To check the practice of listed companies resorting to buy backs of shares instead of payment of dividends, Budget 2019 has withdrawn the exemption enjoyed by the shareholder of a listed company on income arising on account of buy back of shares. Simultaneously, a listed company is now required to pay tax on buy back under section 115QA at the rate of 20% plus applicable surcharge and cess.
“In order to discourage the practice of avoiding Dividend Distribution Tax (DDT) through buy back of shares by listed companies, it is proposed to provide that listed companies shall also be liable to pay additional tax at 20% in case of buy back of share, as is the case currently for unlisted companies,” Union Finance Minister Nirmala Sitharaman said in the Budget speech.
Buy back is a means to reward the shareholders and increase the remaining shareholders’ value in the shares by an increase in earnings per share. To block the listed companies from the practice of resorting to buy back of shares, instead of payment of dividends, the buy back tax has also been extended to listed companies.
Earlier, the surplus arising to the shareholders was taxed as capital gains and when shares were tendered through the stock exchange on which STT was paid, the long term capital gains would have been subject to tax at the rate of 10% (including no tax on capital gain in respect of price as on 31 January 2018 due to the benefit of grandfathering). The Budget 2019 move would be a major deterrent in buy back of shares by listed companies.
According to Ashok Shah, Partner, N.A Shah Associates LLP, the effect of this provision is that a listed company whose buy back is still open today, would be taxed at the rate of 20% plus surcharge and cess on the amount of consideration paid less issue price of such shares. Plus, this would impact buy back by all listed companies in the future, he added.
“The Budget proposes to extend buyback tax to listed companies. This seems to have been done to check the practice of listed companies resorting to buybacks of shares instead of payment of dividends. This would effectively limit the quantum of distributions that listed companies make in light of the tax inefficiencies and does not make any economic sense,” according to a note by Nishith M. Desai. One fails to understand why policymakers do not appreciate that imposing an effective tax of more than 42% on profits distributed to shareholders is counterproductive to reviving animal spirits in the economy, Desai argued.
However, HDFC Securities MD & CEO Dhiraj Relli feels the buy back tax move is justified. “Taxing buy backs at 20% will close a loophole to avoid DDT. Companies may now not be willing to share a bigger portion of their distributable surplus with their shareholders. Dividend distribution may now be on par with buybacks and minority shareholders will be happier to receive dividends rather than being asked to participate in buybacks,” he said.
As per Suresh Surana Founder, RSM Astute, listed companies doing buy backs would now pay tax at the rate of 23.296%. The gains on buy back would be exempt in the hands of the shareholders, he pointed out. At present, only unlisted companies are liable to pay buy back tax at the rate of 23.296% on the net consideration (i.e. buyback price less the issue price received by the company).
“This (move) may result in cascading tax as the difference between the issue price and the buyback price may already have been taxed in the hands of the previous shareholders as capital gains. This would impact shareholders’ returns on their investment in shares of listed companies and also impact the companies at large. This would be an additional burden for all the companies who have already made an announcement for buy back or are in process of the same as the said provision is being applied with immediate effect,” Surana said.
The news has impacted the shares of the companies who have announced buyback. For instance, shares of Wipro, whose buyback is currently in the process, fell 4.26% on Friday following the news.