Buyback of Share by Companies By: Ayushi Raja

 

(The author is an Articled Assistant at SSRPN & CO. She can be approached at cassrpn@gmail.com)

Buyback of shares means re-acquisition of the previously issued shares by a Company from its existing shareholders.The company buys back its shares usually at market value or at premium. Companies use buy back as a means to return cash to shareholders and regain ownership. Tax on buyback of shares in India is now regulated by Section 115QA of the Income Tax Act, 1961.

Why Do Companies Buyback shares?

Buyback is normally used as a means of capital restructuring by Indian companies. The following are certain objectives a company aims to achieve when it undertakes buyback:

• Share buybacks reduce the number of shareholders of the company, thus enhancing the EPS (Earning per share) to shareholders in the long run.

• Management may feel the market has undervalued its share price too sharply, hence a buyback may result in fairer valuation of the company’s stock price.

• Helps to improve key financial ratios like return on net worth, return on assets etc. over a period of time.

• Serves as a positive sign for investors about the confidence of the management in the business.

• Provide exit to investors in times of volatility.

• The taxes to be charged while buying back shares is also divided based on the listing of the company, which are as follows:

• Buyback by Listed Companies

• Buyback by Unlisted Companies

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Objectives of Buyback of Shares :

1. Unused cash: If the company has a huge cash reserve with not many future projects to invest in and if the company thinks the market price of its shares is undervalued, they can buy back shares as a reward for their shareholders.

2. Tax Gains: The companies prefer buyback to reward their investors instead of distributing cash dividends because dividends are taxed at higher rate than capital gains. At present, short-term capital gains are taxed at 15% and long-term capital gains are exempt upto 1 Lakh Rs.

3. Market Perception: By buying shares back from the shareholders at a higher price than the prevailing market price indicates the company shares valuation should be higher.

4. Exit Option: If a company wants to exit the market from a particular country or want to close the companies it can offer to buy back its shares that are trading in the market.

5. Escape monitoring of accounts and legal controls: If a company wants to avoid the regulations of the market regulator by delisting. They avoid any public scrutiny of its books of accounts.

Methods of buyback :

A company can buy back its own shares from:

• From the existing shareholders on a proportionate basis

• From the open market

• From old lots

• By purchasing securities issued to employees of the company pursuant to a scheme of stock option or sweat equity

Conclusion  :

A share buyback is an effective way for management to boost up the company’s undervalued share price and reduce dilution. The process requires management to show confidence in their business operations. It is not necessary that every buyback automatically benefits shareholders. It is important being an investor one should gauge the purpose and the timing of a buyback and also have a look at the overall financial situation of the company. A shareholder must reconsider all his views before purchasing shares of the company which is involved in the process of a buyback.

The tax provisions relating to taxability of Buyback of Shares in the hands of shareholders shall be discussed in the further article.