Don't Back These Buys

Buybacks help you to save taxes and earn premiums over market prices. But if you participate in them, they can eliminate the possibilities of higher profits later

- Yagnesh Kansara

Over the past few months, buyback of shares by companies with surplus funds was back in fashion. Recently, a few firms resorted to it. At the time of writing, another six, including TCS, NTPC and NMDC, were in the various stages of the process. A single change in the last Budget made them fairly attractive, both for the companies and investors, compared to payment of high dividends. Apart from bonus issues, buybacks and dividends are ways in which firms reward their shareholders.

What Budget 2020 did was to tax dividends in the hands of the investors, rather than the earlier practice of putting the burden on companies. Suddenly, individuals in the highest tax bracket had to pay 35.88 percent (including surcharges) as taxes on the dividends. This discouraged firms from declaring higher dividends as the shareholders felt that they received less than what they were due. It was perception change—tax was paid in both cases but by different entities.

Hence, buybacks became a preferred option because it attracted a lower tax rate, which had to be paid by the firm. In such a case, the company paid 23.3 percent (including surcharge), which was lower in effective terms because the issue price (face value in most cases) was subtracted for tax calculation from the amount received by the investor. There was no income tax implication, including capital gains, for the shareholder, who participated in the buyback offer.