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Why new tax proposal could spoil Indian companies' appetite for buybacks
September, 13th 2017

I must have been in the bathroom when the decision was approved,” legendary investor and Berkshire Hathaway boss Warren Buffett once remarked on the company’s decision to pay a dividend in 1967. Since then, Berkshire has never paid a dividend on the Buffett philosophy that there are better ways to reward shareholders like acquiring other firms or buying back shares when the stock price is depressed.

Over the last five years, Indian companies seem to have taken a leaf out of Buffett playbook while rewarding shareholders. (See table below)

What has triggered this trend?

The 2016 budget introduced a 10 percent additional tax on dividends above Rs 10 lakh in the hands of a single shareholder. This was in addition to the 20 percent existing dividend distribution tax which companies had to pay even for dividends below Rs 10 lakh.

Firms with high promoter holdings were unhappy with the move as a big chunk of the dividend went to the promoters. The choice was between the companies shelling out the additional tax, or lowering the dividend to a point where it did not increase the tax liability.

Companies like Wipro, where promoters hold close to 73.18 percent stake, reduced its dividend to Rs 873 crore in FY17 as against Rs 3,549 crore in FY16 and Rs 2,945 crore in FY15. Had Wipro maintained FY17 dividend at the same level as the previous year, it would have to fork out an additional Rs 262 crore as per the revised tax rate.

Nevertheless, in April 2016, the company proposed to buy back up to 4 crore shares worth Rs 2,500 crore. This financial year, it announced a Rs 11,000 crore buy back to return cash to shareholders.

Wipro is not alone in using the buyback route to return cash to shareholders. So far this financial year, 20 companies have announced buybacks cumulatively worth Rs 24,215 crore.

We analysed the data of BSE-500 companies where promoters hold 50 percent or more stake, excluding the state owned companies. We found that dividend distributed by this set of companies has fallen 33 percent from Rs 30,700 crore in FY15 to Rs 20,306 crore in FY17. Furthermore, in companies where promoters held more than 70 percent, dividend payout fell 43 percent in this period.

What could spoil the party?

A report in the Hindu Business Line says the Central Board of Direct Taxes (CBDT) is examining if profits from share buybacks can be subject to long term capital gains tax.

"Today if a promoter of a listed company participates in a (share) buyback, he will be exempted from long term capital gains if the securities were held for more than 12 months. Even if for some reason a promoter has not held the shares for one year, he is still better off paying short-term capital gains tax of 15 percent than the dividend distribution tax of 20 percent," said Bobby Parikh of BMR Advisors.

While details of such taxation are clear, experts speculate the taxman is likely to target only investors holding shares above a certain threshold level. Taxing all investors equally would make the buyback process unattractive, as investors would then prefer to sell the shares in the open market rather than tendering shares in the buyback.

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