Income tax implication of buy back of shares and reduction of capital

Broadly both reduction of capital and buy back of shares are only different forms of reorganization of the capital structure of the company. From both these events income can arise in the hands of the shareholder either as deemed dividend or capital gains. A part or portion of the divisible profits of the company is distributed among the shareholders as dividends. At the first instance dividend is paid on preference shares at fixed rates since preference shareholders have a preferential right to dividend over equity shareholders. Thereafter dividends is paid to the equity shareholders at or below the percentage recommended by the board as confirmed by the members at the annual general meeting. Accordingly to the extent reduction of share capital is made out of accumulated profits of the company, these are deemed dividend. Under Section 2(22) (d) of the IT Act dividend includes any distribution made by a company on the reduction of its capital to its shareholders to the extent the company possesses accumulated profits. Under Section 2(22)(c) of the IT Act any distribution to its shareholder by a company on its liquidation to the extent to which the same is attributable to its accumulated profits, immediately before its liquidation, whether capitalized or not, Under Section 46(2) of the IT Act when a shareholder receives any money or other assets from a company on its liquidation, the resulting income will be chargeable under the head capital gains for amounts or market value of the assets received after deducting from there amount attributable to accumulated profits of the company assessable as dividend within the meaning of Section 2(22) (c). In buy back of shares there cannot be any dividend income but only capital gains in the hands of the shareholder. According to Section 2(22)(iv) of the IT Act any payment by a company on purchase of its own shares from a shareholder under Section 77A of the IT Act does not amount to dividend. Under Section 46A of the IT Act when a shareholder or holder of specified securities including shares under the employees stock option scheme receives any consideration from the company for the purchase of those shares, then the excess of such consideration over and above the cost of acquisition is assessable as capital gains. Here cost means the indexed cost. It has been held by the Supreme Court in Kartikeya Sarabhai vs. CIT reported in(SC)94 Taxman 164 that redemption of preference share capital can also give rise to capital gains in the hands of the shareholder. It has been held by the Supreme Court that where for reduction in the value of shares the member has not only been given cash but also property by the company, while computing

receipts for capital gains the portion attributable to accumulated profits have to be deleted. With effect from assessment year 2005-2006 long term capital gains on securities listed on a recognized stock exchange, liable to Security Transaction Tax, has been abolished vide exemption under new Section 10(38) of the IT Act