Distribution of profits: Buy-back of shares may still be viable?

By Saumil Shah & Nitin Bohra

Dividend has been one of the preferred ways amongst Indian corporates to distribute profits to their shareholders. However, considering the additional dividend tax levy in the hands of non-corporate resident shareholders, buy-back of shares by listed companies has emerged as one of the preferred ways to distribute profits in recent years. This is also evident from the fact that the return of cash by listed companies to shareholders through the buy-back route got a big boost since the introduction of super-dividend tax.

The buy-back of shares by listed companies was more attractive on account of two aspects. First, the buy-back of shares by them was not subject to buy-back tax (BBT), and second, the receipt of consideration in the hands of shareholders was subject to capital gains tax, and where listed shares were held for more than 12 months, the same was exempt from tax. The combination of all these led to distribution of profits back to shareholders with almost no tax.

Post the introduction of long-term capital gains tax on the sale of listed shares and BBT on listed shares, the direction has certainly changed. As stated in the Budget speech by the finance minister, the reason for introduction of BBT on listed shares was to discourage the practice of listed companies announcing buy-back of shares instead of dividends, to avoid the dual levy of dividend tax.

However, after rolling out BBT on listed shares, it is interesting to analyse whether listed companies should switch to dividends as the preferred route for distributing profits to shareholders. A plain vanilla analysis still appears to be in favour of buy-back in the scenario where the majority of shareholders are non-corporate resident shareholders. With the levy of additional dividend tax in the hands of such shareholders, buy-backs offer a tax arbitrage of nearly 10%.

This arbitrage may further increase if significant cost-base is available to the companies on shares being bought-back, as the same would reduce the BBT liability considerably, thereby leading to more surplus in the hands of shareholders. A detailed analysis of shareholding pattern (viz. corporates or non-corporates, residents or non-residents), consideration received on issue of shares proposed to be bought back etc, are essential for holistic comparison between buy-back and dividend route.

Another advantage of the buy-back route from a stock market perspective could be its positive impact on the EPS and consequently on the P/E ratio, as shares bought back are extinguished and lead to a lower capital base. It is also noticed that the buy-back price proposed under the offer is generally higher than the ruling market price, which imbibes greater confidence amongst shareholders.

Apart from taxes, one must be also cognisant of other legal and commercial aspects that need consideration while deciding on buy-back vis-à-vis dividend route, viz. disproportionate participation from promoters and public shareholders, limits on buy-back size with minimum 15% entitlement for small shareholders, restrictions on fund raising for the next six months, constraint on maintaining minimum debt-equity ratio of 2:1 post-buy-back, etc.

Based on the above analysis, it becomes evident that opting for buy-back or dividend is not a straightforward task. It would require much more deliberation and consideration. Furthermore, recent remarks by the finance minister to address DDT as regressive tax levy have fuelled the speculation on the removal of DDT. If it is removed, it would certainly change the rules of the game. In such a scenario, it would be interesting to see what happens to BBT?

Source: Financial Express