Tax Implications
Tax treatment is where buybacks and secondary sales diverge significantly, especially after regulatory changes in October 2024.
Taxation on Buybacks (Post-October 2024)
Previously, companies paid a buyback tax and shareholders received proceeds tax-free. This changed with the Finance Act 2024.
Current tax structure:
- The buyback amount is treated as deemed dividend in the hands of the shareholder
- The shareholder adds this amount to their total income
- Tax is calculated at the individual’s income tax slab rate (typically 30% for high earners, plus applicable surcharge and cess)
Example calculation:
- Employee receives Rs 10 lakhs from buyback
- Tax liability: Rs 3,12,000 (including surcharge and cess)
- Net proceeds: Rs 6,88,000
Taxation on Secondary Sales
When shares are sold to another investor, the transaction is treated as a capital gain.
For unlisted shares (private limited companies):
- Long-term capital gains: If shares are held for more than 24 months, tax rate is 12.5% (as per Finance Act 2024)
- Short-term capital gains: If held for less than 24 months, taxed at slab rate
Example calculation:
- Employee sells shares worth Rs 10 lakhs to investor
- Shares held for 3 years (long-term)
- Tax liability: Rs 1,25,000
- Net proceeds: Rs 8,75,000
The difference: In this scenario, secondary sales save Rs 1,87,000 in taxes compared to buybacks, a significant impact for employees.
Legal Requirements for Buybacks Under Companies Act 2013
Buybacks are governed by Section 68 of the Companies Act, 2013. Private limited companies must comply with specific conditions:
Quantitative Limits
- MaximumBuyback Amount
Companies can buy back up to 25% of the total paid-up equity capital and free reserves combined. - Debt-Equity Ratio
After the buyback, the company’s debt-to-equity ratio must not exceed2:1. This ensures the company remains financially stable. - Source ofFunds
Buyback must be funded from:
- Free reserves (accumulated profits)
- Securities premium account
- Proceeds from issuing specific types of shares or securities
Approval Requirements
For buybacks up to 10% of capital:
- Board resolution is sufficient
- Directors must pass a resolution approving the buyback
For buybacks between 10% and 25%:
- Special resolution required
- Shareholders must approve through a vote (75% majority)
Solvency Declaration
Directors must file a declaration of solvency stating:
- The company can pay its debts as they become due for 12 months following the buyback
- This is a legal affidavit with personal liability for directors
Lock-in Period
After completing a buyback, companies typically cannot issue new equity shares for 6 months (except for ESOP issuances, which may be exempt).
What Founders Should Evaluate Before a Liquidity Event
Assess Your Financial Position
Questions to answer:
- Do we have sufficient cash reserves without compromising operations?
- What is our runway after the buyback?
- Will this affect our ability to raise future funding?
Understand Stakeholder Preferences
Consider:
- Do employees prefer immediate liquidity (buyback) or higher tax efficiency (secondary)?
- Are investors willing to buy shares from employees (enabling secondaries)?
- What percentage of the cap table needs liquidity?
Evaluate Tax Efficiency
Given the significant tax differences post-2024, secondary sales are generally more tax-efficient for employees and early investors compared to buybacks.
Plan for Regulatory Compliance
Buybacks involve multiple legal filings and documentation:
- Offer letters to shareholders
- Form SH-11 filing with Registrar of Companies
- TDS compliance and withholding tax certificates
Documentation and Legal Support for Buybacks
Executing a buyback involves complex legal documentation and regulatory filings. Errors in compliance can result in:
- Penalties from the Ministry of Corporate Affairs
- Tax notices for incorrect withholding of taxes
- Disputes with shareholders over valuation
- Personal liability for directors
Critical documents required:
- Board resolution approving buyback scheme
- Valuation report for unlisted companies
- Declaration of solvency by directors
- Offer letter to eligible shareholders
- Payment confirmations and tax deduction certificates
- Form SH-11 for ROC filing
