Taxation of Share Buybacks in India
Regime 2 deemed dividends and Regime 3 capital gains explained
A comprehensive legal and tax analysis of return of capital, promoter tax rates, and double-taxation traps for retail investors.
Post Your Requirement - FreeThe 3-Regime History of Share Buybacks in India
Share buyback taxation in India has undergone a massive shift twice in the span of eighteen months. The applicable tax regime depends strictly on the date the buyback payment is received by the shareholder:
Regime 1: Until 30 September 2024 (Exempt for Shareholders)
Under the historical framework, the company repurchasing the shares bore the entire tax burden. The domestic company paid a special buyback tax under Section 115QA at a flat rate of 20% (plus surcharge and cess, effectively 23.296%) on the "distributed income" (buyback price minus the amount originally received by the company at issue). The shareholder received the proceeds completely tax-free under Section 10(34A).
Regime 2: 1 October 2024 to 31 March 2026 (FY 2025-26 - Deemed Dividend)
To eliminate the tax arbitrage where promoters and HNIs preferred buybacks over dividends, the Finance (No. 2) Act, 2024 shifted the tax burden entirely to the shareholder. Section 115QA was abolished for companies. Instead:
- The entire gross buyback proceeds are treated as a deemed dividend under Section 2(22)(f).
- This income is taxed under "Income from Other Sources" at the shareholder's applicable slab rates (up to 39% or 35.8%). No deduction for cost of acquisition is permitted.
- The cost of acquisition of the tendered shares is treated separately as a capital loss under Section 46A.
Regime 3: From 1 April 2026 (FY 2026-27 Onwards - Capital Gains)
Recognizing the double-taxation trap created by Regime 2, the Finance Act 2026 restored capital gains treatment for buybacks. Tax is levied only on the actual gain (Buyback Price minus Cost of Acquisition). However, promoters pay normal capital gains plus an additional buyback tax, resulting in an effective tax rate of 22% for corporate promoters and 30% for individual promoters, plus a flat 12% surcharge on that additional tax component.
The Section 46A Capital Mismatch & Phantom Loss Trap
Under Regime 2 (applicable for FY 2025-26 buyback receipts), shareholders face a severe mismatch between different tax heads:
- Slab-tax on gross receipts: If you bought shares at ₹100 and tender them at ₹300, the full ₹300 is taxed at your slab rate (e.g., 30% plus cess = 31.2%).
- Capital loss on cost: Your ₹100 purchase cost is recorded as a capital loss in your capital gains schedule.
- Set-off restrictions: This capital loss cannot offset the deemed dividend income, because capital losses can only offset capital gains under Indian tax laws.
- The Phantom Loss Trap: If a retail investor has no other taxable capital gains (from selling property, gold, or other stocks) in the same financial year, they cannot utilize this capital loss. While the loss can be carried forward for up to 8 years, the investor pays tax on the gross receipt immediately, locking up their capital in a "phantom loss."
Legality of Taxing Return of Capital: Taxmann Legal Analysis
The reclassification of gross buyback proceeds as deemed dividends under Section 2(22)(f) has raised critical legal and constitutional debates on platforms like Taxmann:
- Entry 82, List I Scope: Under the Seventh Schedule of the Constitution, Parliament has the power to tax "income." Taxing the original return of capital (the purchase cost) rather than income is argued to exceed the legislative competence of Parliament.
- Article 265 Compliance: The Constitution mandates that no tax shall be levied except by authority of law. Taxing capital recoveries under the guise of dividend income challenges the economic reality of the transaction.
- No Accumulated Profits Limitation: Traditional deemed dividend clauses (Section 2(22)(a)-(e)) are strictly capped to the extent of the company's "accumulated profits." Section 2(22)(f), however, taxes the entire proceeds, meaning it taxes the return of the company's capital/share premium itself.
- Navnit Lal Javeri Precedent: Courts have historically upheld deemed dividends (such as taxing shareholder loans) only as anti-evasion fictions capped at accumulated profits. Section 2(22)(f) lacks this anti-evasion link by taxing the return of capital, making it constitutionally vulnerable.
