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Calculate actual returns before participating in buybacks

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has been the buzzword for many companies in the past year. Over 20 companies, including market movers like Reliance Industries, have announced their plans to buy back shares. Many would be also tempted to participate in these, especially if the price announced is higher than the existing market price.

For promoters, there are several options to buy back shares. While the Ambani brothers bought shares from the open market, companies can buy back shares directly from individual shareholders, popularly known as the tender route. “The former typically happens if the buyback price is much higher than the market price,” says of Ghalla Bhansali Stock Brokers.

Though the price offered might be higher, individual investors need to take into account an important aspect, tax liability. Says Homi Mistry, partner at Deloitte Haskins & Sells: “When an individual does not sell shares on the stock exchange, ie sells it in a buyback, open offer or private placement, capital gains earned in such transactions get indexation benefit.”

Say, you earn Rs 1 lakh from sale of shares in a buyback, off the stock exchange. Assuming you had the shares for more than a year, you would be taxed at 10 per cent without indexation or 20 per cent with indexation, whichever is lower. In an open market transaction, if shares were held for more than a year, long-term capital gains tax would stand at zero, provided the securities transaction tax (STT) is paid.

If the stock was held for less than a year, then the capital gains would be added to the income and taxed, according to the slab. In other words, the could be as high as 33 per cent in the short term, whereas it would be 15 per cent in case of open market transaction.

The process works like this: The shareholder transfers the shares to an escrow account and submits the buyback form (with a proof of escrow transfer) to the depository or the company. Since this sale is taking place through a private deal between the promoter and the shareholder, the income tax department taxes it differently.

This transaction changes the process to calculate tax on long-term capital gains. Since off-market transaction is not required to pay STT, the long-term capital gains tax is indexed and then calculated, says Amitabh Singh, partner at Ernst & Young.

Typically, debt instruments, property and even physical gold get the indexation benefits. Explains Kaushik Mukherjee, executive director (tax & regulatory practices), PwC: “This is the process to calculate tax liability on capital gains on transfer of shares, but not through the stock exchange. Any long-term asset can get indexation benefit. For instance, gains from sale of house property after three years also get indexation benefits.”

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Dear Mr Chidambaram…

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