[2011] 15 taxmann.

com 61 (Article)

Buy-back of shares by a subsidiary - Tax implications for holding company

GOPAL NATHANI CA

Tax implications for holding company in case of buy-back of shares by a subsidiary have been covered in this write-up. Introduction 1. The buy-back of shares was prohibited in India until October 31, 1998. Indian companies were permitted to buy back their own shares by the Companies (Amendment) Ordinance, 1998. The Ordinance inserted two new sections (77A and 77B) in the Companies Act, 1956 which laid down the provisions and restrictions on the transactions of buy-back of shares. Under the new provision, a company may buy-back its own shares or other specified securities from its free reserves, securities premium account, or the proceeds of an issue other than the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities. Further it is a settled law that extinguishment of right in the asset on account of extinguishment of the asset itself is not a transfer of the right in the asset by the Supreme Court in Vania Silk Mills (P.) Ltd. v. CIT [1991] 191 ITR 647/59 Taxman 3. In the case of a transaction of buy-back of shares, the company buys back its own securities in accordance with section 77A of the Companies Act, 1956, which requires company to extinguish and physically destroy the securities bought back within seven days of the close of the buy-back transaction. Ordinarily any such transaction would not attract any capital gains as it results in the extinguishment of the capital asset. Section 46A's insertion after section 45 in the Income tax Act, 1961, hence, became necessary to hold such transactions subject to capital gains. Further, therefore, the difference between the amount received by the shareholder on the buy-back of the shares and the cost thereof is to be considered as capital gains under section 46A of the Income-tax Act, 1961. The heading viz. 'capital gains on purchase by company of its own shares or other specified securities' is also indicating in this direction. Relevant provisions 2. Section 47 contains a basket of transactions that are not to be considered as transfer. One such transaction is a transaction between a holding and its 100 per cent subsidiary under clause (iv). More particularly section 47 reads as under: "47. Transactions not regarded as transfer.Nothing contained in section 45 shall apply to the following transfers:
(i) ** (ii) ** (iii) **

** ** **

(iv) any transfer of a capital asset by a company to its subsidiary company, if (a) the parent company or its nominees hold the whole of the share capital of the subsidiary company, and (b) the subsidiary company is an Indian company." (Unquote) The language employed in the preceding section 46 is also indicative of the fact that what is envisaged in sections 46 and 46A is the special nature of transactions that do not actually result from any transfer of capital assets per se but are deemed to be capital gains for the purpose of charge under section 45. In other words, what section 46A attempts in a limited way is to describe the transaction of buy-back of shares as one resulting from transfer of a capital asset, no matter causing extinguishment of the shares itself further; therefore specifically suggests the mode of computation of capital gains in such a case. Section 46A, therefore, only subsists in section 45, meaning thereby is that all other provisions of the Chapter IV, viz., section 47 to section 55A would find their use and application in the situation they warrant in individual case. The section inserted by the Finance Act consequent to an amendment in the Companies Act alongside the rationale as explained by the Board is as under: "46A. Capital gains on purchase by company of its own shares or other specified securities.Where a shareholder or a holder of other specified securities receives any consideration from any company for purchase of its own shares or other specified securities held by such shareholder or holder of other specified securities, then, subject to the provisions of section 48, the difference between the cost of acquisition and the value of consideration received by the shareholder or the holder of other specified securities, as the case may be, shall be deemed to be the capital gains arising to such shareholder or the holder of other specified securities, as the case may be, in the year in which such shares or other specified securities were purchased by the company. Explanation.For the purposes of this section, "specified securities" shall have the meaning assigned to it in Explanation to section 77A of the Companies Act, 1956 (1 of 1956)." The Rationale : "28. Clarification of tax issues arising out of the provision to allow buy-back of shares by the companies: 28.1 The Companies (Amendment) Ordinance, 1998 [subsequently enacted as the Companies (Amendment) Act, 1999], inserted section 77A in the Companies Act, 1956, which allows a company to purchase its own shares subject to certain conditions. The shares bought back have to be extinguished and physically destroyed and the company is precluded from making any further issue of securities within a period of 24 months from such buy-back.

