Buybacks to be taxed under capital gains

The budget has announced a major overhaul in the taxation of share buybacks, shifting them from dividend taxation to the capital gains framework, while imposing a higher effective tax on promoters to curb misuse of the route. Once legislated, it will apply to buybacks after April 1.The silver linings: Many shareholders could end up with a lower tax burden or even a nil tax burden. To illustrate: the long term capital gains tax arising on sale of listed shares (held for more than 12 months) is 12.5% without indexation (Further long term capital gains of up to Rs. 1.25 lakh arising against listed shares/equity MFs are exempt from tax). For shares held for less than 12 months, the tax on short term capital gains is 20%. On the other hand, under the existing regime, a shareholder who fell in the top slab ended up paying 30% tax on the ‘deemed dividend’ component arising on a buy-back, plus surcharge and cess – which translated into an effective tax rate of 35.88%.Under the budget proposal, consideration received by shareholders on buyback of shares will no longer be treated as dividend income. Instead, it will be taxed as capital gains, aligning buybacks with the treatment of share sales in the market. “In the interest of minority shareholders, I propose to tax buyback for all types of shareholders as capital gains.However, to disincentivise misuse of tax arbitrage, promoters will pay an additional buyback tax,” the FM mentioned in her speech.“In case of buyback of shares, both listed as well as unlisted, the shareholder was subjected to tax on the entire buyback proceeds as dividends, with cost of the shares being allowed as a capital loss. This was unfair to shareholders other than promoters, particularly domestic retail shareholders of listed companies, where often it was more beneficial to sell the shares on the market at a lower price and pay capital gains tax, rather than paying the higher dividend tax. Now, the law is being rationalised for buybacks completed on or after April 1, 2026,” states Gautam Nayak, tax partner at CNK& Associates.