From October 2024, under India’s Finance (No. 2) Act, 2024, the entire payout from a buyback will be taxed in shareholders’ hands as a deemed dividend, marking a sharp break from the earlier system where companies paid a buyback tax and investors received proceeds tax-free.
The idea is to create parity between dividends and buybacks, since both return surplus cash. But the new approach may have unintended consequences—from higher tax bills to reduced flexibility for companies and investors alike.
Under the new rule, the entire buyback amount—not just the profit over cost—is taxed at the shareholder’s marginal income-tax rate.
This means investors could be taxed on money they never actually earned, especially long-term holders or those with concentrated positions. The resulting capital loss can only offset future gains, not current income.
For high-bracket taxpayers, the effective tax on buyback proceeds could exceed 30-35%, compared with the 23% company-level levy previously in place.
Global lessons
Major economies have taken different routes to tax share buybacks, balancing flexibility with fairness.
In the United States, the 2022 Inflation Reduction Act introduced a 1% excise tax on net buybacks, calculated as the market value of stock repurchased minus new issuances. This modest, company-level tax was meant to close loopholes without distorting payout decisions—and so far, US buyback volumes remain robust.
The United Kingdom maintains a neutral stance. Most buybacks are taxed as income for individuals, except in rare cases where capital gains treatment applies. In addition, a 0.5% stamp duty is levied on share transfers, including buybacks. Though political calls for heavier taxation surface occasionally, many experts are skeptical—they argue companies would simply shift to higher dividend payouts instead.
Singapore, by contrast, exemplifies tax simplicity. Buybacks are treated as capital transactions; neither firms nor shareholders face tax unless the activity is deemed trading in nature. This approach ensures maximum payout flexibility and deep market liquidity.
Seen against these models, India’s shareholder-level taxation—without cost adjustment—appears unusually harsh, potentially undermining buybacks as an efficient capital management tool.
How Indian companies may respond
The new regime will likely reshape corporate behaviour in several ways.
First, since buybacks now attract the same tax as dividends but involve more procedural complexity, companies may prefer regular dividends for their simplicity.
Second, some firms may reduce overall cash distributions, choosing instead to retain earnings or repay debt. This could slow market liquidity and reduce capital recycling.
Third, companies might experiment with special dividends or capital reduction schemes to minimize tax exposure—though these face regulatory and legal constraints.
Global experience shows that modest buyback taxes, like the US 1% levy, rarely deter activity. But taxing buybacks at ordinary income rates, as under India’s new rule, could sharply reduce their frequency and appeal. In the UK and other jurisdictions with higher or more complex buyback taxes, firms have historically pivoted toward dividends instead.
The change also creates uncertainty for foreign investors. Many rely on tax treaties that cap withholding rates on dividends or grant preferential treatment for capital gains.
By reclassifying buybacks as dividends, India risks double taxation and cross-border disputes, as other jurisdictions may continue to view such proceeds as capital gains. This mismatch could deny investors credit for taxes paid in India, eroding returns and dampening global appetite for Indian equities.
Fixing the imbalance
The intent behind the reform—to eliminate arbitrage between payout types—is understandable. But in practice, it creates a less predictable and arguably less equitable environment for both domestic and foreign investors.
To restore balance, India could consider measures seen in other jurisdictions, such as limiting taxation of buybacks to a reasonable cap, allowing shareholders to deduct acquisition cost directly from buyback receipts in the year of payout, grandfathering deals announced before October 2024, or adopting hybrid treatment based on investors’ residency and treaty status.
Such measures would align India more closely with international best practices, ensuring market efficiency while preserving tax revenues.
Ultimately, the message matters. Over-taxing any form of equity return—whether dividends or buybacks—risks discouraging long-term investment.
When managed responsibly, buybacks are not loopholes but legitimate tools of corporate discipline and investor confidence. The 2024 reform sought to simplify and align policy, but it may instead be undermining a key pillar of India’s capital market structure.
A careful re-examination, informed by global experience and market realities, is essential if India wants to remain a magnet for both domestic and international capital.
Pratibha Kumari is currently working as Assistant Professor at TAPMI Bengaluru. She completed her PhD from Indian Institute of Management Raipur on the thesis titled ‘Investigating the Effects of Mandatory Dividend Policy Regulation on Indian Firms’.
