The ITAT, Mumbai has held1 that the premium paid by the company on buyback of shares of a warring shareholder group is deductible as business expenditure in the hands of the company. Thus, it allowed the premium of Rs. 6.82 crores (over the face value of Rs. 8.40 lakhs) paid for buying back 34% of the shares held by such group. Though the decision is similar to a few earlier decisions on similar set, it is still noteworthy. This is because, strangely, it allows the whole of the premium paid for buyback of shares deductible as business expenditure. It is submitted that this does not consider the nature of buyback of shares, particularly its accounting and legal implications and hence requires reconsideration. At the very least, a grossly excessive amount is allowed as deduction. Nevertheless, the decision, even if diluted, would be useful in several situations that are commonly seen in case of unlisted companies and also seen recently in case of listed companies.
The essential ground for allowing deduction was that the buyback was in the interests of the company which otherwise was suffering because of internecine disputes. After the settlement/payment, the Company’s business saw a revival of fortunes in terms of significantly increased sales.
In doing this, it followed an earlier decision2 of the same Tribunal, the appeal against which was dismissed by the Bombay High Court. In this case too, it was noted that on account of the disputes between two shareholder groups, the sales had gone down and the company faced other difficulties. After the settlement and buyback of shares, the company saw increased sales and profits, new confidence by the bankers by way of fresh loans, etc.
There is another decision3 of similar ratio, though here, it is not clear whether and what part of the amount paid as settlement to shareholders was for buyback of shares.
However, when the Company buys back shares, it is generally returning the value of the shares in the form of face value as originally paid, accumulated reserves and value of assets like goodwill, etc. that is not recognized in the books. Such return can hardly be a business expenditure.
The accounting treatment under accounting principles and also under Section 77A (and related provisions) of the Companies Act, 1956, clearly supports this. The face value of shares bought back is reduced from the paid up capital and the surplus (premium) is debited to reserves such as securities premium account or other reserves (other than revaluation reserve). These provisions generally do not permit debiting the amount paid to profit and loss account for the year.
There is, however, merit in these decisions for a partial amount, to the extent the facts support them. There may be cases where shareholders may create such a nuisance value that it may seriously impact the working of the company (as what has happened in the above cited cases). The Company may end up buying back shares at a price higher than their fair value, just to get such hurdles out of the way so the Company can focus on its business. The excess may be deductible because it represents purely the amount paid on account of business expediency. But the fair value paid should, it is submitted, still not be deductible.
In the present decisions, the whole of the premium amount paid (the face value, incidentally, was very nominal) has been allowed as a deduction.
The fact that the shares constitute a very significant percentage of capital (34% in this case) should have also been a relevant factor for not allowing such deduction.
There is another way to look at this. Often, similar inter-shareholder group disputes are settled by one group buying out the other. In such a case, the amount paid would be treated as a cost of shares purchased which would be treated as a revenue expenditure. Only on eventual sale of the shares such amount would be deductible but even in such a case, only “excess”payment paid for removing nuisance would effectively be deductible. To take an example, if, say, the fair value of the shares is Rs. 100 but Rs. 120 is paid, then, assuming that the shares are sold the very next day at Rs. 100, the excess Rs. 20 (and not Rs. 120) would only be available as a deduction.
Nevertheless, these decisions would have relevance in cases of settlement of shareholder disputes. In particular, it would also be helpful in the several cases of buyout of minority/small shareholders during complete delisting since often the Company pays a higher price to get rid of small but litigative shareholders.
1. Chemosyn Ltd. v. Assistant Commissioner of Income-tax, 8(3) (OSD), Mumbai (2012) 25 taxmann.com 325 (Mum.)
2 Echjay Industries Ltd. v. Dy. CIT  88 TTJ 1089
3 USV Ltd. JCIT ((2007) 106 TTJ 535 Bom-Trib