Change in tax structure prompted India Inc to favour buybacks again in FY21

In 2020-21, Indian firms offered to buy back shares worth Rs 39,295 crore, or 97% more than Rs 19,972 cr proposed in the previous financial year

Share buybacks have made a strong comeback as tax considerations have once again made India Inc favour the route to reward their shareholders.

In 2020-21, India Inc offered to buy back shares worth Rs 39,295 crore (actual amount acquired stood at Rs 34,624 crore)—97 per cent more than Rs 19,972 crore (actual amount acquired stood at Rs 17,843 crore) proposed in the previous financial year.

Furthermore, the share of buybacks in the total shareholder reward kitty (dividend + buyback) rose to 21 per cent in FY21 from 8.3 per cent in the preceding financial year, an analysis of data provided by Prime Database shows.

“Buybacks have emerged as a popular option for companies that have excess cash sitting on their balance sheets to reward shareholders who may be looking for an exit while at the same time allowing the company to recapitalise and improve the relative returns for existing shareholders,”said Karan Marwah, Partner and Head – Capital Markets advisory, KPMG in India.

To be sure, the dividend numbers for FY21 could be slightly depressed as some companies—banks in particular— refrained from paying dividends in the wake of the covid-19 pandemic. As a result, the total dividend kitty shrank by over 30 per cent in FY21.

The latest Rs 9,200-crore buyback announcement by tech-major Infosys, however, shows that India Inc could continue to make use of this route in the ongoing financial year.

“From 1 April 2020, dividends are taxed in the hands of shareholders. Previously, dividends received by shareholders were made tax-free in their hands, as the company was subject to dividend distribution tax (DDT). On the other hand, capital gain on the buy back on or after July 5 2020 is exempt in the hands of shareholders. Therefore, buy back is a much better way to reward investors,” said Vineet Nagla, Partner, White & Brief Advocates.

Between FY17 and FY19, buybacks had gained currency as corporates looked to explore tax arbitrage between buybacks and dividends. To plug the loophole, the government introduced a 20 per cent buyback tax in FY20. This led to a 68 per cent slump in buybacks that year.

While the 20 per cent buyback tax remains in play but net tax paid by shareholders on dividends received has shot up as it is now taxed as per the individual tax slabs—which in some cases can be in excess of 40 per cent. This titled the scale somewhat back in favour share repurchase programmes during the just-concluded financial year.

“Dividends impact promoters and significant shareholders with an additional tax burden of 20-30 per cent over a buy back. No reason why shareholders would want to bear that burden, especially companies with large promoter or investor shareholding,” said Praveen Raju, Partner, Spice Route Legal.

While buybacks may make more sense from a taxation point of view but from a regulatory standpoint they can be difficult to execute.

“The decision for a company to either declare a dividend or go for a buyback is a function of multiple factors such as current stock price, market capitalisation, existing debt structure, and legal restrictions,” said Prashaant Rajput, also a partner at White & Brief Advocates. “Companies in sectors, such as technology, that have a low debt-to-equity ratio, high net cash levels and high payout ratios are more inclined towards share buybacks.”

As per Sebi rules, companies with high debt-to-equity ratio cannot go for share buybacks. Also, the buyback amount cannot exceed a fourth of paid-up capital and free reserves.