Mathematical Tax Computations Across Regimes
Consider an individual investor (30% tax slab) who purchased 1,000 shares at ₹100 each (total cost ₹1,00,000) and tenders them in a buyback at ₹300 each (total proceeds ₹3,00,000). Shares held for >12 months:
Scenario A: Under Regime 2 (FY 2025-26)
- Deemed Dividend taxable under Other Sources: ₹3,00,000
- Tax payable (at 30% slab plus 4% cess = 31.2%): ₹93,600
- Capital Loss booked under Section 46A: ₹1,00,000
- Net tax if no other capital gains exist to offset loss: ₹93,600 (An effective tax rate of 93.6% on the actual gain of ₹2,00,000).
Scenario B: Under Regime 3 (FY 2026-27)
- Long-Term Capital Gain (Proceeds - Cost): ₹2,00,000
- Tax under Section 112A (12.5% on gain, assuming ₹1.25L exemption already used): ₹25,000
- Net tax: ₹25,000 (A savings of ₹68,600 compared to Regime 2).
Tendering in Buyback vs. Selling on the Stock Exchange
| Particulars | Tendering in Buyback (Regime 2) | Open Market Sale (FY 2025-26) | Regime 3 (FY 2026-27 - Buyback/Sale) |
|---|---|---|---|
| Taxable Income Head | Income from Other Sources (Gross) | Capital Gains (Net Gain) | Capital Gains (Net Gain) |
| Tax Rate | Slab Rate (up to 39%) | LTCG at 12.5% / STCG at 20% | LTCG at 12.5% / STCG at 20% |
| Cost Deduction | NIL (becomes separate Capital Loss) | Fully Deductible | Fully Deductible |
In FY 2025-26, selling on the open market was significantly better. In FY 2026-27, they achieve parity, so tendering is preferred if the buyback offer price has a premium over the market price.
Double Taxation Relief & TDS Rules for Non-Residents
When a Non-Resident Indian (NRI) participates in a buyback, the transaction is subject to specific international tax rules:
- TDS under Section 195: Under Regime 2, the company deducts TDS on the deemed dividend at a default rate of 20% (plus surcharge and cess). Under Regime 3, TDS applies on capital gains (12.5% for LTCG, 30% or 40% for STCG based on status).
- DTAA Treaty Benefits for residents of the Singapore: Under the India-Singapore DTAA, residents of Singapore can claim tax relief. Dividend income is taxed at a capped rate of 10% or 15% in India, and you can claim tax credit under Singapore tax rules.
- Country-Specific Application: The actual tax rate applied is determined dynamically based on the NRI's specific tax residence certificate country.
- Mandatory Documentation: To claim DTAA benefits, the NRI must submit a valid Tax Residency Certificate (TRC) issued by their home government, a declaration in Form 10F (filed online), and their Indian PAN.
- Foreign Tax Credit (FTC): Taxes paid in India can be claimed as a credit in the NRI's home country to avoid double taxation, by filing Form 67 (in India) and local tax forms (e.g., Form 1116 in the US).
Reporting Buybacks in ITR Schedules (FY 2025-26 & FY 2026-27)
- Form Selection: You must file ITR-2 (salary, capital gains) or ITR-3 (business income). ITR-1 cannot be used.
- Deemed Dividend (Regime 2): Report the gross proceeds in Schedule OS under the head "Income from Other Sources" as "Deemed Dividend under Section 2(22)(f)".
- Capital Loss (Regime 2): Report the cost of acquisition in Schedule CG as the cost of shares, with sale consideration entered as NIL. This registers the capital loss under Section 46A.
- Capital Gains (Regime 3): Report the transaction in Schedule CG (under Section 112A for listed shares) with actual buyback price as sale consideration and actual cost as cost of acquisition.
- TDS Verification: Reconcile TDS credits in Form 26AS and AIS before filing.
Frequently Asked Questions
1. Which buyback tax regime applies to me right now?
The regime is determined by the date the buyback payment was received, not the date of announcement. Payments received between 1 October 2024 and 31 March 2026 fall under Regime 2 (deemed dividend at slab rate). Payments received from 1 April 2026 onwards fall under Regime 3 (capital gains). Payments received before 1 October 2024 fell under Regime 1 (exempt in shareholder's hands).
2. Under Regime 2, can I deduct my share cost from the buyback proceeds before paying tax?
No. Under Regime 2, the entire buyback proceeds are taxed as deemed dividend with no deduction for cost of acquisition against that income. The cost of acquisition arises separately as a capital loss under amended Section 46A. This capital loss can only be set off against other capital gains and cannot reduce the deemed dividend income from the same buyback.
