Is Share Buyback Still a Viable Exit Strategy for Startup Investors?

Share buyback has always been seen as a viable exit strategy by startup investors, alongside IPO, M&A and secondary sale. In fact, the mention of share buyback is often made in shareholder agreements as a potential exit option for the investor. However, from 1 October 2024, the tax rules for buybacks in India have changed in a big way, which directly impacts its viability as an exit route for startup investors. Let's break it down:

How Buybacks Were Taxed Earlier (Till 30th September 2024)

Under the earlier rules, a buyback was largely tax-neutral in the hands of individual investors.

Here is how it worked:

• The company paid a special “buyback tax” under section 115QA @20% on the difference between the buyback price and the issue price of the share.

• The amount received by shareholders on buyback was exempt in their hands under section 10(34A).

• Since the shareholder’s receipt was exempt, there was normally no capital gains tax when shares were tendered in a buyback.

So, from an investor’s point of view, the tax was simple – the company handled it. From the government’s point of view, however, this structure kept the tax burden at company level and created some perceived imbalances.

The New Buyback Tax Rules (From 1 October 2024)

For buybacks taking place on or after 1 October 2024, three key changes apply:

• No company-level buyback tax: Section 115QA no longer applies to these buybacks. The company does not pay buyback tax.

• Amount received is “deemed dividend”: The full consideration received by the shareholder in a buyback is treated as dividend under section 2(22)(f) and is taxable in the shareholder’s hands (as “Income from Other Sources”) at the applicable slab or treaty rate.

• Cost shows up as a capital loss: For capital gains purposes, the “consideration” for the buyback is deemed to be nil under the amended section 46A. So, the shareholder effectively books a capital loss equal to the cost of those shares.

What this means in practice:

• The shareholder pays tax on the entire amount received from the buyback (without set off of the cost of acquisition) at their applicable tax rate (or treaty rate, in case of eligible non-residents). Therefore, if the investor falls in the highest tax slab (which is quite likely for HNIs), they will end up paying 30% + applicable surcharge (10%-15%) + 4% cess on this income, which was 100% tax free earlier.

• The cost of acquisition becomes a capital loss. This loss:

  • can be set off only against other capital gains (short-term or long-term, as allowed by law), and

  • can be carried forward for up to 8 assessment years if not fully set off

• The capital loss cannot be set off against the dividend income created by the same buyback

This "split" treatment - dividend income now and capital loss later - is the core structural change.

An illustration for better understanding:

Startup Venture A is a highly profitable venture, having raised ₹150 Crores from venture capital funds and angle investors in its Series A round 5 years back. At the time of its Series A fundraise, its share price was ₹150 per share, whereas now it has a share price of ₹3000 per share, a 20x rise in 5 years. The investors are now seeking an exit from the company. The founders decide to offer an exit through a share buyback. Let's compare the tax impact of the buyback on the investors under the erstwhile rules and the amended rules:

Particulars	Before 01.10.2024	After 01.10.2024
Price per share at the time of issue	150	150
Price per share at the time of buyback	3000	3000
Taxable income per share	2850	3000
Total number of shares	1 Cr.	1 Cr.
Total taxable income	2,850 Cr.	3,000 Cr.
Taxable in the hands of	Company	Investor
Tax rate	20% + 12% surcharge + 4% cess	30% + 15% surcharge + 4% cess
Tax impact	664 Cr.	1,076 Cr. (capital loss of 150 Cr. can be set off with long term capital gains income)

Therefore, under the new buyback rules, the investors end up paying all the tax, which is about 1.6x of the overall tax impact applicable earlier.

Now let us compare the tax impact on the share buyback route with a share transfer route (which may happen under an M&A transaction or a secondary transfer to a new investor or to the founders):

Particulars	Share Buyback (after 01.10.2024)	Share transfer
Price per share at the time of issue	150	150
Price per share at the time of exit	3000	3000
Taxable income per share	2850	3000
Total number of shares	1 Cr.	1 Cr.
Total taxable income	2,850 Cr.	3,000 Cr.
Taxable in the hands of	Investor	Investor
Nature of income	Long term capital gains	Other income (as buyback is considered as deemed dividend)
Tax rate	12.5% + 15% surcharge + 4% cess	30% + 15% surcharge + 4% cess
Tax impact	426 Cr.	1,076 Cr. (capital loss of 150 Cr. can be set off with long term capital gains income)

Therefore, by exiting through the buyback route, the investor ends up paying about 2.5x of the tax that she would've otherwise paid under the secondary sale or M&A exit routes.

Conclusion

The new share buyback rule has significantly changed how buybacks are taxed in India, shifting the tax burden entirely to investors. Before the change in tax rates applicable on long term capital gains from unlisted shares on 23.07.24, the tax impact on share buybacks was quite comparable with the tax impact on secondary sales, the only two difference being - one, indexation benefit was additionally available in case of secondary sales, and two, who pays the tax (the company in case of buyback and the investor in case of secondary sale). However, post the new amendment, buybacks have become far more expensive, virtually rendering it unfeasible for startup investors as an exit route. In case of individual investors especially, who may not otherwise have long term capital gains to be set off with the long-term capital loss arising from the buyback, may end up with a significant cash outlay in the year of exit.

This leads us to question:

1. What would be the tax impact under the new buyback rule if the investor is an NRI?

2. How can startup ventures which have built up huge surplus reserves structure an exit transaction with investors, if M&A or secondary sale to a new investor are not preferred?

You can reach out to us here, to have your questions answered.

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Disclaimer: The material herein is provided for informational purposes only. The information should not be viewed as professional, legal or other advice. Professional advice should be sought prior to actions on any of the information contained herein. CKA is not responsible for any matter concluded by any person based on the contents of this article.