Budget 2019: Share buyback no longer tax efficient as compared to dividends; how it impacts companies

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July 06, 2019 2:21 PM

After Finance Minister Nirmala Sitharaman introduced an additional tax of 20 per cent on buyback of equity shares by listed companies, share buybacks will no longer remain tax efficient as compared to distributing dividends.

Budget 2019, budget, budget highlights, budget 2019 date, budget 2019 PDF, budget 2019 highlights, budget 2019 income tax, budget highlights 2019 indiaBudget 2019: The new share buyback tax came into effect from July 5th for listed companies.

Budget 2019: After Finance Minister Nirmala Sitharaman introduced an additional tax of 20 per cent on buyback of equity shares by listed companies, share buybacks will no longer remain tax efficient as compared to distributing dividends. Earlier, while distribution of dividends incurred a Dividend Distribuion Tax for firms, and further at the hands of the investors, the tax liability during a share buyback by used to rest only with the investor. The Budget has now introduced 20% tax on distributed income for buyback of equity shares listed on a recognized stock exchange. Taking stock of the development, Kotak Securities said in a note that the tax-efficient route of buyback has been constrained by the change. “Effectively, the cost of distribution of cash to shareholders stands a minimum of 20%,” the firm said in a report.

Finance Minister Niramala Sitharaman, in her maiden budget speech earlier this week, proposed that all listed companies will be brought at par with unlisted companies, and will be liable to pay a 20% additional tax on share buybacks. This was done to discourage companies from undertaking share buybacks instead of giving dividends to avoid Dividend Distribution Tax, she said. The new rule came into effect from 5 July 2019. Explaining the reasoning behind the move, Kotak Securities said that the rationale of imposing this tax is a belief that companies are using buyback to circumvent payment of dividend distribution tax.

Dividend vs share buyback: How they compare

While Dividend Distrubution attracts a total tax of 20.56%, after the latest rule, buyback of equity shares will attract tax at the rate of 20% (plus surcharge), noted Kotak Securities. “The rationale of imposing this tax is a belief that companies are using buyback to circumvent payment of dividend distribution tax,” said the report, adding that on the face of it, the tax liability would apply on both tender and open market route, since the tax on share buyback does not differentiate between the mode.

Also read: Budget 2019: Top stocks to buy after Budget 2019; avoid firms with high promoter holding

According to Mihir Vora of Max Life Insurance, this development will impact the market sentiment negatively. “The market reaction today is, to an extent due to such expectations – the benefits to these segments, while being in the right direction, were not as substantial as hoped. Higher tax on HNIs and buyback tax were also sentient-negative,” Mihir Vora, CIO, Max Life Insurance tweeted. Mayuresh Joshi, Portfolio Manager, Angel Broking noted that while the move made with the intent of closing the loophole on DDT, it has impacted the market sentiment negatively.

Impact on companies

After the new share buyback tax, Indian IT firms would find it more difficult to administer structured share buyback programs, says Kotak Securities. “Shareholders tendering shares have to deal with the long-term capital gains tax liability ( in case of a buyback). Dividend received in the hands of shareholders in excess of Rs 10 lakh is also taxable at the rate of 10% (plus surcharge). The tax liability is broadly similar under both forms of cash distribution. Dividends are easier to administer though,” noted the firm in the report.

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