By Raghu Palat, Chairman and Managing Director, Cortlandt Rand Consultancy
On November 14, two companies, GHCL and Infosys-both highly regarded entities-offered to buy back their shares from existing shareholders. While GHCL is attempting to buy back shares totalling Rs 300 crores, Infosys proposed a significantly higher buyback aggregating Rs 18,000 crore. To entice shareholders to offer their shares for repurchase, Infosys is offering a 16% premium of its current price while GHCL is offering a premium of 14%.
At first glance, many investors may be tempted to participate in the buyback to capture this immediate gain. However, before taking advantage of what appears to be a lucrative opportunity, it is essential to understand what a buyback actually entails.
New Tax Reality
What is a buyback? It is the repurchase of its own shares by the company that originally issued them. Once the company buys its shares back, it can either hold those as treasury shares and offer them to employees at the time stock options are given or cancel them to reduce its total outstanding issued share capital.
Companies seldom initiate buybacks because they have exhausted their authorised share capital. If a company already has sufficient shares available for employee stock options, why would it still choose to buy back its shares? The explanation lies in the strategic purposes that buybacks are designed to serve.
The company may argue that its shares are undervalued. But then how does that affect the company or impact the company? After all, the company is not trading in its own shares. Another common justification that is advanced is that a buyback would correct the market price. That does not often happen as would be seen in recent months. Bajaj Consumer Care repurchased its shares in September at Rs 290 and these shares are now trading at Rs 269. Similarly, Tanla Platform repurchased its shares at Rs 875; the shares are now available at Rs 618. The July repurchase of SIS was at Rs 404 and these are now trading at Rs 336. In short, after shares are repurchased, they rarely surface at a higher valuation or even rise. This begs the question, why would a company be concerned about whether the shares are not reflecting its market price? The only plausible explanation is that the promoters or majority shareholders want to reduce the floating stock, thereby increasing the control they have on the company.
Decoding Promoter Intent
A buyback also signals that the company has surplus cash-far more than it requires for its operations or expansion plans and is using the repurchase as a way to deploy excess funds. When a company is seeking to repurchase its shares, it is important to ascertain what its borrowings are. If a company is burdened with costly debt, it would arguably be more prudent to reduce or eliminate those interest expenses and work towards becoming debt-free.
A buyback can also make the company appear more attractive to investors. By reducing the number of outstanding shares, the earnings per share automatically increase, creating an impression of improved performance.
Buybacks are engineered to make it look attractive to shareholders to tender their shares. If you hold an Infosys share purchased at Rs 1,600 and are now able to sell it for Rs 1,800, it may seem like an obvious decision-especially since the stock is currently trading at around Rs 1,545. However, under the tax rules introduced in October 2024, you will not be able to tell the tax authorities that you have made a capital gain of Rs 200. Instead, the entire amount you receive from the buyback is treated as a dividend and taxed at 10%. As a result, although the offer price is Rs 1,800, the post-tax amount you actually receive is Rs 1,620. You are, however, allowed to record your original purchase cost as a loss, which can then be set off against future capital gains.
You may be wondering what happens to the cost of acquisition of the shares you tender for buyback. Can it be claimed as a deduction against the deemed dividend income? The answer is no-the cost of acquisition cannot be offset against the dividend income arising from a buyback. However, this cost can be carried forward as a deemed capital loss and used to offset capital gains from the sale of shares that you already hold. However, if you have no capital profits this gets carried forward ad infinitum.
If the shares tendered were bonus shares, the situation is different. Bonus shares have a cost of acquisition of zero, so one could argue that no deemed loss is available to be carried forward. Therefore, the entire proceeds you get from the bonus shares will be deemed as income and will be taxed.
Finally, once your shares are bought back, you will no longer be entitled to future dividends, bonus issues, or other corporate benefits on those shares which may work out to more than the money you would make on the buyback.
In my opinion, you should think carefully-and perhaps more than once-before offering your shares for a buyback.