Buy-Back Taxation clarified: Why own shares cannot be treated as property?

Background of the Case

In a recent ruling, the Delhi High Court (hereinafter referred to as the “Court”) in the case of Globe Capital Market Ltd¹ (“the Company” or “the assessee”) examined the taxability of buy-back by a company of its own shares under Section 56(2)(x) of the Income-tax Act, 1961 (“the Act”). The dispute before the Court was whether such a buy-back, undertaken at a price lower than the fair market value, could be regarded as an “acquisition of property” so as to attract taxation under Section 56(2)(x) of the Act.

Facts of the Case

• The assessee company is engaged in the business of share broking and clearing of trades.
• In the year 2018-19, the Company bought back 28,62,500 equity shares at INR 313.40 per share, amounting to approximately INR 89.71 crores. The Company also discharged buy-back distribution tax of approximately INR 20.69 crores under Section 115QA of the Act.
• During assessment proceedings under Section 153A, the Assessing Officer (“AO”) determined the fair market value (“FMV”) of each share at INR 370.46 as per Rule 11UA, against the buy-back price of INR 313.40 per share, resulting in a shortfall of INR 57.06 per share.
• The AO invoked Section 56(2)(x) of the Act, treating the buy-back as an acquisition of property (shares being capital assets), and added the aggregate shortfall of approximately INR 16.33 crores to the income of the Company.
• CIT(A) allowed the Company’s appeal holding that a buy-back of own shares constitutes reduction of share capital and not purchase of a capital asset and accordingly deleted the addition.
• The Tribunal dismissed the Department’s further appeal, affirming the CIT(A)’s order. Aggrieved, the Revenue preferred an appeal before the Delhi High Court.

Key Issues

1. Whether the provisions of Section 56(2)(x) of the Act read with Rule 11UA are attracted to a transaction involving a company’s buy-back of its own shares at a price lower than the fair market value.
2. Whether a buy-back of own shares constitutes acquisition of “property” within the meaning of the Explanation to Section 56(2)(x) of the Act.
3. Whether a buy-back under Section 68 of the Companies Act, 2013 constitutes reduction of share capital or acquisition of a capital asset, having regard to the mandatory obligation to extinguish and destroy bought-back shares under Section 68(7) of the Companies Act.

Key Takeaways

1. Applicability of Section 56(2)(x) to a Company’s Buy-back of its Own Shares

• The Court held that Section 56(2)(x) of the Act is not attracted to a buy-back by a company of its own shares, as it contemplates a transaction where a person “receives” property from another; a company cannot, in law, acquire its own shares as property.
• The Revenue argued that the definition of “property” under Section 56(2)(x) includes “shares and securities” without distinguishing between own shares and those of another company, and that the deeming fiction must apply.
• The Court acknowledged that this textual argument appears attractive at first blush. However, when tested against the framework of the Companies Act, common prudence, and the Income-tax Act as a whole, the argument does not withstand scrutiny. The provision is aimed at preventing under-valued transfers of property as a mechanism to generate undisclosed income, an object entirely absent in a statutory buy-back compliant with all regulatory requirements.

2. Whether Buy-back of Own Shares Constitutes Acquisition of “Property”

• The Court noted that although the Explanation to Section 56(2)(x) includes “shares and securities” within the definition of “property”, this definition must be read in the context of the charging provision itself, which requires that the assessee “receives” property.
• For the issuing company, its own shares are not assets but instruments evidencing the capital contribution of its members; they do not constitute property in the hands of the issuer.
• The inclusion of shares in the definition of “property” applies to third-party transactions, i.e., where an entity acquires shares issued by another company at below fair market value. Extending the definition to a company’s own shares upon buy-back would require a strained and impermissible reading of the provision.

3. Buy-back as Capital Reduction under Section 68 of the Companies Act, 2013

• The Court held that buy-back of shares is fundamentally an act of capital reduction, permissible only through the statutory route of Section 68 of the Companies Act, 2013.
• A company has no power to purchase its own shares except under Section 68 of the Companies Act, 2013. Hence, such a transaction is otherwise alien to the concept of corporate identity and impermissible under company law.
• Section 68(7) of the Companies Act mandates that the company extinguish and physically destroy the bought-back shares within seven days of the completion of the buy-back. This statutory obligation conclusively negates the possibility of the company holding or retaining any property post buy-back, rendering the premise of an asset acquisition factually and legally untenable.
• The Court held that a person cannot be taxed on deemed profit from property that vanishes as a direct legal consequence of the very transaction under scrutiny and that buy-back of its own shares is antithetical to buying an asset.

Conclusion

The Court dismissed the department’s appeal in its entirety and affirmed the concurrent findings of the CIT(A) and the Tribunal. The Court held that the AO’s characterisation of the buy-back of own shares as a transaction leading to generation of profit or deemed profit under Section 56(2)(x) of the Act is legally flawed and untenable.

The judgment reaffirms that a company’s buy-back of its own shares conducted in compliance with Section 68 of the Companies Act is a reduction of share capital and not an acquisition of a capital asset. The mandatory extinguishment of shares post buy-back ensures that no “property” survives to attract the deeming provisions of Section 56(2)(x).

The court’s reasoning harmonises the income-tax provisions with the corporate law framework, ensuring that a legitimately structured and tax-compliant transaction does not attract penal or unintended tax consequences.

Kretha Comments

The Delhi High Court’s ruling in Globe Capital is a welcome and principled decision that brings much-needed clarity to the taxation of buy-back transactions from the perspective of the buying company. The judgment decisively rejects the mechanical textual approach adopted by the Revenue and instead opts for a purposive and harmonious interpretation that looks at the economic and legal reality of a buy-back.

1. TS-529-HC-2026(DEL) ↩︎