In this new era of New India where the Laws of the country are being moulded and stretched in a completely judicious and well thought out manner, Individuals and Corporate are diligently taking in their stride this revolutionary process, although with some pain usually associated with such a transformation. However, introduction of new/add on taxes like GST on the Indirect Tax front and TDS on rent by all, additional surcharge of 10% on income above Rs.50 lakhs of every individual etc. on Direct Tax front in the recent Budgets have been taken positively by all. One such insertion of new form of tax by Finance Act, 2016 is section 115BBDA that provides “Tax on Dividend” in the hands of recipient being Individual, HUF and Firm if such dividend exceeds Rs.10 lakhs. Further, the scope of this tax on dividend has been widened by the Honorable Finance Minister in his Budget 2017-18 by extending such tax to all resident assessees except domestic company and certain funds, trusts, institutions, etc. For years companies have preferred to pay dividend to their shareholders particularly promoters due to the fact that it rendered tax free income in the hands of recipients including promoters, and companies end up paying just 15% (plus surcharge and cess) dividend distribution tax. Hence, the profits of the companies were reaped by promoters by paying just 15% tax (plus surcharge and cess). Now this new section 115BBDA increases the impact of tax from 15% to 25% (plus surcharge and cess) (15% in the form of DDT and 10% if dividend in excess of Rs.10 lakhs). This article is based on such facts and reasons that makes the “Buyback Option” the most trending and cost effective tool for companies in the recent times to allow funds to flow to its shareholders. Read on…
Tax Impact of Buy back on Listed and Other Companies
Not ignoring the fact that in the listed companies (both in BSE and NSE), promoters hold up to 75% of the shareholding of the company; the tax impact would be hugely affecting the promoters of such companies. Promoters of these companies are majorly interested in withdrawing surplus cash available with the company by avoiding the tax impact.
Under the Income-tax Act, 1961, section 115QA provides for taxing of buyback of shares from the shareholders by the companies (other than listed companies) at the rate of 20% (plus surcharge and cess) in the hands of the Company. The aforesaid section 115QA was inserted with effect from 1st June, 2013. Hence, those companies listed on recognised stock exchanges are exempted from paying tax on buyback of shares. Further, long term capital gain to such shareholders of listed companies, who receive money under such buyback through stock exchange where security transaction tax is paid, is exempt under section 10(38) of the Income-tax Act, 1961. In a nut shell, if a company listed on recognised stock exchange buybacks its shares through stock exchange (STT paid), then neither the company nor the shareholders (primarily promoters of such company) are liable to pay any form of taxes under such buyback. Also, such amount received on buyback is excluded from the purview of definition of Dividend under section 2(22)(iv) of the Income-tax Act, 1961, if such buyback is done in accordance with section 68 of the Companies Act, 2013. Further, in today’s stringent tax regime, buy back of shares is the best option for promoters holding majority of shares in the company, to withdraw ideal funds from their company without payment of tax which is now not the case with dividend distribution. Since with effect from 13th April, 2015 Security and Exchange Board of India vide its Circular No. CIR/CFD/ POLICYCELL/1/2015 allows promoters to tender their shares in the buy back through the stock exchange mechanism where security transaction tax (STT) will be paid on such shares bought back. However, if the shares are held for a period less than twelve months, in which the promoters are hardly to fall under, then in such case there will be short term capital gain in the hands of the shareholder which will be taxed under section 111A of the Income-tax Act, 1961 at the rate of 15%. On the other hand, if such listed company prefers to pay dividend to its shareholders, majorly as promoters holding substantial shares wanting to withdraw profits from the company, than in such case, with effect from 1st April, 2017, if the shareholders being individual, HUF or a firm, resident in India, receives such dividend in excess of Rs.10 lakhs are liable to pay tax at the rate of 11.33% (including cess and surcharge on income up to Rs. 1 crore) on such total amount of dividend received. Such tax under section 115BBDA would be in addition to dividend distribution tax payable by such listed company at the rate of 17.30% (including cess and surcharge on income up to ` 1 crore) in current scenario. Hence, there is double taxation on such part of dividend income and total tax borne would be 28.63% as against zero tax under buyback option. Stretching the domain of the said section 115BBDA, with effect from 1st April, 2018, honorable Finance Minister in his budget for the year 2017-18 amended the above section 115BBDA, by including in its ambit all specified assessees except domestic company, fund, institution or trust. Hence, making buyback of shares more attractive tool for listed entities.
