Introduction
- In the context of shares, the term 'buyback' refers to a corporate action wherein, to raise share capital, the company buys back the shares it has already issued.
- The buyback can be carried out from the existing shareholders too. The share price is usually higher than the original price because the buyback is meant to be beneficial to the shareholders.
- The buyback of shares can either be done through the open market or through legal tender.
- Buying back shares from the secondary market is also known as an 'open market mechanism'.
- In the case of a buyback through legal tender, the shareholders can apply within a stipulated time for the buyback of shares.
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What Are the Charges for a Buyback?
- The charges of a buyback for a legal tender are Rs. 20 plus GST, and they are non-refundable.
- No matter if the order gets accepted or fails to be completed, the company has to bear these mandatory charges.
- There are various statutory charges related to investing. Some of them are listed below:
- Brokerage charges
- Securities transaction tax
- Transaction charges for each transaction
- Goods and service tax
- Charges levied by the Securities and Exchange Board of India (SEBI)
- Stamp charges
Is Income Tax Applicable on a Share Buyback?
- Under the Income-tax Act of 1961, income tax is applicable to the buyback of shares by a company.
- Under the Finance Act 2013, a buyback tax is applicable to the buyback of shares. All listed companies that resorted to the buyback of shares after July 5, 2019, are liable to pay this tax.
- Also, under the Finance Act 2013, the investor is no longer liable to pay the capital gains tax on the shares for a buyback.
- Let us take an example to understand this better. Prior to the amendment of the Finance Act of 2019, Company X Ltd. repurchased 1000 shares in May 2019 for a price of Rs. 500 per share.
The issue price of the same is Rs. 50. In this case, there will be no tax liability for X Ltd. On the other hand, the shareholders are liable to pay capital gains tax at the rate of Rs. 450 (500 minus 50). Now consider the buyback to be carried out after July 2019, i.e., post the amendment of the Finance Act of 2019. In this case, the company will buy back 500 shares with a market price of Rs. 650 per share and an issue price of Rs. 50. The company will be liable to pay the buyback tax at a rate of 20% on the income that is distributed. However, the individual shareholders are not supposed to pay any taxes.
What Are the Key Reasons for a Share Buyback?
A buyback can take place for various reasons, such as:
- Ownership
The widespread ownership of the shares of a company incurs higher costs for the company. The company may resort to buying back shares to preserve ownership and save on costs.
- Share price correction
Sometimes, the shares can be highly undervalued in the market. A buyback ensures that the share price is corrected in the market.
- Financial position
A buyback increases the earnings per share for the company by reducing the number of shares. This enhances the overall financial position of the company. It also helps it show better earnings per share.
- Promoter shareholding
If the promoters are willing to increase their shareholding, then the buyback of shares is a strategy the company can easily rely upon.
Conclusion
- Even though the company makes a buyback decision, it's not easy to execute the same as it involves many charges.
- The company should make the buyback decision depending on the costs it will have to incur.
- With the introduction of the Finance Act 2019, shareholders are exempt from any tax levied on the buyback of shares.
- A buyback can have both limitations and advantages for the company. The company should evaluate both prospects thoroughly before making any buyback decision.