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FM Clamps Down On Tax Avoidance Via Share Buybacks

Published on Fri, Mar 01,2013 | 09:24, Updated at Sat, Mar 02 at 12:32Source : 

By: Ameya Kunte,

"Some unlisted companies have avoided dividend distribution tax by arrangements involving buyback of shares.” With these words the Finance Minister introduced an anti-avoidance provision to tax share buy-backs. Mr. Chidambaram is proposing a Dividend Distribution Tax (DDT)-like levy on share buy-backs by unlisted companies. This “buy-back tax” is proposed at 20% (plus 10% surcharge and 3% cess).

Equity share buy-back has been one of the preferred routes for profit extraction from India (especially by MNCs). Profit distribution by a Indian subsidiary company to foreign shareholder attracts DDT @ 15%. In case of FDI, there are issues on availability of DDT credit in the home country of the non-resident investor. Accordingly, in such cases DDT paid in India becomes a cost at the MNC Group level.

Use of share buy‑back thus provided a more efficient route for profit repatriation, especially in case of investments flowing in  from favourable  treaty jurisdictions (like Mauritius, Cyprus, Singapore or Netherlands).  Due to a specific amendment made in 1999 (Sec 46A of the Income Tax Act), share buy-back is regarded as “capital gains” under the domestic law. Thus, if a favourable tax treaty allocated taxation rights on capital gains to the residence state (and not India), gains arising on a share buy-back are exempt in India. Thus, the profits made by a subsidiary can be distributed without any tax incidence in India. Further, Sec 77A of the Companies Act, 1956 provides fairly simple steps to carry out share buy-backs especially in closely held unlisted companies. Since the buy-back provisions under Company law as well as Income-Tax Act were explicit (& permissible), an application of general “anti-avoidance” doctrine would have been very difficult to apply in order to tax these transactions.

The Authority for Advance Ruling (AAR) in Armstrong World Industries Mauritius Multiconsult Ltd [TS-628-AAR-2012] allowed the benefit of India-Mauritius DTAA on a share buy-back. AAR observed that ‘mere fact that investment made through Mauritius is not sufficient to hold the transaction as tax avoidance scheme’. However, subsequently AAR in another case (applicant’s name withheld citation - [TS-196-AAR-2012]) held that a share buy-back by an Indian company with a Mauritian shareholder was a “tax avoidance” scheme. AAR held that the buy-back scheme was a 'colourable device' to avoid payment of DDT in India.  [Subsequent to this AAR ruling, IT Department is also learnt to have issued notices to a few companies who have been involved in share buy-back transactions].

The introduction of buy-back tax in Finance Bill 2013 puts to rest the controversy on whether the buy-back structure is essentially for avoiding tax. The Budget proposal (which in a way affirms the latest AAR ruling) tries to plug the tax arbitrage on distribution of profits as capital gains versus dividend. Also the way, in which this amendment is introduced in the IT Act, it will take away the alternate legal argument of claiming “holding –subsidiary exemption” which is available u/s 47 of the Income Tax Act. A transfer of assets by a 100% Indian subsidiary to its parent company enjoys capital gains exemption under the domestic law (without resorting to treaty). Thus, a view could be taken that a share buy-back between holding –subsidiary companies is covered by the exemption.

The buy-back tax [introduced under a new Chapter XII-DA under Income Tax Act] is applicable on the “distributed income” by an unlisted company which means ‘the consideration paid by the company on buy-back of shares as reduced by the amount which was received by the company for issue of such shares’. The Budget proposals [new section 115QA] state that the tax on the distributed income by the company shall be treated as final payment of tax and no further credit shall be claimed by the company or by the shareholder. The shareholder is exempt from tax on income from buy-back and the company is not entitled to claim tax paid as a deduction. The tax is payable within 14 days from the date of payment of consideration to the shareholder.

Like DDT, there will be a question mark regarding the availability of credit in the hands of the shareholder on the buy-back tax paid by Indian company. Treaties normally allow tax credit (subject to domestic law provisions in home country) on the tax levied on the income recipient in source country (eg: India). In the case of a buy-back, the tax will be levied on the Indian company and the shareholder would be fully exempt. Thus, absent tax credit, buy-back tax (like DDT) would be a cost at the Group level for MNCs.

For domestic shareholders of unlisted companies, the proposed amendment would be neutral as the share buy-back is any way taxable @ 20% (as long term capital gain). These provisions (once enacted) would be applicable from June 1st, 2013, thus providing a window of next 3 months!

Tax on share-buy-back coupled with increase in tax rates for royalty/FTS clearly suggests FM’s intention to tax MNCs on profits from Indian activities and clamp down on legally permissible tax planning devices.


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