Budget 2024-25 necessitates a re-look at exit strategies

The Union Budget 2024-25 reflects the Finance Minister, Nirmala Sitharaman’s unwavering resolve to simplify the taxation regime and provide tax certainty to taxpayers.

While the FM has announced a comprehensive review of the Income-tax Act, 1961, in the future, the Budget has already taken a few steps towards simplification of the tax regime. The abolition of the buyback tax and overhaul of the capital gains tax regime are among the most significant changes proposed in the Budget.

While the proposed simplification of such regimes aims to reduce tax litigation and thereby facilitate ease of doing business, these amendments are also likely to impact the tax cost of businesses, especially the promoters, who had structured their investments in accordance with the extant tax regimes. Thus, it may be pertinent to evaluate the impact of some of these proposals on Indian promoters, especially vis-à-vis their exit strategy.

Exit through the sale of shares to get costlier

The most common and obvious mode of exit/dilution for a promoter is through sale of shares, whether through a share purchase agreement, Offer-For-Sale (“OFS”), or other channels. However, with the Budget overhauling the capital gains tax regime, these amendments are likely to increase tax costs for promoters looking to exit listed entities or seeking to transfer shares under an OFS, as the long-term capital gains tax rate for such promoters would increase from 10 per cent to 12.5 per cent. Further, a resident promoter will no longer have the option to pay long-term capital gains tax at the rate of 20 per cent, after claiming indexation benefit on gains arising from sale of listed securities.

However, long-term capital gains tax on the sale of unlisted shares is proposed to be reduced to 12.5 per cent as compared to the prevailing rate of 20 per cent. A comparative analysis of the capital gains tax implications arising from some of the scenarios has been summarised below:

Buyback is no longer a lucrative option

Buyback tax was introduced in 2013 to align the tax treatment of share buybacks with the then-existing dividend taxation regime (i.e., shift the tax incidence to the company) and prevent shareholders from avoiding capital gains tax liability arising on account of buyback by claiming various exemptions.

However, with the abolition of the erstwhile dividend distribution tax and the sun-setting of various capital gains tax exemptions, the Budget now proposes to shift the tax incidence back onto the shareholders in the event of a buyback. Under the proposed regime, buyback proceeds will now be taxed as dividends in the hands of shareholders. This means that such proceeds will now be taxed at rates as high as 35.88 per cent^[1] (in the case of resident shareholders), as against the rate of 23.296 per cent^[2] payable by the company under the buyback tax regime. This change significantly impacts Indian promoters since companies have historically leveraged buybacks as a tax-efficient method for returning value to them.

To illustrate the impact of this proposed change, consider the following example:

Buyback tax is typically computed based on the difference between the consideration received on account of buyback and the issue price of the shares (i.e., the amount the company received when the shares were issued). Even if a shareholder acquired the shares at a price higher than the issue price (say, through a secondary transaction), the buyback tax is computed based on the issue price of the shares. This means no adjustment or deduction will be made for the secondary shareholder’s cost of acquisition. That said, the proposed regime allows shareholders to treat the entire cost of acquisition of the shares being bought back, as a capital loss, which can be claimed against any future capital gains.

Conclusion 

This article highlights only a couple of significant changes proposed in the Budget that may be relevant for an Indian promoter. The Budget also announced several other proposals regarding long-standing tax regimes, like angel tax and rationalisation of withholding tax provisions. Hence, it is advisable that Indian promoters carefully re-evaluate their investments and exit strategies in light of such proposals.

Additionally, the FM’s Budget speech suggested that more such amendments can be expected in the future. Therefore, as the landscape evolves, Indian promoters must stay informed, vigilant and adaptable to navigate any challenges posed by these future proposals effectively. Staying updated and preparing for evolving regulations will be crucial for deploying effective business strategies.

^[1] Inclusive of applicable surcharge and cess.

^[2] Inclusive of applicable surcharge and cess.

The author is Co-Chair, FICCI Young Leaders Forum