Share buyback to attract higher tax

Mumbai: The government has imposed higher tax on buy back of share to stop companies from misusing the route to circumvent payment of dividend distribution tax.

The Finance Bill 2019 has introduced tax of 20 per cent on distributed income for buyback of equity shares listed on a recognised stock exchange.

It is proposed in the Union Budget that effective from 5th July 2019, buyback of equity shares will attract tax at the rate of 20 per cent (plus surcharge), similar to dividend distribution tax.

Over the past few years, hundreds of companies have rewarded investors through this route especially several large IT sector companies like Infosys, Wipro and TCS.

Indian IT stepped up payout of free cash flow through a mix of dividend and buyback (more tax efficient) in the past three years.

The amendment made in the Finance Bill of 2019 says that - Clause 36 of the Bill seeks to amend Section 115QA of the Income Tax Act relating to tax on distributed income to shareholders.

According to experts, the rationale of imposing this tax is a belief that companies are using buyback to circumvent payment of dividend distribution tax. On the face of it, the tax on buyback of equity shares does not differentiate between the mode - tender or open market route, implying tax liability on both modes of buyback.

Indian IT companies have stepped up payout ratio in the past three years and used a mix of dividend and buyback as compared to largely dividends in the period prior to this, said Kotak Securities in a report.

"For example, of the total cash returned to shareholders by TCS in the past two years, 60 per cent was done through buyback and 40 per cent through dividend. Wipro has largely used buybacks after continuous increase in dividend distribution tax with nearly 90 per cent of the payout in the form of buyback in the past two years," Kotak Securities said.

IT companies started using buyback after (1) consistent increase in dividend distribution tax, (2) imposition of tax on dividends at the rate of 10 per cent in hands of individuals, partnerships, etc. for dividend in excess of Rs 1 million and (3) the government allowed tender buyback to be done through the stock exchange route, it further said.

This third aspect was important since there was no long-term capital gains tax imposition on shares sold through a recognised stock exchange by shareholders.