What connects Narayan Murthy, Sudha Murthy and Nandan Nilekani? Well apart from all other things not participating in Infosys recent share buyback as a promoter is the common thread between them. They probably did that because the taxation landscape for share buybacks in India underwent quite a change from October 1, 2024, which fundamentally changed what was once a tax-efficient mechanism for companies to transfer money to shareholders. What used to be a win-win situation has now become a tax trap for many investors, especially those in higher income brackets.
About the author: Abhishek is part of a freefincal’s curated list of fee-only financial advisors and a fee-only India member. He can be contacted via his website, sahajmoney.com.
What changed from October 1, 2024? Before this date, share buybacks offered attractive tax treatment to investors tendering their shares in buyback. As companies paid buyback distribution tax at an effective rate of 23.3%. In turn shareholders effectively received buyback proceeds completely tax free under Section 10(34A). This made buybacks one of the most tax efficient ways for companies to transfer money to shareholders.
But now companies are no longer required to pay tax on buyback proceeds. Instead, the tax liability has shifted entirely onto shareholders as the amount received by shareholders is treated as “deemed dividend” and taxed as “Income from Other Sources” at their applicable income tax slab rate. This means that income tax rates could reach up to 30% for individuals in the highest bracket (plus 10% surcharge and 4% cess on surcharge, for an effective rate of approximately 33.88%).
Additionally, the original cost incurred while buying the original shares cannot be deducted against the buyback proceeds to reduce investors taxable income. Instead, this cost becomes a notional capital loss under Section 46A. This loss can be set off only against future capital gains and not against the dividend income from the buyback itself. Investors can carry forward this loss for up to eight years.
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How does this affect Infosys shareholders? Consider Infosys’s buyback at ₹1,800 per share. Suppose you purchased these shares at ₹100 per share. The tax impact of participating would vary significantly based on your income bracket.
High income individual (30% tax bracket) participating in buyback
- Buyback proceeds: ₹1,800 per share
- Tax liability at 30%: ₹540 per share
- Post-tax amount: ₹1,260 per share
- Notional capital loss created: ₹100 per share (your original purchase price)
Selling in the open market
If you sold the same shares at the current market price of approximately ₹1,523 per share:
- Sale proceeds: ₹1,523 per share
- Capital gain: ₹1,423 per share (₹1,523 – ₹100)
- Long-term capital gains tax at 12.5%: ₹178 per share
- Post-tax amount: ₹1,345 per share
The reality
Despite the buyback offering a ₹277 premium over the market price per share (₹1,800 vs. ₹1,523), a shareholder in the high-income bracket ends up ₹85 worse off per share after taxes by choosing the buyback route.
The situation is even more unfavourable when you factor in the future value of the capital loss. Your ₹100 per share cost basis becomes a loss you can only use to offset future capital gains taxed at 12.5% but you pay 30% tax today.
Another example
Let’s consider another example. Suppose you have shares purchased for ₹13 lakh and would receive ₹18 lakh in a buyback:
- Buyback proceeds taxed at 30%: ₹5.4 lakh in tax
- Post-tax proceeds: ₹12.6 lakh
- Capital loss created for future offset: ₹13 lakh
If instead you sold in the open market at a proportional price:
- Open market proceeds: ₹15.23 lakh (at the same price ratio)
- Capital gain: ₹2.23 lakh
- LTCG tax at 12.5%: ₹27,875
- Post-tax proceeds: ₹14.95 lakh
You lose approximately ₹2.35 lakh in after tax proceeds by choosing the buyback.
So, should you tender your shares in buyback or sell in open market?
The answer depends on your income tax bracket:
If You’re in a High Income Bracket (30% or higher)
No. The tax cost outweighs the buyback premium for most scenarios, especially if you have a long holding period. Selling in the open market and paying 12.5% long term capital gains tax is vastly more efficient than bearing dividend tax at 30% or higher. The Infosys promoters’ decision to skip the buyback reflects this mathematical reality.
If You’re in a Lower Income Bracket (Below 15%)
Possibly. The buyback effectively becomes tax-neutral or favourable, as you’d pay similar or lower tax rates on either route. A careful comparison of the specific numbers is warranted.
Conclusion
Share buybacks are no longer the tax efficient mechanism for capital returns that they once were. For investors in higher tax brackets or with long holding periods, the era of enthusiastically participating in every buyback offer has ended. Instead, tax planning now requires comparing the buyback route against selling in the open market and making a clear assessment of whether the buyback premium justifies the differential tax cost.
The days of one-size-fits-all buyback participation are over. Individual tax optimisation is now essential.