If an unlisted public company or a private company prefers to do buy back, then in such case the company will have to pay tax at the rate of 23.072% (including surcharge and cess) under section 115QA of the Income Tax Act, 1961, whereas capital gain arising to shareholders of such company would be exempt under section 10(34A) of the Income Tax Act, 1961. Hence, again buy back of shares is more tax efficient even for unlisted companies than dividend distribution as the same results in tax under section 115-O at the rate of 28.63%.
Whistle Blower Points
• As per the recent amendment under Section 10(38) of the Income-tax Act, 1961 where the third proviso was inserted after the second proviso to clause (38) of section 10 by the Finance Act, 2017, w.e.f. 1-4-2018, certain transactions related to sale of equity shares through stock exchange (STT Paid) shall be taxable if they are acquired on or after 1st October, 2004 without the payment of STT. Hence, an investor tendering his/her shares in the buy back offer has to have an insight in the list of transactions notified by the Central Board of Direct Taxes under Notification S.O. 1789 (E) dated 5th June, 2017 which renders the transfer of shares taxable even though STT is paid on its sale. Further, the said notification seems to make it a little confusing for anyone to have a clear understanding although it is a very good attempt by our government to curb money laundering activities in shell companies.
• If the company (listed or not) has another company as its shareholder, then in such a case the shareholder company will end up paying Minimum Alternate Tax (MAT) on amount received on buy back under section 115JB of the Income Tax Act, 1961 at the rate of 20.38885% (including cess and surcharge with book profits up to `10 crore.
• Further, where unlisted company in which public are not substantially interested, opts to buy back its shares, such company cannot buy back at a price lower than it fair market value under section 56(2)(viia) of the Income-tax Act, 1961. Such fair market value to be calculated in terms of Rule 11UA of Income Tax Rules.
To conclude regarding the tax impact, we can say that buyback is very much a tax efficient way to distribute profits of the company as compared to other alternatives like dividend distribution mechanism in today’s law changing scenario.
Financial Impact of Buy back on Companies Performance Ratios
Buyback of shares is not only tax efficient but it also entails some financial benefits by improving the company’s financial ratios.
Buyback of shares leads to reduction in number of shares outstanding during the year which will have a favourable impact on the Earning Per Share (EPS) and Book Value (BV) of the company. This will also improve Return on Equity of the Company.
In case of listed company where the secondary market is sluggish and the market price of the shares is underperforming, resorting to buyback of shares helps the company to increase its market price of its shares thereby increasing its market capitalisation. Further, buyback of shares results in lower Price/Earnings ratio (P/E ratio) which the investors consider favourable while investing in shares of such companies, which again will lead to increase in market price of the company’s shares.
Buyback is the most cost effective way for any company that desires to reduce its surplus unwanted share capital by resorting to section 68 of the Companies Act, 2013 thereby not requiring it to follow tedious, time consuming and costly procedure of Reduction of Share Capital under section 66 of the Companies Act, 2013 which involves getting approval from National Company Law Tribunal (NCLT).
How Small Shareholders/ Investors Can Benefit From Buyback Offers of Listed Companies?
Before unwinding the strategic benefits that a small investor can bag in through the buyback offer by a Listed Company, it is important to know the statutory definition of “Small Shareholders” as specified under Regulation 2(1)(la) of the SEBI (Buyback of Securities) Regulations, 1998. It states that,
“Small Shareholders means a shareholder of a listed company who holds shares or other specified securities whose market value, on the basis of closing price per share or other specified securities on the recognized stock exchange in which highest trading volume in respect of such security as on record date is not more than two lakhs rupees."
