Buyback of Shares: Tax Implications for Companies & Shareholders

A share buyback used to be one of the more tax-efficient ways for a company to return capital to shareholders, largely because the company absorbed the tax cost under Section 115QA and the shareholder walked away with tax-free proceeds. That changed for buybacks undertaken on or after October 1, 2024, and the shift in where the tax liability sits, and how much of it there is, is significant enough that both companies planning a buyback and shareholders participating in one need to understand the new mechanics before assuming the old numbers still apply.

What Changed on October 1, 2024

Before this date, a company undertaking a buyback paid tax under Section 115QA at an effective rate of roughly 23.3% (inclusive of applicable surcharge and cess) on the distributed income, essentially the difference between the buyback price and the amount originally received by the company for those shares. The shareholder receiving buyback proceeds paid no further tax on that amount, since it was exempt under a corresponding provision.

For buybacks from October 1, 2024 onward, Section 115QA no longer applies at the company level. Instead, a new limb was added to Section 2(22)(f) bringing the entire sum received by a shareholder on a buyback within the definition of "dividend." The practical result: the company no longer bears a buyback tax, but the shareholder now pays tax on the full proceeds as deemed dividend, at their own applicable slab rate, with no offset for the amount they originally paid for the shares at the time the dividend income is computed.

How the Shareholder Is Taxed Now

The full buyback amount received by the shareholder is treated as deemed dividend income and taxed at their applicable slab rate (or the relevant treaty rate, for non-resident shareholders), the same way ordinary dividend income is taxed after the abolition of DDT. For a shareholder in a high tax bracket, this can mean a substantially higher effective tax cost on the buyback proceeds than a flat company-level buyback tax used to produce, particularly compared to the pre-October 2024 regime where the shareholder paid nothing directly.

This mirrors the shareholder-level taxation approach already in place for ordinary dividends since DDT was abolished; see our companion guide on dividend distribution and taxation for how that works for a regular payout.

The Capital Loss Mechanic Under Section 46A

Here is the part that often gets missed: because the buyback consideration is taxed entirely as deemed dividend, what happens to the shareholder's original cost of acquiring those shares? Under the amended Section 46A, the sale consideration used to compute capital gains on the buyback is deemed to be nil. Since the shareholder receives no capital gains credit for the buyback amount (it has already been taxed as dividend), the entire cost of acquisition of the shares surrendered in the buyback effectively becomes a capital loss.

Whether this loss is short-term or long-term depends on how long the shareholder held the shares before the buyback. That capital loss can be set off against other capital gains in the same year under the normal set-off rules (long-term loss only against long-term gains; short-term loss against either), and any unabsorbed loss can be carried forward for up to 8 assessment years. For a shareholder who has other capital gains to absorb the loss against, this materially softens the higher dividend-tax hit; for one who does not, the loss may simply sit unused for years.

This interaction, dividend tax on the full amount received plus a capital loss on the amount originally invested, is the single most important planning point in the current buyback regime, and it is easy to model incorrectly without walking through both sides together.

TDS on Buyback Proceeds

Because buyback proceeds are now classified as deemed dividend, the same withholding mechanism applies as for an ordinary dividend payout. The company deducts TDS under Section 194 for resident shareholders once the prescribed annual threshold is crossed, at the standard rate applicable to dividend income, provided the shareholder has furnished a valid PAN. For non-resident shareholders, TDS is deducted under Section 195, generally at the domestic withholding rate unless a lower rate is claimed under the applicable DTAA with the required documentation (Tax Residency Certificate and Form 10F).

A Note on Section Numbering and Further Changes

What This Means for Companies Planning a Buyback

A buyback is no longer the clean tax-arbitrage tool it once was relative to a dividend; both routes now tax the shareholder directly, and the buyback route adds the capital-loss wrinkle on top. Companies should model the after-tax outcome for their actual shareholder base, factoring in each shareholder's slab rate, holding period, and whether they have other capital gains to absorb the resulting loss against, rather than defaulting to a buyback on the assumption that it remains inherently more tax-efficient than a dividend. For closely held companies weighing a buyback as part of a broader promoter exit or capital restructuring, this is worth modelling alongside our guidance on startup valuation and cap table planning.