Monday, 16 March 2020

Buy-back Tax amendments could exanimate the Buy-back Process





There are multiple ways by which companies can restructure their capital. Each process has its own advantages and disadvantages. The various benefits that buy-back of shares provide led to the Government introducing it as a concept of the year 1998. Some of them are listed below:


(a) Buy-back of shares helps a firm be more flexible in reversing decisions or split the buy-back through longer periods, unlike cash dividends paid by a company
(b) Cash dividends require continuous payments in future, but buy-back of shares is a one-time payment. Naturally, a firm holding excess cash deposits with no viable way of re-investing may consider repurchasing its shares in place of paying cash dividends
(c) Buy-back of shares increases the controlling capacity of the firm, as the number of shares publically available is reduced
(d) Buy-back helps shareholders in need of cash and who are willing to sell their shares to accommodate the same. On a similar note, shareholders who do not require immediate cash may hold on to it for the future
In short, buy-back of shares helps firms provide cash to the desired shareholders and also provides flexibility in the time period of holding for existing shareholders.
In addendum to the reasons above, the following benefits are why buy-back would be preferred over regular cash dividends:

(a) Nature of Cash Flows:
When cash flows are in a stable condition, cash dividends would be preferred over buy-back of shares. However, in situations when cash flow timings are unstable, it is better to re-purchase shares than to give out cash dividends
(b) Under-valuation of Shares:
Buy-back of shares is appropriate particularly when the market value of a share is less than its face value, i.e. when the shares are undervalued. If that is the case, the firm may achieve two goals:
(i) If the shares are undervalued, the existing or remaining shareholders will enjoy some benefits if the firm purchases shares at a lower value
(ii) News of this re-purchase will reach capital markets and lead to them reacting upon hearing so
(c) Uncertainty of Further Investment:
Buy-back of shares can be treated as an investment of surplus cash, which , provides maximum benefit to the remaining shareholders as investments. When share prices are undervalued, the management should consider re-purchasing its own share at a reduced price

(d) As a financing decision
Buy-back of shares increases the financial leverage of a firm. It does so by reducing the amount of paid-up capital having the same amount of debt financing. A firm may change its capital structure after repurchasing of shares and issuing debt after ascertaining the capital mix between debt and equity. Thus, buy-back of shares is a valid approach towards changing the capital structure or financial leverage of a company.

Based on the advantages stated above, it can be easily concluded that buy-back is a mutually beneficial process for the company, existing shareholders, and for shareholders exiting.  Furthermore, any gains earned by shareholders were taxable in the hands of the shareholders alone.  For unlisted shares, these gains were taxed as short term capital gain or long term capital gain depending on the period they were held for by the exiting shareholders. For listed shares, since Securities Transaction Tax was being paid, the long term capital gain was exempt till March 2018, after which they also become taxable in the hands of shareholders.  Hence buy-back is also advantageous for the government as they are getting tax on profits earned by the shareholders. 

In recent times, the Government considered buy-back as a tool to evade dividend distribution tax and accordingly introduced section 115QA as a remedy. After which, buy-back was first made applicable on unlisted shares and then on listed shares.  Accordingly, now in case of buy-back, shareholders are not required to pay tax on their gains. Instead, companies are now required to pay tax on the difference between the issue and buy-back prices. Thus, due to the introduction of buy-back tax, the tax incidence of shareholders has been shifted to companies initiating the buy-back, making the process more expensive and complicated. 

The buy-back tax cost could discourage companies from opting for the buy-back process and missing out on the advantages listed above. Earlier, the Government could receive their revenue from the shareholders and now they’re collecting it from the companies instead. As such, there is no significant benefit other than reducing the tax collected from N shareholders, by collecting it directly from the company.

The Government may have eased the tax collection process for the buy-back process, but they now risk alienating companies from initiating it. It would be advisable for them to reconsider this approach.
       


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