Hence, from the above definition it is clear that many retail investors having investment in shares up to market value of ` 2,00,000/- of the listed company making buyback offer, shall fall under the definition of “Small Investors”.
Now the next question is, “What is the significance of the above definition?” As per Regulation 6 of SEBI (Buyback of Securities) Regulation, 1998 it is mandatory of the Company making buy back offer to reserve at least 15% of the total buy back offer of shares for small shareholders. Hence, company is obliged to buy back at least 15% of the total buy back offer of shares from small investors for whom there is a guaranteed returns in such an offer. Now let’s understand this whole gainful mechanism in a practical scenario.
Company making buyback offer tends to make an offer at a price that is relatively higher than the current market price in the secondary market since their intentions are to bring up the current market price of the shares through such offer. Further, big net worth companies make huge buy back offers in lieu of dividend to shareholders. In such scenario one can estimate the assured average buy back of shares (acceptance ratio) from small shareholders through distribution schedule provided by the company in its latest annual report under “Corporate Governance” section. Since the buyback price is higher than the price as on the current date and the record date is set as a future date of public announcement made by the company, one can buy the shares from the secondary market at the lower price up to the market value of ` 2,00,000/- before the record date and can assure to get his/her shares buy backed by the company at the higher offer price, thus resulting in handsome gain in a short period of time. Let’s understand this with an example. Hence, an investor shall keep following two important factors in mind in case of buy back before tendering his/her shares in the offer:
1. Buy Back Price
2. Acceptance Ratio
This can be further better understood with the help of an example given below.
Example: X Limited, a company listed in a recognised stock exchange, makes a Buyback offer of 10 crore shares to its investors at a price of ` 1000/- on a record date, which is trading at a current market price of ` 833/-. Out of this 1.50 crore are reserved for small shareholders, i.e., 15% of 10 crore. Hence, the investors have an opportunity to cash in up to 20% profits if they buy the shares of X Limited at current market price. Also, buy back disclosures are considered as a material event under listing agreement by Security and Exchange Board of India and hence their disclosures are made by the listed company much before the announcement of the record date, allowing the investors to enter the market by purchasing the shares at lower price so as to tender them at higher buy back price offered by the company.
Now, let us have a look in the following example of the Distribution Schedule of shareholding pattern in case of X Limited as provided by the company in its latest Annual Report:
As we can see from the above, the number of shareholders holding up to 200 shares in the company is around 6.27 lakhs holding around 2.87 crore shares. Hence, at a buyback offer of ` 1,000/-, these shareholder shall become eligible to tender their shares and get the benefit of 15% reservation for buy back of shares that X Limited is required to reserve for small shareholder. However, depending on the market price these numbers can further go up, due to other investors entering to secure the benefit of buyback.
Now, the acceptance ratio in this buy back offer comes to around 52%, since if all the small shareholders tender their 2.87 crore of shares in the buyback offer, company is bound to buyback 1.50 crore shares reserved as required under Regulation 6 of SEBI (Buyback of Securities) Regulation, 1998. That is if a shareholder tenders his 200 shares in the buy back, his 104 shares shall be accepted by X Limited that will fetch him around 20% return on 104 shares tendered if the cost of buying such shares is ` 833/- per share
However, for a small shareholder the cost of holding balance 96 shares can get higher since post buy back the current market price of the shares tend a fall. But since the investor has already received ` 1,04,000/- for tendering 104 shares in the buy back out of ` 1,66,600/- cost for buying 200 shares at the rate of ` 833/- per share, the average cost of 96 shares comes to ` 652/- per share, which might be much lower than the discounted current price post buyback. Hence, it may not be dreadful under such circumstances for the small shareholders if the acceptance ratio for buy back of shares by the company is not 100%.
