The Securities and Exchange Board of India (Sebi), earlier this year, introduced a new and improved mechanism for tendering and settlement of shares through stock exchanges, with the intention to make de-listing, buyback and takeover offers by companies more efficient and widespread.
The new mechanism is available on stock exchanges that have nationwide trading terminals, in the form of a separate window known as an “acquisition window”. This facility has also been extended to companies which are listed exclusively on recognised regional stock exchanges and a platform will be provided by the exchanges to such companies.
During the tendering period, sellers are allowed to place orders for selling shares through their respective brokers. These shares are finally transferred to the escrow account of the acquirer through the special account of the clearing corporation. This will be done in a manner similar to settlement of trades in the secondary market, with an option of direct payout to the shareholders. The company must make a number of additional disclosures, like broker details, stock exchange details, methodology for placement of orders, special account to be opened by the clearing corporation, etc. For shares which are locked-in, only off-market mode would be available.
Prior to the introduction of this mechanism, investors were liable to capital gains tax on de-listing, buyback and takeover offers, on the difference between the tender price and cost of acquisition because these offers were carried out off-market. Now, as these transactions will be carried out on the floor of the stock exchanges, such transactions will only be liable to securities transaction tax. Consequently, under the Indian tax laws, long-term capital gains (capital gains on shares held for more than 12 months) will be tax-exempt.. Further, this mechanism will further lead to reduction of short-term capital gains tax to 15% (excluding the surcharge/ education cess) instead of being taxed at normal rates. However, it will result in additional tax outflow in the form of securities transaction tax (STT) of 0.025%.
Currently, dividends distributed by companies are liable to dividend distribution tax whereas buyback of shares is not; thus, buyback may be a more viable alternative than dividend for payout of cash to investors.
Since the present mechanism would result in additional cash flows in the hands of the shareholders due to substantial tax benefits, this mechanism is more likely to result in increased investor participation.
It may also serve as the right opportunity for over-capitalised companies to buy back their shares and achieve an optimum capital level. Further, increased participation by shareholders may also lead to better price discovery through market forces.
Presently, companies seeking to de-list their shares have to acquire shares up to a certain threshold from the shareholders. Since this mechanism would lead to increased investor participation, such de-listing offers are more likely to become successful. Further, an investor will now have a tax-efficient exit opportunity in case of a takeover offer also.
In spite of the significant benefits to the investors as well as the companies under the new mechanism, there may be certain perceived hiccups. Some of them could be in terms of perceived under-valuation of stock in market, potential dilution of promoter stake (especially in family-driven businesses) in case of buybacks and also the fact that Indian investors’ perception towards dividend payout is more favourable due to their consistent visibility, especially in the case of blue-chip companies, versus cash payout in the form of buyback. However, it needs to be noted that this mode of cash distribution could definitely prove to be more efficient than conventional dividend distribution, especially in cases where a company has surplus cash available from, say, stake sales or business divestitures. The percolation of new mechanism which seeks to garner wider investor participation ought not to be dampened by mere perception issues. The key, of course, lies in sending out the right message to investors.
Falguni Shah & Shankar Ganesh
Shah is partner, and Ganesh is associate director (M&A tax), PwC India. Views are personal