The taxation of share buybacks underwent a significant transformation from October 1, 2024. What was once a tax paid by the company under the buyback tax regime is now largely taxable in the hands of shareholders. However, the manner in which the law was drafted has created an unusual consequence for Assessment Year (AY) 2026-27, potentially resulting in a “double tax benefit” for certain individual taxpayers, particularly those falling within the rebate threshold.
This anomaly, however, is short-lived, as the Government has already moved to change the taxation framework through the Finance Act, 2026.
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The Post-October 2024 Buyback Tax Regime
The Finance (No. 2) Act, 2024 fundamentally altered the taxation of buybacks undertaken by domestic companies from October 1, 2024.
Under the amended provisions:
- The amount received by a shareholder on buyback is treated as a deemed dividend under Section 2(22)(f).
- The shareholder is taxed on the entire buyback consideration at applicable slab rates.
- No deduction is allowed for the cost of acquisition while computing such dividend income.
- Simultaneously, for capital gains purposes, Section 46A deems the full value of consideration as “Nil”, resulting in the cost of acquisition becoming a capital loss.
This creates an unusual situation where the same transaction generates taxable dividend income and a separate capital loss.
Illustration: Infosys Buyback
Consider the following example:
- Shares tendered in buyback: 65 shares
- Buyback proceeds received: ₹1,22,400
- Cost of acquisition of shares: ₹1,10,000
Step 1: Taxation as Dividend
The entire buyback proceeds of ₹1,22,400 are treated as deemed dividend income under Section 2(22)(f). The shareholder cannot deduct the cost of shares while computing this income.
For a taxpayer whose total income remains within the rebate threshold under the applicable tax regime, the tax liability on this deemed dividend may effectively become nil.
Step 2: Capital Loss Recognition
For capital gains purposes, the law treats the consideration as nil. Consequently:
Capital Loss = Cost of Acquisition – Nil
= ₹1,10,000
Thus, the shareholder acquires a capital loss of ₹1,10,000.
Step 3: Set-Off Against Capital Gains
The capital loss can be set off against eligible capital gains in accordance with the Income-tax Act.
If the loss qualifies as a short-term capital loss and is adjusted against short-term capital gains taxable at 20%, the tax saving could be:
₹1,10,000 × 20%
= ₹22,000
Therefore:
- Dividend income may suffer no tax because of rebate/slab benefits.
- Capital loss may reduce future capital gains tax.
This effectively creates a dual tax advantage arising from a single buyback transaction.
Why Middle-Class Investors Benefit the Most
The anomaly is particularly beneficial for taxpayers whose overall income remains within the rebate limits.
For such investors:
- Buyback proceeds increase taxable income but may still remain within the rebate threshold.
- No actual tax may be payable on the deemed dividend.
- The entire acquisition cost survives as a capital loss.
- The capital loss can offset taxable gains from other equity or capital market transactions.
In practical terms, the investor receives the buyback proceeds while simultaneously preserving a tax asset in the form of a capital loss.
Legislative Intent and Criticism
The tax structure attracted criticism soon after its introduction.
Many tax professionals argued that taxing the gross buyback proceeds as dividend without allowing deduction for acquisition cost resulted in inequitable outcomes, particularly for minority shareholders. At the same time, the availability of capital loss created planning opportunities and tax arbitrage.
The Government subsequently acknowledged these concerns while presenting the Union Budget 2026.
Budget 2026 Changes the Rules
Recognizing the distortions under the 2024 framework, the Finance Act, 2026 has overhauled the taxation of buybacks.
The new regime proposes that buyback receipts be taxed directly as capital gains, allowing the shareholder to deduct the cost of acquisition while computing taxable gains. This effectively removes the peculiar situation where the same transaction simultaneously generates deemed dividend income and capital loss.
According to the Government’s explanation, the change was introduced to ensure a more rational and equitable tax treatment for shareholders and to eliminate arbitrage opportunities created by the earlier provisions.
Conclusion
For AY 2026-27, taxpayers who participated in buybacks undertaken after October 1, 2024 may encounter one of the most unusual outcomes in recent tax law history. The entire buyback consideration is taxed as deemed dividend, yet the cost of acquisition simultaneously transforms into a capital loss.
Where the taxpayer’s income remains within the rebate threshold, the dividend income may escape tax altogether, while the capital loss can still be utilized against future capital gains. The result is a rare “double benefit” that was likely unintended and has since been addressed through the Budget 2026 amendments.
For investors filing returns for AY 2026-27, careful reporting of both the deemed dividend income and the corresponding capital loss will be crucial to ensure compliance and to legitimately avail the tax benefits available under the law as it stood during the relevant period.
