Tax Relief for Investors but a New Compliance Puzzle for Companies

Buybacks allow companies to repurchase their own shares, returning surplus capital to shareholders in a tax-efficient manner. However, under the Income Tax Act, 1961, the taxation of buybacks has shifted repeatedly, reflecting the government’s effort to balance corporate flexibility, tax equity, and anti-avoidance concerns.

Under the Companies Act, 1956, Section 77 treated buybacks as impermissible capital reductions, requiring court approval and making them rare in practice. The 1999 amendment introduced Section 77A, permitting companies, subject to authorisation in their articles of association, to repurchase up to 25% of paid-up capital and free reserves in a financial year.

This framework was consolidated under Section 68 of the Companies Act, 2013, which applies to public and private companies. In the years that followed, firms increasingly favoured buybacks over dividends, particularly during the era of Dividend Distribution Tax, as shareholders could potentially benefit from lower capital gains taxation.

The Finance Act, 2013 introduced Section 115QA, imposing an additional tax on the "distributed income" of unlisted companies undertaking buybacks – the difference between the buyback price and the issue price. This provision was later extended to listed companies to address perceived tax arbitrage, including arbitrage through routing structures involving foreign portfolio investors.

After the abolition of DDT, the Finance (No. 2) Act, 2024 removed the company-level buyback tax with effect from October 1, 2024. Buyback proceeds were instead treated as deemed dividends under Section 2(22)(f), taxable in the hands of shareholders at applicable slab rates, with a nil cost of acquisition for computing income and no ability to claim capital loss set-off.

The Finance Bill, 2026, proposes yet another recalibration. The regime is set to revert to capital gains taxation for buybacks, broadly restoring the pre-October 2024 position. Shareholders would be taxed on net capital gains rather than gross dividend income, and eligible capital losses may be available for set-off.

However, the Bill introduces an additional levy targeted at ‘promoter’ shareholders. For listed companies, “promoter” would be defined in accordance with SEBI regulations; for unlisted companies, the term would draw from the Companies Act, 2013, and additionally cover any person holding directly or indirectly more than 10% of the share capital.

The proposed amendments are to take effect from April 1, 2026.

Under the revised framework:

• All shareholders would be taxed on net capital gains.
• Non-promoter shareholders would generally be taxed at beneficial capital gains tax rates.
• Eligible capital losses may be available for set-off.
• Promoters would face an additional levy, aimed at addressing perceived asymmetries under prior regimes. 

In her Budget speech, the Finance Minister stated that the revised structure seeks to rationalise taxation and reduce distortions that incentivised buybacks over dividends. For minority shareholders, capital gains treatment may offer greater clarity and reduce classification disputes. For promoters, the additional levy is positioned as a corrective measure to align the tax burden evenly across shareholder payouts.

Frequent regime shifts — from company-level taxation (2013-2024), to deemed dividend treatment (October 2024-March 2026), and now back to capital gains with promoter-specific levy — have imposed repeated recalibrations on corporates and investors. Each transition necessitates fresh tax modelling, shareholder communication, system updates, and legal review.

The deemed dividend phase, in particular, generated significant withholding and reconciliation challenges, including mismatches in reporting and the need for corrective filings.

The proposed reliance on promoter definitions raises interpretational challenges. Section 2(69) of the Companies Act, 2013 defines "promoter" broadly, covering: persons "named" as promoters in filings, persons exercising control over company affairs, and persons in accordance with whose advice or directions the board is accustomed to act. This expansive formulation could potentially cover non-shareholders, advisors, or de facto influencers, diverging from the traditional understanding of promoters as significant equity holders with control.

The SEBI Issue of Capital and Disclosure Requirements Regulations define “promoter” and “promoter group” in a manner that may include relatives and connected entities. The intersection of these definitions with buyback taxation raises several practical questions, particularly in cases involving family trusts, layered holding structures, or mixed ownership vehicles.

Listed companies like Reliance Industries, PI Industries, and Adani Enterprises use family trusts for promoter holdings, triggering SEBI ICDR promoter definitions. Applying the ICDR promoter and promoter group definition for buyback taxation raises multiple critical questions: Say, if a trust holds 40% promoter stake, are beneficiaries indirect shareholders (with pro-rata split) or does the trustee hold in fiduciary capacity? For layered trusts mixing individuals and HUFs, will the Act aggregate the holdings across all layers or test each tier separately for the applicability of levy? 

The absence of harmonisation between definitions under company law and securities regulations could create uncertainty for both taxpayers and tax authorities.  For instance, the ICDR promoter group definition (adopted in the Finance Bill) takes a narrow view of relatives, excluding sons-in-law or daughters-in-law. If they are beneficiaries, how will promoter buyback taxation apply?

Without detailed guidance, these ambiguities could lead to increased litigation and advance ruling applications.

While large, well-resourced companies may be better equipped to absorb such shifts, smaller listed and unlisted entities face disproportionate planning and compliance burdens.  The reversion to capital gains taxation may ultimately simplify the framework. However, the introduction of a differentiated promoter levy—without clear operational guidelines—risks reintroducing complexity in a different form.

To ensure the durability of this revised regime, the timely issuance of detailed FAQs, explanatory memoranda, and computational illustrations would be essential. A stable and predictable tax environment remains central to fostering long-term investor confidence and supporting India’s broader economic ambitions.

As India aspires to achieve developed-economy status by 2047, policy coherence and consistency will be as critical as reform intent. The effectiveness of the revised buyback regime will ultimately depend not merely on its design, but on the clarity and stability with which it is implemented.