A version of this article was published by Business World on February 03 2026. Please click here to read the article.
In the good old days, we were all told by our parents and teachers that continuous learning is the most important element for our success. With the advent of technological developments, this belief underwent a change - unlearn and relearn (reskill).
Over the years, the Union Budget has become a much-awaited event that throws light on the thinking of the government. The Union Budget 2025, presented by the finance minister, Nirmala Sitaraman, presents us one such opportunity to unlearn and relearn.
Like every year, the finance minister proposed various tax changes. Some of them are for providing clarity, while some of them provide tax incentives. However, there is one change which appears to be in the nature of course correction, i.e., taxation of buy-back of shares.
Historically and more specifically, pre-2013, the buy-back of shares was treated as a transfer and gains thereon were taxed as capital gains. However, in 2013, this classical style of taxation was modified significantly through the introduction of a Buy-back distribution tax. Buy-back distribution tax was akin to dividend distribution tax, whereby the Indian companies undertaking buyback were subject to paying buy-back tax on the distributed income/reserves. This levy was troubled with various shortcomings, such as the tax was levied on the company, irrespective of gains in the hands of shareholders; foreign shareholders were not able to get credit for the taxes paid by the Indian companies in their home country, etc. Having said that, this also resulted in tax savings, more specifically for the Indian promoters. This was evident by more and more Indian companies adopting buy-backs as a means to distribute profits to their shareholders rather than declaring dividends. There was a clear tax arbitrage that was available and utilised.
This arbitrage was noticed by the tax regulators, and that gave birth to a unique method of taxing buy-back. In 2024, the buy-back distribution tax was abolished and replaced with taxation of buy-back as a dividend. In effect, buy-back proceeds were entirely taxed as dividends and at the slab rate applicable to the recipient shareholder. At the same time, the legislators acknowledged the fact that the shares bought back got extinguished and hence provided that the cost of shares shall be allowed as a loss by deeming the sale consideration of buy-back as nil for computation of capital gains. In a way, this meant that gross buy-back proceeds were taxed as dividends, while the cost of the share was allowed as a capital loss to be carried forward.
This amendment certainly reduced the attractiveness of buy-back since the domestic shareholders were taxed as per the slab rate, and many of them at the highest rate of 30 per cent (plus applicable surcharge and cess). From a non-resident shareholder's perspective, while this scheme meant availability of credit for taxes paid in India on dividends, in their home country, but it also posed some difficulty in determining the character of income as dividends or capital gains under the tax treaties. In some cases, for instance, unitholders of InvIT or REIT, buy-back proceeds were exempt if the underlying SPVs were in the old tax regime, while they were able to claim capital loss.
The finance minister, through the Budget 2026, proposes to go back to the classical form of taxing buy-back, i.e., capital gains. The stated objective behind this proposal is to rationalise the taxation. However, the proposal also entails differentiation in the rate applicable to promoters vs non-promoters. While the non-promoters are proposed to be taxed at the rates prescribed for taxing capital gains on shares, for promoters, an additional tax rate is proposed to be levied. The table below captures the effective tax rates (without surcharge and cess) under different scenarios:
