The Income Tax Act, 1961, contains detailed provisions on how capital gains should be taxed in India. Among them, Section 46A of Income Tax Act holds special importance as it governs the tax treatment of capital gains on purchase by company of its own shares or other specified securities.
This provision was introduced to ensure that when companies buy back their own shares, shareholders are taxed fairly, and such transactions are not used as loopholes to avoid capital gains tax. Moreover, the section empowers tax authorities to keep a check on compliance and, if necessary, reopen a completed assessment where income has escaped taxation.
What is Section 46A of Income Tax Act?
Section 46A clearly states that capital gains arising from the purchase by a company of its own shares or other specified securities shall be chargeable to tax. In simple terms, if you, as a shareholder, sell your shares back to the company during a buyback, the difference between the buyback price & your acquisition cost will be treated as capital gains and taxed accordingly.
This provision also covers other specified securities notified under the law. The goal is to prevent any ambiguity about whether such transactions should be considered dividends or capital gains. Section 46A makes it clear—they fall under the capital gains head."
Capital Gains on Purchase by Company of Its Own Shares
Whenever a company goes for a buyback of shares, shareholders who participate in the buyback must recognize capital gains. The calculation works as follows:
- Sale Consideration = Buyback price received by shareholder.
- Cost of Acquisition = Price at which shareholder originally purchased the shares.
- Capital Gain = Sale Consideration – Cost of Acquisition.
The nature of capital gain (short-term or long-term) depends on how long the shares were held. If held for more than 12 months (in case of listed shares), it becomes a long-term capital gain; otherwise, it is a short-term capital gain.
Thus, Section 46A ensures that tax buybacks as capital gains are properly brought into the tax net.
Why Section 46A Was Introduced
Earlier, there was confusion on whether buyback proceeds should be treated as dividends or capital gains. Companies often preferred buybacks as a way to distribute surplus funds while minimizing tax outflow for shareholders.
To resolve this, Section 46A was inserted, clarifying that capital gains on purchase by company of its own shares or other specified securities will be taxed under the head “Capital Gains.” This eliminated misuse & created a transparent mechanism for taxing such transactions.
Also Read: Documentation for International and Domestic Transactions
How Tax Buybacks Are Treated as Capital Gains
Under Section 46A, buybacks are taxed like any other capital gains transaction. The tax rate and exemption depend on whether the gain is long-term or short-term:
- Long-Term Capital Gains (LTCG): Taxed at 10% if above ₹1 lakh (for listed equity shares).
- Short-Term Capital Gains (STCG): Taxed at 15% for listed shares if STT is paid.
- Other Cases: Normal slab rates apply.
This uniform taxation ensures clarity for both companies & shareholders. It also prevents avoidance of dividend distribution tax (DDT), which was earlier a loophole.
Empowers Tax Authorities to Reopen Completed Assessments
A unique feature connected with Section 46A is that it empowers the tax authorities to reopen a completed assessment if they believe income from buybacks has not been properly taxed.
For example, if a company conducted a buyback and shareholders did not disclose the capital gains in their returns, the Income Tax Department can revisit the case, reassess income, and impose tax along with interest and penalties.
This makes it critical for taxpayers to declare such gains correctly to avoid scrutiny later.
Computation of Capital Gains under Section 46A
The computation of capital gains on purchase by company of its own shares or other specified securities is straightforward:
- Determine the buyback consideration received.
- Deduct the original purchase price of shares.
- Adjust for brokerage or transfer charges.
- Apply the tax rate depending on whether the gain is short-term or long-term.
For instance, if you bought shares at ₹200 per share & the company buys them back at ₹450, your gain is ₹250 per share. This will be taxed as capital gains depending on the holding period.
Also Read: PPF & Income Tax: The Section That Turns Your Savings Into Tax-Free Wealth
Impact on Shareholders
For shareholders, Section 46A has several implications:
- They must report buyback proceeds as capital gains, not as dividends.
- They may face short-term or long-term capital gains tax depending on holding period.
- Non-disclosure can lead to reassessment by tax authorities.
While the taxation may increase individual liability, the transparency and certainty brought by Section 46A are beneficial in the long run.
Impact on Companies
For companies, buybacks remain an effective tool to manage capital structure, boost EPS (earnings per share), and return surplus cash to shareholders. However, they must comply with legal provisions, including SEBI regulations, Companies Act, & tax laws.
Since Section 46A shifts the tax liability to shareholders, companies no longer need to pay dividend distribution tax (which has been abolished). This makes buybacks an attractive option for corporates.
Difference Between Dividend Tax and Section 46A Taxation
A common confusion arises: why not treat buybacks as dividends? The answer lies in intent and mechanics. Dividends are profits distributed from earnings, while buybacks involve the company purchasing shares, thereby reducing capital.
Section 46A distinguishes this clearly. Instead of being taxed as dividend income, buybacks are taxed as capital gains—ensuring fairness in taxation and preventing misuse.
Judicial Interpretations of Section 46A
Courts and tribunals have repeatedly upheld the principle that capital gains on purchase by company of its own shares or other specified securities fall under Section 46A. Judicial precedents have emphasized that the nature of income must be treated as capital gains, even if companies try to classify it differently."
This judicial backing strengthens the provision & leaves little room for ambiguity.
Practical Example
Imagine a shareholder who purchased 1,000 shares of XYZ Ltd. at ₹150 each. After five years, the company announces a buyback at ₹400 per share.
- Buyback Proceeds = ₹4,00,000
- Cost of Acquisition = ₹1,50,000
- Capital Gains = ₹2,50,000
Since the holding period exceeds one year, this is long-term capital gain & taxed at 10% under Section 112A.
This shows how tax buybacks as capital gains operate in practice under Section 46A.
Also Read: The Hidden LTCG Exemption Most Investors Forget to Claim
Conclusion
Section 46A of Income Tax Act plays a vital role in regulating taxation of buybacks. It ensures that capital gains on purchase by company of its own shares or other specified securities are taxed correctly, closing loopholes that once existed. The section also empowers the tax authorities to reopen a completed assessment, ensuring compliance & fairness in the tax system.
For shareholders, understanding Section 46A is crucial to avoid future disputes with the tax department. For companies, it provides a clear framework to conduct buybacks without ambiguity.
💡 Want expert help in understanding provisions like Section 46A and how buybacks are taxed? Visit Callmyca.com to get professional guidance and simplify your compliance journey.
