From Deeming to Differentiation: The Persistent Distributive Asymmetry in India's Buyback Taxation

The author is Saanvi Arora, a Third Year B.B.A. LL.B. Student from Indian Institute of Management, Rohtak.

Keywords: Buyback Taxation

Introduction

The evolution of taxation of equity share buybacks in India has undergone a tumultuous journey over the recent years giving rise to a tangle of consequences that have become evident in practice. The latest Infosys buyback, priced at ₹1,800 per share with an 18% premium over the market rate is a glaring example of the challenges embedded in the legal framework evolved after the Finance Act (“FA”) amendment of 2024 which deemed the entire buyback consideration as dividend income under Section 2(22)(f) of the Income Tax Act, 1961 (“the Act”), placing the tax burden squarely on shareholders. 

The tax issues that arose post-FA 2024 have been addressed by the FA 2026, by doing away with the taxation of buybacks as dividend and reverting to a capital gains model, however, this legislative change has opened another pandora’s box of challenges. The new scheme while broadly a step in the right direction is another overhaul of a key repatriation strategy. It also faces limitations insofar as it impact various shareholders in vastly different ways creating inequality. 

This piece argues that the amendment while a welcome change, adversely impacts certain shareholder categories, specifically promoters and companies. This piece attempts to break down the legislative trajectory, examine the distributive consequences for various stakeholders and evaluate the broader commercial implications. 

Three Regimes of Buyback Taxation 

The taxation of buybacks have undergone three structurally distinct phases in under a decade, with each one being motivated by the perceived failure of its predecessor. Before a closer look it is imperative to acknowledge that under the Act, distributions by a company to its shareholders are taxable either as dividends or as capital gains depending on the transaction’s character. Section 2(22) defines “dividend” to include “any distribution" representing a release of accumulated profits, thereby extending the scope to non-periodic profit sharing. 

The First Regime 

Prior to 2013, buyback proceeds were taxed as capital gains under Section 46A of the Act. The difference between the consideration received and cost of acquisition formed the taxable gain. FA 2013 and FA 2019 imposed a buyback tax on unlisted companies and listed companies respectively. Section 115QA caused the amount to be payable by the company on the difference between the buyback and issue price, while shareholders were exempt under Section 10(34A). The attractiveness of buybacks increased with FA 2020 when it abolished the Dividend Distribution Tax, taxable in the hands of shareholders as “income from other sources.” In 2023 alone, 48 companies repurchased shares worth Rs, 48,452 crore, compared to Rs, 13, 423 crore by an identical number of companies in 2024. 

The Second Regime 

FA 2024 abolished Section 115QA and inserted clause (f) of Section 2(22) to include buyback proceeds within the definition of deemed dividend. The proceeds were rendered taxable in the hands of shareholders and the consideration was received was considered nil for capital gains computation under Section 46A. This integrated framework purported to achieve parity between dividends and buybacks and eliminate tax arbitrage, yet in effect, it redistributed the tax burden asymmetrically across shareholder categories. 

The Third Regime 

FA 2026 proposed to dismantle the deeming fiction model and restore capital gains treatment for buyback proceeds, marking a shift back to square one. 

Distributive Asymmetries 

Under the second regime, resident individual shareholders were the most adversely affected stakeholder category. The mandatory 10% Tax Deducted at Source (TDS) was applied, with the final tax liability calculated by integrating the buyback consideration into their total income under the applicable income tax slabs. This created a significant burden for shareholders in the higher tax brackets, where the cumulative tax may exceed the premium received from the buyback. It also did not permit an offset for the shareholder's acquisition cost and required capital losses from such transactions to be treated separately. However, the new era promises an improved situation with tax only applicable on net capital gains and deductible acquisition cost. Erstwhile benefactors of the second regime, corporate shareholders have now lost the availability of the inter-corporate dividend deduction under Section 80M, For multi-tier corporates this loss brings back the concern of cascading taxation. Corporate Promoters also face a significant 22% effective tax on buyback gain.