3. Is the buyback capital loss from Regime 2 wasted if I have no other capital gains?
Not necessarily. The capital loss can be carried forward for up to 8 assessment years, provided the ITR for the year the loss arose was filed on time. It can be used to offset capital gains in any of those future years, subject to normal set-off rules: short-term capital loss can offset both STCG and LTCG; long-term capital loss can only offset LTCG.
4. Under Regime 3, is a promoter always taxed at 22% or 30% on buyback gains?
These are the effective rates after the additional buyback tax is applied. Non-promoter shareholders pay standard capital gains rates: 12.5% LTCG or 20% STCG on listed shares. The promoter differential applies only to those who meet the promoter definition under the SEBI Buyback Regulations (for listed companies) or the Companies Act definition or above-10% shareholder threshold (for unlisted companies).
5. Is TDS deducted on buyback proceeds?
Under Regime 2 (October 2024 to March 2026): yes, the company deducts TDS as the proceeds are treated as deemed dividend. Under Section 194, TDS at 10% applies where the total dividend paid to the shareholder during the financial year exceeds ₹10,000. Under Regime 3 (from April 2026): standard TDS rules for capital gains apply. TDS is generally not deducted by the company on capital gains payable to resident investors.
6. If I participate in a buyback under Regime 2 and also sell shares on the market in the same year, can the buyback capital loss offset my market sale capital gains?
Yes. The capital loss from the buyback (your share cost under amended Section 46A) and the capital gains from open-market sales are both in the capital gains head and can be set off against each other. Short-term capital loss from the buyback can offset both STCG and LTCG from market sales. Long-term capital loss can only offset LTCG.
7. Which ITR form should I file if I participated in a buyback?
Under Regime 2, the buyback proceeds appear as dividend income and the capital loss appears in the capital gains schedule. This combination requires ITR-2 for salaried individuals or ITR-3 if business income also exists. ITR-1 cannot be used. Under Regime 3, the buyback is purely a capital gains transaction. ITR-2 applies for salaried individuals with capital gains; ITR-3 if business income is also present.
8. What is the definition of distributed income under Section 115QA?
Under the pre-October 2024 regime, distributed income was defined as the buyback consideration paid by the company to the shareholder less the amount originally received by the company at the time of issuing those shares (the issue price).
9. How does the W-8BEN form help NRI investors in a buyback?
Submitting a W-8BEN form to the foreign broker certifies the tax residency in a country that has a DTAA treaty with the US, reducing US backup withholding tax on US company stock buybacks. For Indian buybacks, NRIs submit Form 10F and a Tax Residency Certificate to claim lower treaty rates.
10. How does the double tax avoidance agreement (DTAA) help NRI investors residing in the Singapore?
Under the India-Singapore DTAA, residents of Singapore can claim tax relief. Dividend income is taxed at a capped rate of 10% or 15% in India, and you can claim tax credit under Singapore tax rules. Submitting a TRC and Form 10F online to the Indian Income Tax Department is mandatory to claim these benefits.
11. Why was Regime 2 criticized by retail investors?
It was criticized because taxing the gross proceeds at individual slab rates (up to 39%) without allowing cost deductions created excessive tax liabilities. The corresponding capital loss on cost under Section 46A could not be set off against the dividend income, resulting in double taxation for investors without other capital gains.
12. Can I carry forward capital losses from buybacks if I file a belated return?
No. To carry forward capital losses to future years, you must file your ITR on or before the original due date under Section 139(1). If you file a belated return, the loss cannot be carried forward.
13. What is the holding period threshold for unlisted shares in a buyback under Regime 3?
For unlisted shares, the holding period to qualify for LTCG is more than 24 months. LTCG is taxed at 12.5% without indexation. STCG (held <= 24 months) is taxed at the individual's slab rate.
14. What is the surcharge rate for promoters under Regime 3?
Under the Finance Act 2026, a flat surcharge of 12% applies specifically on the additional promoter buyback tax component, regardless of the promoter's total income level.
15. What is the TDS rate on payments made to NRIs residing in the Singapore?
Under the India-Singapore DTAA, the withholding tax rate on dividends (including Regime 2 deemed dividends) is capped at 10% or 15% (typically 15% for portfolio investments). A Tax Residency Certificate (TRC), Form 10F, and an Indian PAN are mandatory to claim this benefit.