Time for a relook at tax on buybacks to boost shareholder returns

The legal and regulatory framework governing buybacks is primarily under the Companies Act, 2013, and the Sebi Buyback of Securities Regulations, introduced in 1998 and updated in 2018 and 2023

Globally, share buybacks are an extremely popular mechanism for companies to return capital to shareholders, rightsize their balance sheets, and signal confidence in their financial health. For example, Apple has done buybacks worth $430 billion over the last five years, boosting its share price. However, like every other aspect of economic activity in India, the only policy objective of the state has been to extract as much money as possible by taxing buybacks, leaving companies lukewarm to the idea and depriving shareholders in the process. This becomes immediately apparent in a bear market, when the stock prices of outstanding companies with strong cash flows are down but none of them feels impelled to launch a buyback offer. What can be done to encourage companies to buy back their shares in a move that would be beneficial for shareholders? 

The legal and regulatory framework governing buybacks is primarily under the Companies Act, 2013, and the Securities and Exchange Board of India (Sebi) Buyback of Securities Regulations, introduced in 1998 and updated in 2018 and 2023. Before this, the Companies Act, 1956, did not allow companies to repurchase their own shares because it was seen as a potential misuse of corporate funds, which could harm creditors or minority shareholders. The concept gained traction globally, particularly in the United States (US), prompting India to reconsider its stance in order to align with international practices and provide companies with greater financial flexibility.

  In 1998, Sebi introduced the Buyback of Securities Regulations, which allowed companies to repurchase their shares either through the open market or via a tender offer. In 1999, Reliance Industries did a buyback of shares, but the practice has remained unpopular due to onerous regulations, lack of growth, and low cash in companies. In the 2000s, when our economy started doing better, a few more buybacks happened, including a ₹3,000 crore buyback by Reliance Industries through open-market purchases.

  In the 2010s buybacks became a bit more popular and this was due to a combination of several factors: Economic growth, tax incentives, and the maturing stock markets. The Companies Act, 2013, replaced the 1956 Act and further streamlined the process under Section 68, allowing companies to buy back up to 25 per cent of their paidup capital and free reserves in a financial year. Buybacks also came to be seen as a better alternative to dividend due to their tax efficiency. Until 2016, dividends were subject to dividend distribution tax (DDT) paid by companies (15-20 per cent including the surcharge and cess) while buybacks attracted a lower tax, making them more attractive. The Finance Act, 2016, introduced an additional 10 per cent tax on dividend income exceeding ₹10 lakh for individuals, making buybacks more popular.

  In 2016-17 over 40 listed companies announced buybacks worth ₹30,000 crore—the highest value in a single financial year till then. This included Reliance Industries, which had announced a ₹10,440 crore buyback plan between 2012 and 2013, though it achieved only 38 per cent of its target, acquiring shares worth ₹3,900 crore. Tata Consultancy Services (TCS) planned a ₹16,000 crore buyback in 2017, the largest ever “through the tender” route. TCS repeated large-scale buybacks in subsequent years following a strategy of returning 80-100 per cent of free cash flows to shareholders. Infosys also announced a ₹13,000 crore buyback in 2017. Interestingly, in 2017 the number of buyback offers exceeded initial public offerings (IPOs) for the first time in Indian capital market history. In 2019 around 70 companies did buybacks in the first half of the year, which has been the highest number ever; almost all of them rushed to complete their offers (worth over ₹35,000 crore) before the 2019 Budget taxed buybacks at 20 per cent. In contrast, in the full year of 2018, only 63 companies bought back their shares.

  As expected, following the 2019 amendment, the number of buybacks fell to only 48 in 2023. There was another round of tax changes in 2024. Buybacks are now taxed as dividend at their income tax slab rates — they were taxed as capital gains earlier at 23.3 per cent. High-net-worth individuals (HNIs) and institutional investors now face higher tax liabilities (up to 37 per cent for top brackets). In contrast, the US has only 1 per cent tax on buybacks, which also came about only recently under the Inflation Reduction Act of 2022. Also, from April 1, open-market buybacks through exchanges have been banned, which limits corporate choices. If the government thought that it was freeing the corporate sector from buyback tax and shifting it on to shareholders, it was a short-sighted view. While tax on buyback is not voluntary, choosing to participate in an offer is. Shareholders would hardly be excited about such a hugely taxed source of income.

  Share buybacks allow companies to enhance shareholder value, signal confidence, and optimise their capital structure. Firms with excess cash, like software giants and public-sector companies, have utilised buybacks to reduce idle reserves when there are no worthwhile investment opportunities. Buybacks that use tax-paid past profits ought to be left alone. But greedy, cash-strapped governments see buybacks as a means of grabbing taxes. It is time for a relook in a declining market. If the government puts a flat 10 per cent tax on buybacks, irrespective of income slabs, hundreds of cash-rich Indian companies would go for it, probably increasing the government’s tax intake. A low, flat tax policy will give a boost to the market at no additional cost and cheer millions of shareholders. These are the crucial points where an extractive state can turn into an inclusive state. Will it happen?

  The writer is editor of www.moneylife.in and a  trustee of the Moneylife Foundation; @Moneylifers