The Finance Act of 2024 has fundamentally altered the tax landscape for share buybacks in India, moving the tax burden from companies to investors. This change, effective from October 1, 2024, has replaced a long-standing and predictable system with a new regime that is drawing significant criticism from tax professionals, industry bodies, and investors alike.
From Capital Gains to Dividend: Understanding the Radical Shift
Under the previous system, listed companies undertaking buybacks paid a buyback tax under section 115QA. Shareholders receiving the proceeds enjoyed them tax-free. The 2024 amendment scrapped this mechanism entirely.
The new rules introduce a two-part taxation process for shareholders. The entire buyback consideration is now taxed as a "deemed dividend" under section 2(22)(f) of the Income Tax Act. Simultaneously, the original cost of the shares bought back is treated as a capital loss under the newly introduced section 46A.
This capital loss can be adjusted against other capital gains in the same financial year or carried forward for set-off over the next eight years, provided the income tax return for the year of loss is filed on time.
For high-income taxpayers, this means buyback proceeds could be taxed at slab rates as high as 35.88%, even though the transaction involves surrendering ownership rights—a classic capital event, not income. The capital loss is classified as long-term or short-term based on the holding period of the shares before the buyback.
Real-World Tax Impact: A Potential Trap for Investors
The practical effect creates a complex circularity. Investors first pay tax on the full buyback amount at their high income slab rate. Later, they get relief via a capital loss set-off, but only against future capital gains which are themselves taxed at a lower rate (e.g., 12.5% for long-term gains on listed shares).
This results in taxpayers paying a high tax upfront and receiving relief later, and only if they have sufficient capital gains to utilize the loss. This deviates from global practices in countries like Australia and the UK, where buybacks are taxed as dividends only to the extent of the profit component.
To illustrate, consider an investor who bought 100 shares at Rs. 40 each in 2020 (total cost: Rs. 4,000). If 20 shares are bought back in 2024 at Rs. 60 each, Rs. 1,200 is taxed as deemed dividend. A capital loss of Rs. 800 (20 shares * Rs. 40) is generated. If the investor later sells 50 remaining shares in 2025 at Rs. 70 each, creating a capital gain of Rs. 1,500, the earlier loss of Rs. 800 can be set off, leaving a chargeable gain of Rs. 700.
The Core Anomaly: Taxing Capital as Income
A major point of contention is that a buyback is not always funded by a company's accumulated profits. Companies can use retained earnings, share premium, or even proceeds from a fresh issue of shares to finance the repurchase.
In cases using share premium or fresh issue proceeds, there is no distribution of profit whatsoever. Yet, the entire payout is deemed dividend income for the shareholder. Ravikant Kamath, a partner at EY India, highlights that this leads to the artificial taxation of a capital receipt.
He gives a stark example: a loss-making company using its share premium to buy back shares at Rs. 20 against a face value of Rs. 100 would still trigger dividend taxation for the shareholder, even though the investor suffers an economic loss.
Calls for Reform Ahead of Budget 2026
In light of these issues, experts like Kamath are advocating for changes in the upcoming Union Budget for 2026. Key recommendations include restoring the capital gains treatment under section 46A, where tax is levied only on the difference between the buyback price and the cost of acquisition.
Another suggestion is to exempt from dividend taxation any buyback funded purely out of share premium or fresh issue proceeds, as these are capital transactions. For buybacks funded from retained earnings, a split approach is proposed: only the portion representing accumulated profit should be taxed as a dividend, while the amount representing returned capital should be treated as a capital gain.
The new regime has already seen action, with listed companies like Infosys, Bajaj Consumer Care, Tracxn Technologies, SIS, Infobeans Technologies, and Dhampur Sugar Mills undertaking buybacks in 2025. However, the tax community awaits clarifications and potential corrections to what many see as a flawed and economically distortive policy shift.