28.2 The above newly introduced provisions of buy-back of shares threw up certain issues in relation to the existing provisions of the Income-tax Act. The two principal issues are whether it would give rise to deemed dividend under section 2(22) of the Income-tax Act and whether any capital gains would arise in the hands of the shareholder. The legal position on both the issues were far from clear and settled and there was apprehension that there will be unnecessary litigation unless the issues are clarified with finality. 28.3 The Act, therefore, has amended clause (22) of section 2 of the Incometax Act by inserting a new clause to provide that dividend does not include any payment made by a company on purchase of its own shares in accordance with the provisions contained in section 77A of the Companies Act, 1956. It has also inserted a new section, namely, section 46A in the Income-tax Act, to provide that any consideration received by a shareholder or a holder of other specified securities from any company on purchase of its own shares or other specified securities shall be, subject to provisions contained in section 48, deemed to be the capital gains. 28.4 This amendment will take effect from 1st day of April, 2000, and will, accordingly, apply in relation to the assessment year 2000-01 and subsequent years. [Sections 3 and 33]" The words 'shall be deemed to be capital gains' in section 46A are plain and simple as indicating charge to capital gains under section 45. Also there is only one charging section for each head of income, viz., section 15 for salaries, section 23 for house property, section 28 for business income, section 45 for capital gains and section 56 for other sources. Further use of the words 'subject to the provisions of section 48' is a pointer to the mode of computation as per the existing scheme of the provisions of section 48. Decision of Supreme Court 3. The fact that section 46A is only a section advocating the mode of computation and not charging section can be understood on the reading of the decision of the Supreme Court in CIT v. B.C. Srinivasa Setty [1981] 128 ITR 294/5 Taxman 1 wherein after examining the scheme of the I.T. Act, it held as under (pp. 299-300): "Section 45 charges the profits or gains arising from the transfer of a capital asset to income-tax. The asset must be one which falls within the contemplation of the section. It must bear that quality which brings section 45 into play. To determine whether the goodwill of a new business is such an asset, it is permissible, as we shall presently show, to refer to certain other sections of the head 'Capital gains'. Section 45 is a charging section. For the purpose of imposing the charge, Parliament has enacted detailed provisions in order to compute the profits or gains under that head. No existing principle or provision at variance with them can be applied for determining the chargeable profits and gains. All transactions encompassed by section 45 must fall under the governance of its computation provisions. A transaction to which those provisions cannot be applied must be regarded as never intended by section 45

to be, the subject of the charge. This inference flows from the general arrangement of the provisions in the I.T. Act, where under each head of income the charging provision is accompanied by a set of provisions for computing the income subject to that charge. The character of the computation provisions in each case bears a relationship to the nature of the charge. Thus, the charging section and the computation provisions together constitute an integrated code. When there is a case to which the computation provisions cannot apply at all, it is evident that such a case was not intended to fall within the charging section. Otherwise, one would be driven to conclude that while a certain income seems to fall within the charging section there is no scheme of computation for quantifying it. The legislative pattern discernible in the Act is against such a conclusion. It must be borne in mind that the legislative intent is presumed to run uniformly through the entire conspectus of the provisions pertaining to each head of income. No doubt there is a qualitative difference between the charging provision and a computation provision. And ordinarily the operation of the charging provision cannot be affected by the construction of a particular computation provision. But the question here is whether it is possible to apply the computation provision at all if a certain interpretation is pressed on the charging provision. That pertains to the fundamental integrity of the statutory scheme provided for each head." Conclusion 4. Thus, according to the Supreme Court, there is only one charging provision, viz., section 45 and other computation provisions for computing the income so that the charging section and the computation provisions together constitute an integrated code, and where there is a case to which the computation provisions cannot apply at all, such a case will not fall within the charging section. It is in the light of this position that section 46A has been inserted in the Act to define the mode of computation of capital gains in case of buy-back transactions, viz., the extent of the charge, i.e., the difference between the cost of acquisition and the value of consideration received by the shareholder. Thus, the benefit of exemption vide provisions of section 47 may be possible in respect of transactions involving buy-back of shares by the wholly owned subsidiaries so that the consideration received in such cases by the holding company would escape capital gains taxation. However, they would be subject to MAT liability on the capital gains.