Buy-Back of Own Shares Does Not Constitute Acquisition of Property by the Company under Anti-Abuse provisions of Section 56(2)(x) of the Income Tax Act

The Hon’ble Delhi High Court, in an appeal preferred by the Revenue against the orders of the Commissioner of Income Tax (Appeals) (‘CIT(A)’) and the Income Tax Appellate Tribunal (‘Tribunal’), examined the interesting question of whether a company’s buy-back of its own shares at a price lower than the fair market value (‘FMV’) constitutes an acquisition of “property” attracting the provisions of Section 56(2)(x) of the ITA. The respondent-assessee, Globe Capital Market Ltd., engaged in the business of share broking and clearing of trades, had during bought back 28,62,500 equity shares and had duly paid tax on distributed income under Section 115QA of the ITA.

During assessment proceedings under Section 153A/143(3), the Assessing Officer noted that the FMV per share as per Rule 11UA of the Income Tax Rules, 1962 was higher than the buy-back price and treated the difference as deemed income under Section 56(2)(x) since the buy-back constituted an acquisition of property at a price below FMV.

The CIT(A) allowed the assessee’s appeal, holding that the transaction was not a purchase of shares simpliciter but a buy-back of its own shares amounting to reduction of share capital, and therefore the provisions of Section 56(2)(x) read with Rule 11UA were not applicable. The Tribunal affirmed this order, and the Revenue appealed before the High Court.

Before the High Court, the Revenue contended that the definition of “property” under Section 56(2)(x) does not create any distinction between shares of the assessee company itself and shares of any other company. The Revenue argued that since the shares purchased at a rate lower than FMV constitute “property” as defined, the provisions of Section 56(2)(x) should apply, and the deeming fiction therein was rightly invoked by the AO. The Revenue also submitted that the scope of Section 56(2)(x) is wider than the previously applicable Section 56(2)(viia) and pointed to the explanatory notes to the Finance Bill, 2017 to emphasize the legislative intent of widening the scope of income from other sources.

The Court observed that the buying of own shares is otherwise alien to the concept of a corporate entity and the provisions of the Companies Act. The Court emphasized that buy-back of shares essentially means reduction of capital of the company, which is otherwise impermissible unless recourse to Section 68 of the Companies Act is taken. Crucially, the Court noted that sub-section (vii) of Section 68 mandates that after completion of the buy-back, the company shall extinguish and physically destroy the shares so bought back. The Court further held that a person cannot be taxed for so-called deemed profit from property which accrues to it consequent to the destruction of the very same property. The Court observed that “buy-back of its own shares is antithesis to buying an asset” since once the shares are bought back, the purported property extinguishes or vanishes, and hence, the very hypothesis that the respondent-company had acquired an asset at a rate lesser than FMV had no legs to stand on.

Conclusion:

This decision of the Delhi High Court is significant for companies contemplating or undertaking buy-back of shares and for stakeholders in such companies. By holding that a buy-back of own shares under Section 68 of the Companies Act results in extinguishment and destruction of shares, and therefore cannot constitute acquisition of “property” under Section 56(2)(x), the ruling reinforces that the deeming provisions of Section 56(2)(x) must be read in consonance with the Companies Act framework governing buy-backs, and that a company cannot be said to derive deemed income from property that ceases to exist upon completion of the buy-back.