Buybacks draw firms as taxes squeeze dividends

Companies to pay shareholders via buybacks, which attract zero tax

In order to reward shareholders, especially promoters, companies are opting for share buybacks over dividend payouts. This is because buybacks attract zero tax whereas dividends are taxable and now attract additional levy. Bharti Airtel and Bharti Infratel on Saturday said their boards would decide whether to go for dividends or buyback — or both.

Technology firm Wipro has announced a Rs 2,500-crore buyback (to start in May) and a final dividend of Rs 1 per share as against Rs 7 per share for the previous financial year (2015-16). Wipro joined nearly half a dozen listed companies, including pharma firm Dr Reddy’s Laboratories, that have announced buybacks since the start of the new financial year (2016-17) on April 1.

The trigger for buybacks over dividends is the additional 10 per cent tax announced in this year’s Budget on individuals receiving dividend income in excess of Rs 10 lakh in a financial year. This tax is an addition to the 20 per cent dividend distribution tax. The dividend income (in excess of Rs 10 lakh) attracting the additional tax is typically earned by promoters and large shareholders. Hence, companies are shifting to buybacks to protect promoter and shareholder income from taxes.

According to a recent analysis by the Business Standard, the additional 10 per cent tax on dividends may eat as much as Rs 6,000 crore of promoters’ income in the country’s top-100 dividend-paying companies.

“Dividend distribution in India can be inefficient from a tax perspective due to the 20.4 per cent dividend distribution tax. In addition, the Budget has enforced an additional 10 per cent tax on all individuals (including Hindu Undivided Family) that receive a dividend income of more than Rs 10 lakh in a financial year,” Vaibhav Dhasmana and Atul Goyal, analysts at Jefferies, said.

Market players say more companies will go for buybacks, but will not completely abandon the dividend route.

“Buybacks cannot be applied in all situations. Promoter shareholders will have to be mindful of their holdings. If the public shareholders do not participate in the buyback and a promoter participates, it will lead to the dilution of the promoter’s holding. Hence, buybacks will work only when promoters have a comfortable holding,” said Sudhir Bassi, executive director, Khaitan & Co. According to rules, a company has to observe a six-month cooling-off period after a buyback, during which it cannot raise any capital through equity markets.

"In developed markets, dividends and buybacks are interchangeable as companies use either option to reward shareholders,” said an investment banker working on a buyback.

For an investment banker, doing a buyback is a long process. Dividend payouts can be done quickly and easily.

Notably, all companies are now opting for the ‘tender’ buyback route, as it allows promoter participation.  

The conventional ‘open market’ buyback route is meant only for non-promoter shareholders.

As per a recent analysis done by Business Standard, the additional 10 per cent tax levy on dividends was likely to eat into as much as Rs 6,000 crore of income of promoters in the country's top 100 dividend paying companies.