A buyback of shares is one of the simplest ideas in corporate finance and one of the most closely regulated. A company uses its own surplus money to purchase its own shares from its shareholders, cancels those shares, and ends up with a smaller share capital. Nothing is created and nothing is invested. Value simply moves from the company’s balance sheet into the hands of the shareholders who choose to sell.

The idea is simple. The execution is not. A buyback touches company law, securities regulation, accounting and tax at the same time, and in the last two years the tax and regulatory rules around it have changed more than once. Boards that treat a buyback as a routine treasury decision often discover late in the process that the numbers no longer work. This article explains how buybacks work today, what the law permits, how the money is taxed, and where companies most often go wrong.

Why companies buy back their own shares

The most common reason is surplus cash. A profitable, cash-rich company that cannot deploy every rupee of its reserves into growth has a choice: hold the cash, pay a dividend, or return capital through a buyback. Holding idle cash drags down return on equity. A buyback releases the money and, because the share count falls, lifts earnings per share and book value per share for those who stay invested.

Beyond cash management, buybacks are used to correct what a board believes is an undervalued share price, to tighten a capital structure that carries too much equity and too little debt, to give an exit route to early investors in an unlisted company, or to consolidate promoter control by reducing the shares held outside. In closely held businesses, a buyback is frequently the cleanest way to settle a departing shareholder or to unwind a family holding without disturbing the operating business.

A buyback is also a signal. When management commits real money to purchasing its own shares, the market reads it as confidence. That signalling value is precisely why regulators watch the mechanism closely.

The company law framework

Buybacks are governed by Sections 68, 69 and 70 of the Companies Act, 2013, together with the related rules. The framework is built around a single principle: a company may return capital to shareholders only out of genuine surplus, and never at the cost of its creditors.

A company may fund a buyback only from its free reserves, its securities premium account, or the proceeds of a fresh issue of shares — though not from the proceeds of an earlier issue of the same class of shares. Only fully paid-up shares can be bought back. If the board acts on its own authority, the buyback cannot exceed ten per cent of paid-up equity capital and free reserves. With a special resolution of shareholders, the ceiling rises to twenty-five per cent of paid-up capital and free reserves, and for equity shares the quantity bought back in a financial year cannot exceed twenty-five per cent of the total paid-up equity capital.

After the buyback, the ratio of total debt to paid-up capital and free reserves must not exceed two to one. A further buyback cannot be launched within one year of the closure of the previous one. The shares purchased must be extinguished and destroyed within seven days of completion, because company law does not permit a company to hold its own shares as treasury stock. Where the buyback is funded out of free reserves or securities premium, an amount equal to the nominal value of the cancelled shares must be transferred to a Capital Redemption Reserve, which preserves the capital base on paper even as it shrinks in substance.

Section 70 adds a set of prohibitions. A company cannot buy back through a subsidiary or an investment company, and cannot buy back at all while it is in default on deposits, debentures, preference share redemption, dividend payment or term loan repayment, unless the default has been remedied and a cooling-off period has passed. Procedurally, the company must pass the required resolution, file a declaration of solvency signed by its directors, complete the offer within the prescribed timelines, and file a return of buyback with the Registrar.

Where a proposal exceeds these statutory limits, the buyback route is closed. The alternative is a reduction of capital under Section 66, which requires tribunal approval and a longer timetable.

How listed company buybacks are executed

Listed companies must additionally comply with the SEBI (Buy-back of Securities) Regulations, 2018, which govern pricing, disclosure, timelines and shareholder protection.

The tender offer route remains the mainstay. The company announces a fixed price, usually at a premium to the market, and shareholders voluntarily tender their shares within the offer window. Entitlement is calculated on holdings as at the record date, and if the offer is oversubscribed, acceptance is proportionate. At least fifteen per cent of the offer is reserved for small shareholders, which is the main reason retail participation in tender offers is comparatively attractive.

