prior approval from the RBI for buying back its securities.
• Key Requirements: To avail the automatic route, the key considerations as per Rule 10B of FEMA Regulations are as follows:

1. Compliance with pricing guidelines of SEBI; (if applicable)
2. Compliance with pricing guidelines of RBI
3. The company must not be operating in a restricted sector under FDI policy and should be eligible for FDI under Automatic Route
4. The company shall file a Chartered Accountant Certificate in accordance with SEBI regulations with an AD Bank along with Form FC-TRS. 

Conclusion

Buy back of shares is a method by which a company can repurchase its own shares from the market. This can serve multiple purposes, including returning value to shareholders, improving financial ratios, and reducing excess cash reserves.

Wanting to draft a scheme of buy back of shares, but unsure how? Contact us today.