Non-resident shareholders were subject to Section 115A which was also adjustable under the Double Tax Avoidance Agreement (“DTAA”) as long as a valid Tax Residency Certificate (“TRC”) was produced. Though this is also unclear given the Supreme Court’s verdict in The Authority for Advance Rulings v. Tiger Global International II Holdings 2026 INSC 60. Although Paragraph 31 of OECD commentary on Article 13 specifically supported India’s right to classify buyback proceeds as dividend, no capital loss relief applied under treaties. Conversely, if a treaty classified it as capital gains, India would get full taxing rights, possibly at higher effective rates. This led to treaty mismatches, especially under DTAAs with Netherlands, Mauritius and Singapore. Post the advent of the third regime, the availability of treaty provisions is likely to become available, with shareholders from certain jurisdictions even being eligible for exemptions. The situation still remains dire for non-resident promoters who will have to pay a flat tax percent which might be worse than the dividend rates under several available treaties. The new framework has also largely mitigated the risk of RNOR reclassification because capital gains is less likely to push total income past residential-status thresholds. 

Ripple Effects of the New Regime 

The framework has created a fundamental structural problem, each legislative overhaul has addressed the distortions created by its predecessor, but only by shifting the burden onto a different stakeholder category rather than eliminating it. The deemed dividend era relieved companies but negatively impacted retail investors. Correction for retail investors has exposed promoters and multi-tier corporate structures as discussed below. This mode of sequential correction without comprehensive design is the source of the ripple effects that follow from each legislative one-eighty. Targeted, scenario-tested reform is the appropriate response. 

Under the previously set up, the immediate commercial consequences were severe: buyback effectively collapsed by 90-95% in 2025. The re-pricing by listed issuers and preference of high-slab investors for open-market exits over tendering created a shortage of liquidity. Multiple entities came up with restructured versions of distributions to minimise tax exposure. The new framework can be expected to restore buyback activity. The scope for litigation was also higher previously, the risk, however, has not disseminated, it has merely changed. The absence of a corresponding amendment to Section 2(40) of the Act is likely to be a point of contention. The section does not carve out buybacks from the definition of dividend which means that non-resident shareholders may still argue for dividend characterisation to access treaty rates even though the new framework ostensibly intends to displace the characterisation. 

Additionally, the scope of “indirect” shareholding for the 10% promoter threshold remains unresolved. It is unclear whether holding through subsidiaries, trusts or nominee structures counts toward this limit. Another cause of interpretive uncertainty is caused by the ambiguity in surcharge rate, whether it is capped at 15% for capital gains computer under Section 69 of the Act or under applicable slab rates. Tax planning under both regimes pivots around the promoter and non-promoter divide. Previously, promoters and HNIs would migrate to corporate or treaty-friendly structures to reap benefits but now they may route holdings through instruments with contested promoter classification. GAAR applicability on such arrangements will depend on whether the form chosen has independent commercial substance beyond tax reduction. The new promoter classification has adverse effects for founder-employees who hold above 10% as they will face the effective rate on buybacks of their vested shares creating a deterrent effect on the very stakeholder category most likely to tender under ESOP liquidity programmes. It could also capture private equity investors who are not-promoters but breach the numerical threshold. 

Reforms Needed 

The change caused by FA 2026 reflects a legislature searching for a stable equilibrium between revenue protection and market efficiency. Though a structurally sounder response it certain structural concerns that are imperative to address. First, Central Board of Direct Taxes (“CBDT”) guidance on the Section 2(40) carve-out issue would prevent non-resident treaty shopping back into dividend characterisation. Second, there is also a need for legislative clarity on the surcharge ambiguity for the additional promoter tax. An explicit provision demarcating the base for the additional tax from ordinary capital gains computation would be highly beneficial. Third, adequate measures must also be taken to address the risk of passive investors being captured in the indirect shareholding threshold. The threshold introduced should be tweaked and calibrated to actual control similar to the SEBI definition for listed companies. Fourth, the absence of multi-tier deductibility for inter-corporate will definitely create a new asymmetry for group structures. A transitional provision would be helpful in this regard. 

Conclusion 

Buyback taxation has taken a long journey from initially starting out as pre-2013 capital gains to ending up as post-FA 2026 capital gains. The most pointed lesson from the debacle is the pressing need for stability. The decade of policy flip-flops hamper investor certainty and thereby investment commitments. India’s buyback taxation has come full-circle, it is now the task of legislators and CBDT to ensure it does not go around again.