The open market route through the stock exchange has had a turbulent history. It was progressively restricted and then discontinued altogether from April 2025, on the view that it allowed unequal participation between informed and ordinary shareholders. Following the overhaul of buyback taxation, SEBI reversed that position: amendments notified in July 2026 restored the stock exchange route with effect from 1 August 2026, subject to fresh safeguards. Open market buybacks are now permitted up to fifteen per cent of paid-up capital and free reserves, must be completed within sixty-six working days, and require at least forty per cent of the earmarked funds to be used in the first half of that period. Promoter shareholding is frozen at the ISIN level, compliance with minimum public shareholding is a precondition, shareholders must be intimated electronically, and the appointment of a merchant banker has been made discretionary, with the associated responsibilities redistributed to the company, its compliance officer and its auditors. Promoters cannot participate in an open market buyback.

The tax position: three regimes in two years

Nothing about buybacks has changed as sharply as the tax treatment, and the applicable regime is fixed by the date the consideration is received, not the date the buyback is announced.

Until 30 September 2024, the company paid a distribution tax on the amount returned and the shareholder received the money tax-free. From 1 October 2024, that was reversed: the entire buyback consideration was treated as a deemed dividend and taxed in the shareholder’s hands at slab rates, with no deduction for what the shareholder had originally paid. The acquisition cost instead became a capital loss, usable only against other capital gains. For shareholders without such gains, the outcome was harsh — tax on the gross amount received, with the cost effectively stranded.

That position has now been corrected. Under the Income-tax Act, 2025, as amended by the Finance Act, 2026, buyback consideration received on or after 1 April 2026 is taxed under the head capital gains. The shareholder pays tax on the actual gain — consideration less cost of acquisition — with long-term gains taxed at twelve and a half per cent and short-term gains at twenty per cent, plus applicable surcharge and cess. The deemed dividend treatment has been withdrawn.

One important qualification applies to promoters. To prevent buybacks from being used as a lower-taxed substitute for dividends, an additional levy applies to promoter shareholders, bringing the effective rate to roughly twenty-two per cent for corporate promoters and thirty per cent for others, without distinction between short-term and long-term holdings. Promoter-led buybacks therefore need to be modelled carefully before the resolution is passed.

Buyback or dividend?

With the tax burden now resting on shareholders in both cases, the comparison has become more even, and the decision turns on structure rather than arbitrage. A dividend is paid to everyone in proportion to holdings and is taxed at slab rates on the full amount. A buyback is voluntary, is taxed only on the gain, and changes the shareholding pattern of those who do not participate. A shareholder who wants cash can tender; one who wants a larger share of the business can stay. For companies with concentrated ownership, that flexibility is often more valuable than the tax outcome.

Where buybacks go wrong

The recurring failures are rarely conceptual. They are arithmetic and procedural. Free reserves are computed on the wrong financial statements or on stale accounts. The post-buyback debt-equity test is checked after the board has already committed to a price. Valuation of unlisted shares is not adequately documented, leaving the price open to challenge. The one-year cooling-off period is overlooked when a second tranche is planned. Filings and the Capital Redemption Reserve entry are made late. Withholding obligations on non-resident shareholders are missed, and treaty positions are not evaluated before payment.

Each of these is avoidable with proper sequencing: test the eligibility limits first, model the tax outcome for each shareholder class second, and only then fix the price and pass the resolution.

How SRC Chartered Accountants can help

At SRC Chartered Accountants, we work with promoters, boards and finance teams to take a buyback from an idea on paper to a completed, defensible transaction.

We begin with a feasibility assessment — computing free reserves from audited numbers, testing the statutory ceilings, and confirming that the post-buyback debt-equity position holds. We then model the after-tax outcome for every category of shareholder, including promoters and non-residents, so that the board approves a price it has fully understood. We advise on the choice between a buyback, a dividend and a capital reduction, and we say plainly when the buyback route is the wrong one.

From there we handle execution: share valuation and supporting documentation, board and shareholder resolutions, the declaration of solvency, the offer documentation, the accounting entries including the Capital Redemption Reserve, and all statutory filings within their timelines. For listed clients we manage the SEBI compliance calendar and coordinate with merchant bankers, registrars and auditors. For unlisted and closely held companies, we structure promoter and investor exits in a way that is clean, documented and able to withstand scrutiny.

Our work does not end at completion. We support the tax positions we advise on, including withholding, treaty relief and subsequent assessments, so that a transaction closed today does not become a question five years from now.

If you are considering a buyback, or evaluating it against other ways of returning capital, talk to us early. The decisions that determine whether a buyback works are made long before the offer opens.