InvestorQ : How will the buyback tax be imposed and will it be over and above the capital gains tax that we will pay on buybacks? Will this reduce the buybacks in the market?
Riya Dwivedi made post

How will the buyback tax be imposed and will it be over and above the capital gains tax that we will pay on buybacks? Will this reduce the buybacks in the market?

rhea Babu answered.
3 years ago

Your question is of three parts and we will look at the parts separately. You must have recently read that KPR Mills cancelled its proposed buyback plan. This was the first signal that Indian companies and investors were unhappy with the buyback tax imposed in the Budget 2019. It is interesting that in the last 3 years, buybacks have grown sharply in India due to the tax on dividends imposed in the 2016 Union budget. In fact, in the last 3 fiscal years, the average annual buyback value was Rs.48,000 crore. That is a 10 fold increase after the 10% tax on dividends in the hands of shareholders was introduced for large shareholders in Budget 2016. In short the dividend tax had resulted in a big shift towards companies opting for buybacks as an option to return money to shareholders. However, the government was of the opinion that tax-free buyback were distorting the scene and providing an arbitrage to shareholders, especially the promoters. It is to curb arbitrage that the budget introduced this tax.

Now we come to the second part; how will the buyback tax be imposed. As per the Union Budget, the buyback tax will be imposed at the rate of 20% of the difference between the issue and the buyback price. For example, if the company has issued shares at Rs.200 and the buyback happened at Rs.400 after 3 years, then the buyback tax will be imposed at 20% of (400-200) = Rs.40. This buyback will have to be deducted by the company before paying you the buyback proceeds. Even if you had purchased the shares in the market 15 months back at Rs.300, you will still be charged buyback tax on the difference between the buyback price and the issue price, which is actually unfair.

The concept of tax on buybacks is slightly flawed for a variety of reasons. Firstly, unlike what the government believes, discouraging buy-backs will not encourage investments. That depends on risk and ROI of the investments and no company will invest just because buybacks are expensive. It will only end up like the unrelated diversifications of the 1980s just to avail the higher investment allowances. Buybacks offered a profitable exit to minority shareholders and that route has also been blocked.

There is also the aspect of over taxing equities in India and that a little unfair. While buyback tax may have removed the arbitrage, equity continues to be taxed at exorbitant rates in India. Consider the case of dividends. Firstly, it is a post tax appropriation and secondly, there is a DDT incidence of more than 20% on payouts. In addition, the dividends above Rs.1 million are taxed in the hands of the shareholder at 10%. Now, buybacks are no different. Firstly, the introduction of LTCG automatically implies that any gain made on buybacks will be taxed at 10% above Rs.1 lakh per annum. Now there will be an additional 20% tax on buybacks based on a formula (buyback price – issue price), that is flawed to begin with. This move has made equity the most steeply taxed instrument in India! The only thing that the government must ensure is that in the process the interests of small shareholders are not compromised. In fact, post buyback tax, investors will actually expect higher returns from equities and that will increase the cost of equity, depressing valuations further. That is an angle you may keep an eye on.