In Budget 2026, the government proposed taxing share buybacks as capital gains rather than dividend income. The move addresses a complex and widely criticised tax structure that had led to punitive outcomes for promoters and shareholders as the entire buyback proceeds, including the acquisition cost, were taxed at slab rates.
If this is implemented, employees who are not promoters will pay a 12.5% tax rate on long-term gains held for over one year.
However, with this classification from dividend income to capital gains, to prevent high-networth individual (HNI) promoters from using buybacks as a primary route to extract profits, the Budget has also proposed a higher capital gains tax rate of 30% for such promoters, said Ashish Karundia, founder of Ashish Karundia & Co.
Mayank Mohanka, founder TaxAaram India, and partner at S.M. Mohanka & Associates, explained, “In case of promoter shareholders holding more than 10% of the shares of the company doing the buyback, an additional tax over and above the 12.5% will be required to be paid, so that the effective tax liability works out to 30% in the case of non-corporate promoters and at 22% in case of corporate promoters.”
With these changes, there will essentially be three tax rates on buybacks: 12.5% for employees, 30% for individual promoters, and 22% for promoters that are domestic companies. These rates apply to long-term capital gains (LTCG) after one year of holding, while short-term gains will be taxed at income slab rates.
“The additional tax is required to be paid only by promoters’ shareholders as they have been perceived to have a distinct position and influence in corporate decision-making in relation to buy-back transactions. For non-promoter shareholders, the normal LTCG or STCG rates will apply, and no additional tax will be payable by them,” Mohanka added.
What has changed
Effective October 1, 2024, full proceeds received from a company’s buyback of equity shares are treated as a dividend and taxed at the investor’s income slab rate. This applies regardless of whether the investor made a profit, meaning the entire amount received, including the original investment or cost of acquisition, is taxed as dividend income. Since the cost of acquisition is not deductible, it’s treated as a capital loss that can be set off against other capital gains or carried forward.
But, this created uneven relief: the taxpayer paid tax on the dividend at her tax slab rates of 15%, 20%, or 30% for high-income taxpayers, whereas the tax saved by offsetting it against other capital gains is 12.5%. Besides, the set-off relief could be realised only if there were some other capital gains to utilise.
This mismatch led investors to effectively pay tax on their own capital, thereby reducing the attractiveness of buybacks as a return strategy.
Budget 2026 has addressed this by treating buyback proceeds as capital gains, significantly benefiting non-promoter employees, who will pay 12.5% tax if the shares are held for over one year (and slab rates otherwise).
Before the Finance (No. 2) Act, 2024, classified buybacks as dividend income taxable in the hands of shareholders, companies paid a buyback tax at an effective rate of 23.3%, including surcharge and cess, making such payouts tax-free for shareholders. Karundia noted that many HNI shareholders and large promoters exploited this tax arbitrage by extracting profits largely through buybacks, since the tax liability rested with the company rather than the investor. To plug this gap, the government shifted tax liability onto shareholders, but categorised buybacks as dividends.
Changing tack
This shift especially hurt non-promoter employees who were forced to pay a high tax at slab rates on the entire proceeds, including their own investment, while the benefit of offsetting capital loss was limited to 12.5%.
For example, say an employee in the 30% tax bracket bought shares of his company, ABC, for ₹2 lakh. After 3 years, ABC bought back the shares for ₹3 lakh. The employee would pay ₹90,000 tax on the ₹3 lakh buyback proceeds. Say, he has ₹3.25 lakh in capital gains from mutual funds, which he offsets against a capital loss of ₹2 lakh (the cost of acquisition of shares). He saves ₹25,000 tax (12.5% of ₹2 lakh), whereas he paid ₹60,000 tax on the ₹2 lakh cost of acquisition. Even after offsetting the capital loss, the employee pays ₹35,000 tax on his own invested capital.
As per the Budget 2026 proposals, this employee would pay just ₹12,500 in tax (12.5% on ₹1 lakh in gains).
“By replacing the deemed dividend approach with a calibrated tax on promoters, the amendment reduces opportunities for tax arbitrage while promoting greater equity for minority shareholders,” Karundia added.