CIRCUIT BREAKER. Giving isn’t easy for India Inc.

Corporate India, known for assiduously hoarding its cash, seems to be loosening its purse strings. Bharti Airtel, Wipro, Dr Reddy’s and a host of big names have queued up to announce stock buybacks in recent months. So are these stock buybacks triggered by the recent slump in stock prices? Or is it that, given the limited growth opportunities due to the downturn, the firms think shareholders can find better uses for that cash?

Unfortunately, from the size and timing of the buybacks, it appears to be neither. What seems to have prompted this rash of stock buybacks from India Inc (‘New tax on dividend triggers buyback offers,’ BusinessLine, April 26) is the Centre’s move in its recent budget to slap a 10- per cent tax on large shareholders (read promoters), if they earned over ₹10 lakh in annual dividends.

This tax has essentially made equity dividends of a company taxable three times over, in certain cases. Unlike the interest payouts on debt, equity dividends are paid out of the already-taxed corporate profits. A few years ago, the Centre slapped a dividend distribution tax (DDT) of 15 per cent on companies distributing dividends, at source, to make such taxes easier to collect.

In the 2016 Budget, the much-taxed dividend has again been made taxable in the hands of the super-rich. It is the high tax incidence for promoter-shareholders, which seems to be prompting closely held firms in Corporate India to take the buyback route to returning their cash.

While taxing big dividend receipts of fat cats may have a certain Robin Hood appeal, the government is doing equity investors and the economy a disservice by making it so hard for companies to return their excess cash. The country’s regressive tax regime for dividends and buybacks spawns several problems.

For starters, the trio of dividend distribution tax, buyback tax (yes, there is one) and the ‘super-rich’ tax on dividends essentially creates every incentive for Indian companies to hoard their cash or even fritter it away in unproductive ventures, rather than put it back into circulation in the economy.

By end of FY15, India’s top 500 listed firms (we considered only non-financial firms) had ₹5.09 lakh crore of cash and bank balances sitting on their balance sheets and this number was up from ₹3.86 lakh crore five years ago. Cash (including bank balances) was not an insignificant item on the balance sheet.

It accounted for 10 per cent of the total balance sheet size and represented 20 per cent of all the shareholder funds invested to date, in these firms. Despite the build-up of cash, only 75 per cent of the top 500 firms paid any dividends at all (and this represents the creamy layer of the listed universe). Average payout ratios were at 26 per cent. Such significant surpluses are bound to be a drag on shareholder returns.

After all, when an investor bets his shirt on a company’s share, he is doing so in the hope of raking in a high return on his capital from the business doing well. He isn’t looking to earn bank deposit-like returns from the firm’s treasury division.

Now if these companies made a conscious decision to refrain from new projects in the last five years because of a downturn in their respective sectors, that is quite understandable.

But then promptly returning that cash to shareholders by way of dividends or buybacks, would have helped ensure that the investor was free to redeploy it in other ways. If the cash were distributed, some shareholders could have invested in tax-free bonds and helped channel the money into capital-starved infrastructure projects. Others could have simply spent it, giving the country’s consumption engine a small boost.

Tax rules that actively discourage companies from returning their excess cash have adverse governance implications for listed companies too. With all that extra cash to play around with, firms in cash-rich sectors have every temptation to sink money into the pet projects of the promoters, diversify into unrelated segments or even dispense largesse to group firms in the guise of related party transactions.

It is noteworthy that the investment portfolios of the top 500 listed firms mentioned above were even larger than their cash and bank balances by end of FY15, at ₹5.5 lakh crore.

Apart from locking away capital which can be put to much better use, the stockpiling of cash by companies also makes equity investing a more risky experience for Indian investors.

Globally, both retail and institutional investors acquire stocks as much for their ability to pay back regular dividends, as for the prospect of capital gains from rising prices. Generous dividend distributions, by providing regular cash flows to shareholders even in bear markets, help cushion the impact of wild stock price swings on long-term returns.

But thanks to poor distribution policies, equity investing in India has always been a one-way street. Newbie firms with big business ideas roll out their initial public offers (IPO) and rake in the required sums. Once the IPO is done and dusted, they then have very little to do with their new business owners, save providing them with periodic updates.

With the investor relying almost entirely on stock price gains for returns on his shares, it is not surprising that he should perceive equities as an all-or-nothing bet.

It is certainly not a matter of comfort, given this context, that the Indian stock market today offers one of the most unattractive dividend yields in the world.

While the dividend yield of the BSE Sensex firms is currently at 1.6 per cent, European bellwethers offer over twice this dividend yield at 3.8 to 4.5 per cent. Several of India’s Asian peers (China’s Hang Seng, Thailand’s SET, Malyasia’s Bursa) also offer 3 to 4 per cent.

It is quite likely that the low dividend yield and the resulting lack of regular cash flows, prompts foreign investors to expect quick gains and build in a higher risk premium for Indian stocks as well.

Overall, imposing stiff taxes on corporate distributions may serve the Centre well in the short-term, as every time a company returns cash to its owners, it ends up fattening the public coffers. But it is time policymakers realised that a regressive tax regime on distributions extracts significant long-term costs on the economy.

It results in poor return on capital, bad allocation decisions and more volatile returns for India’s reluctant breed of equity investors.