Of late, many Indian companies have chosen to reward shareholders either through dividend or buyback. The tax treatment of dividend income as well as capital gains on tendering shares in a buyback offer has undergone significant changes in the last two Union Budgets.
Here’s a low-down on the tax implication of buyback and dividend in the hands of investors.
Buyback is tax exempt
A buyback offer essentially is a scheme by which a company repurchases a certain amount of its outstanding shares.
If you tender your listed shares in a buyback offer that is announced — either through the tender offer route or via open market purchases — on or after August 1, 2019, then the capital gains on sale of shares are exempt from tax in your hands.
The Union Budget 2019 shifted the tax burden on buybacks from taxpayers to companies, which are liable to pay buyback tax at the rate of 20 per cent on the difference between the issue price and the buyback price of the share.
Meanwhile, capital gains accounted in the buyback offer of unlisted companies have already been tax exempt for investors since 2013, when the Finance Act introduced buyback tax on unlisted companies.
Since the capital gain from buyback is an exempt income, any loss incurred from buyback is also not available for set-off/carry-forward purposes. For instance, earlier when capital gains from sale of equity shares were fully exempt from tax, any loss from the same could not be set off. Usually, the set-off feature is useful as it reduces the overall tax outgo.
Generally, under the Income-tax Act, a short-term capital loss can be set off against both short-term and long-term capital gain; and the long-term capital loss can be set off only against long-term capital gain. And any unabsorbed capital losses can be carried forward to eight assessment years, including the assessment year in which the loss was incurred.
In such situations (of incurring losses in the buyback process), one can consider selling shares in the open market instead (if the market price is almost close to the buyback price) to enjoy the benefit of set-off/carry-forward, which are not available in the case of buyback.
Note that since there is no tax implication on buyback in the hands of the shareholder, TDS (tax deducted at source) does not come into picture in respect of companies distributing the buyback proceeds to shareholders.
Dividend — taxable at slab rates
Until March 31, 2020, companies distributing dividends were liable to pay dividend distribution tax at an effective rate of 20.56 per cent to the government from their surplus. And the dividend income in the hands of shareholders was exempt. The only exception was in the case where a resident individual received dividend income from a domestic company/companies of over ₹10 lakh. Here, the excess dividend income was liable to tax at a special rate of 10 per cent. When mutual funds paid dividend, tax at the rate of 10 per cent and 25 per cent on equity and non-equity schemes, respectively, had to be paid by the fund houses and the balance was distributed to investors.
But Budget 2020 abolished the dividend distribution tax on dividends announced by corporates and mutual funds.
Effective April 1, 2020, the dividend distributed by a company (domestic or foreign), or a mutual fund, is taxable in the hands of the investor. Dividend receipts must be disclosed as income and taxes have to be paid as per the taxpayers’ applicable slab rates, both under the old or the new tax regime.
Thank the taxman for some mercy . A deduction is allowed for interest expense incurred on money borrowed to invest in shares or mutual funds paying the dividend. However, the deduction should not exceed 20 per cent of the dividend income received.
The Budget 2020 also imposes TDS on dividend income distribution by companies or mutual funds. If the dividend amount exceeds ₹5,000 annually per resident investor, a TDS of 10 per cent has to be deducted from the dividend proceeds before crediting it to the investor. In order to provide some relief to the tax payers amid Covid-19, the government lowered the TDS rate on dividends to 7.5 per cent for FY 20-21 alone, that is, for dividends paid till March 31, 2021. Note that if the PAN (Permanent Account Number) is not updated or erroneously registered with the depository/ registrar and transfer agent/mutual fund, the applicable TDS rate would be 20 per cent.
Meanwhile, if the resident individual’s estimated annual income is below the exemption limit of tax, she/he can submit form 15G/15H to the company or mutual fund so that no TDS is deducted on paying the dividend.