Shortcomings of Buyback
Following are few drawbacks when company opts to buy back the shares:
1. Buy back involves a set procedure to be followed by both the company and the shareholders tendering the shares which makes it a little cumbersome particularly for the shareholders, who are otherwise not required to do any procedural activity in case of dividend declared by the company in which dividend gets credited directly in the bank account of the shareholder without any efforts.
2. In case of Buyback, company may not Buyback all the shares from the shareholder since the company may opt to buy back the shares proportionately.
3. In case of listed companies, buyback procedure is time consuming and requires approval from regulatory bodies like Security and Exchange Board of India (SEBI) while no such approval is required in case the company opts to give dividend. However, SEBI has lowered the duration of buyback from one year to three months which makes it more attractive since the chances of variations in the market price decreases.
4. Buy back of shares requires estimation of acceptance ratio on the basis of distribution schedule given by the company in its latest annual report. Hence, such estimations are not perfect and precise.
5. Buyback procedure requires involvement of Merchant Bankers which makes it an expensive affair for the company opting to buy back the shares.
5. Buyback procedure requires involvement of Merchant Bankers which makes it an expensive affair for the company opting to buy back the shares.
Buy Back under Ind AS Regime
Applicability of Ind AS has been made mandatory for all listed companies with effect from accounting periods beginning on or after 1st April, 2017 by Ministry of Corporate Affairs through its notification dated 16th February, 2015. Further, unlisted companies with net worth of Rs 250 crore or more are also mandatorily required to follow IND AS.
Buy back or repurchase of shares by an entity is governed by Ind AS 32 on Financial Instruments: Presentation. Para 33 of the above Ind AS 32 states that, if an entity reacquires its own equity instruments, those instruments (‘treasury shares’) shall be deducted directly from the equity. No gain or loss shall be recognised in profit or loss on the purchase, sale, issue or cancellation of an entity’s own equity instruments. Such treasury shares may be acquired and held by the entity or by other members of the consolidated group. Consideration paid or received shall be recognised directly in equity.
As is clear from the above, unlike Accounting Standards, Ind AS provides specific provision and accounting treatment in case of Treasure shares where an entity buys its own shares. It states that any expenses, gain or loss related to buy back shall be directly adjusted into equity unlike in a scenario where such expenses are routed through statement profit and loss account. In any case they are not related to usual operations of the business of the entity and hence do not require their mention in the statement of profit and loss account.
Further, as per para AG 36 of Ind AS 32, an entity’s own equity instruments are not to be recognised as a financial asset regardless of the reason for which they are reacquired. Paragraph 33 requires an entity that reacquires its own equity instruments to deduct those equity instruments from equity. However, when an entity holds its own equity on behalf of others, e.g. a financial institution holding its own equity on behalf of a client, there is an agency relationship and as a result those holdings are not included in the entity’s balance sheet.
Rising Trend of Buy Back of Shares
Through various information sources and data available in the public domain, repurchase or buy back of shares by the listed companies are bound to climb to a record high. Nearly over 40 companies have made the buy back of shares worth more than ` 48,000 crore in the financial year 2017-18.
Recently, the Finance Ministry has shortlisted some 12 Central Public Sector Enterprises (CPSE),including Coal India, NTPC, NALCO and NMDC, for a possible buyback of shares in the financial year 2017-18. The other companies which are in the list include NLC, BHEL, NHPC, NBCC, SJVN, KIOCL and Hindustan Aeronautics. These all are listed Companies in recognised stock exchange BSE and NSE. These CPSEs have been asked to buyback the shares following the capital restructuring guidelines set out by DIPAM on May 27, 2016. As per the guidelines, CPSEs having net worth of at least ` 2,000 crore and cash and bank balance of above ` 1,000 crore have to mandatorily go in for share buyback.
1. Income Tax Act, 1961
2. IND AS
3. SEBI (SAST) Regulations, 2011
4. SEBI (Buyback of Securities) Regulation, 1998