Budget 2019: Proposed taxation on share buybacks puts IT firms in a spot

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With the Union Budget proposing a 20 per cent tax on buyback of shares by listed companies, IT services companies are likely to opt for more dividend payout rather than following an elaborate process to do a share repurchase. Currently, buyback is taxable only for unlisted companies but if FM Nirmala Sitharaman's proposal is approved by the Parliament, it will be extended for the listed firms as well.  

In the last three years, most large IT services companies have taken the buyback route to return their surplus cash to shareholders as this option has emerged as the most tax efficient instrument when compared with dividend payout. In case a company declares dividend, it is liable to pay close to 21 per cent dividend distribution tax (DDT).
"If the proposed imposition of 20 per cent on buyback goes through, the arbitrage is gone and companies may like to do more dividend payout than going through the elaborate process of buyback," said said V Balakrishnan, chairman of Exfinity Venture Partners who is also a former chief financial officer and board member of Infosys. "In case of buyback, the company has to file the prospectus and mandatorily follow the one year cooling off period. So, companies may not like to go through so many hassles."

All the major Indian IT services companies have opted for repurchase of shares in the last three years in order to give back their surplus cash to their shareholders. For instance, Infosys is currently conducting a share buyback of Rs 8,260 crore for the second consecutive year after executing a buyback of Rs 13,000 crore in FY18. Similarly, market leader Tata Consultancy Service (TCS) has also conducted two consecutive buybacks of Rs 16,000 crore each in last two fiscal years. Among others, Wipro and HCL Technologies have also conducted share repurchase programmes as part of their capital allocation policies.

"While dividend distribution tax is paid by the company for declaring dividends, tendering of shares in the buyback attracts capital gains in the hands of shareholders. But, with this proposal of 20 per cent tax on buyback, dividend distribution may see preference over the buyback," said Dipti Lavya Swain, partner at HSA Advocates.

According to Amit Chandra, AVP-IT research at HDFC Securities, this additional tax has been a negative news for the (IT) sector which is evident from the way stock markets reacted to the announcement on Friday. "When the IT providers started offering buybacks to shareholders about two years back it was a tax efficient method for them. However, a buyback takes up to 4 months to process since it requires approvals from shareholders and board members across the exchanges where the companies are listed. If now the tax impact boils down to the same level, companies might as well opt for dividends which are easier to process," Chandra added.

According to industry experts, in order to discourage the practice of avoiding Dividend Distribution Tax (DDT) through buyback of shares by listed companies, the government has proposed this move in the interest of protecting revenue.

"While tax is one of the factors for conducting a buyback over declaration of dividend, there are also other factors which are weighed by the company before opting a specific instrument. For example, if the promoter wants to consolidate its position in the company, buyback will be preferred," Swain of HSA Advocates added.