Success rate of buyback programs could decline under new tax structure

The success rate of buybacks could drop under the new tax structure as the higher taxes may deter shareholders from tendering their shares during the repurchase programmes.

According to PRIME Database, the success rate – difference between the proposed buyback amount and actual repurchase made — for buybacks has been an average 98 per cent for the Rs 3.1 trillion worth of shares bought back by India Inc since 2015. Typically, the buyback price announced by the company is at a premium of between 5 per cent and 30 per cent to the prevailing market price. This premium is paid to entice the shareholders to tender the shares in the buyback as opposed to selling them in the open market.

However, with the government moving the buyback tax burden from companies to individual shareholders — the effective tax rate on the gross proceeds via buyback could be in excess of 30 per cent for those in the top tax bracket.

 “It wouldn't be surprising to see an uptick in companies choosing buybacks as a method to distribute surplus funds. However, from the perspective of the shareholders, they might deliberate whether to participate in the buyback, especially when they know there is an immediate tax cost involved. Instead, they may consider selling their shares in the open market,” said Vaibhav Luthra, Tax Partner, EY India.

From October 1, the gross proceeds received on buyback of shares will be taxed in the hands of the shareholder as ‘deemed dividend’.

Ketan Dalal, Managing Director of Consulting Firm Katalyst Advisors said it is “unfortunate that the characterisation of the buyback is dividend, since logically it should have been capital gains.”

Shares sold in the open market could attract either capital gains tax of 20 per cent if the holding period is less than 12 months or 12.5 per cent if the holding period is over 12 months. Market players said while companies will save 20 per cent buyback tax levied currently, it will have to be passed on to shareholders by raising the maximum buyback price to offset the tax blow.

Dividends and buybacks are the two routes to return excess cash to shareholders. The new tax structure is aimed at removing the tax arbitrage between the two. At present, there is no tax outgo for a company paying dividend as they are taxed at the hands of the receiver as per their individual tax slabs.

Industry players said levying the new tax for buybacks done under the “open market” route could be tricky as shares are sold on the exchange platform. Meanwhile, the buyback done under the “tender route” are sold off the exchange platform. However, Sebi has decided to completely phase out the “open market” buyback route from March 2025. Currently, shares sold under this route are labelled differently to differentiate if the buyer is the company or just another investor.