The 12% surcharge: who's affected and who benefits from the new share buyback rules?

The taxation of share buybacks in India has come full circle, reflecting the government's continuing effort to balance revenue considerations with anti-avoidance safeguards. Before 2013 buybacks were treated akin to a sale of shares, with shareholders taxed on the resulting capital gains.

There was no tax incidence at the company level, making buybacks an attractive and tax-efficient route for distributing surplus cash. However, this shareholder-centric regime raised concerns for policymakers, as companies increasingly used buybacks to sidestep the then-prevailing dividend distribution tax, thereby corroding the tax base.In 2013 the rules changed and a new buyback tax was introduced, similar to the prevailing dividend distribution tax.

Under that system, the company had to pay buyback tax on distributed income at the effective tax rate of 23.3%. The objective of that amendment was to curb tax arbitrage between dividends and buybacks.While intended to streamline taxation, the system posed several issues such as uniform levy of tax regardless of gains in the hands of individual shareholders and foreign shareholders could not claim foreign tax credit (resulting in double taxation) for taxes paid by the company in India.Still, that regime worked very well for Indian promoters, who ended up paying less tax overall as they were otherwise chargeable to tax at 30% (plus surcharge and cess) on short term capital gains.

As a result, companies switched to buybacks instead of dividends, taking advantage of available tax arbitrage.Tax authorities eventually plugged this loophole, which led to yet another change in 2024. The buyback tax was scrapped, and buyback amounts started being taxed as dividends in the hands of shareholders.