Corporate tax stimulus might not lead to higher buybacks or dividends

Vivek Ananth | Updated on September 24, 2019 Published on September 24, 2019

Companies might choose to build capacity or cut prices to boost demand

BL Research Bureau

Last Friday, Finance Minister Nirmala Sitharaman brought down the corporate tax rate in India by nearly nine percentage points and also announced a new flat tax rate for companies investing in manufacturing facilities after October 1, 2019. The Centre expects to forego Rs 1,45,000 crore on this corporate tax cut.

However, there is a fear that, without adequate demand from customers, companies might end up using this extra money from the tax cut to reward their shareholders by paying dividends or buying back shares. This could happen if companies don’t cut prices to incentivize demand in the domestic market.

In 2018, Indian companies bought back shares worth nearly Rs 55,000 crore according to data compiled by Bloomberg. In 2019, until July 5, 2019, companies bought back or announced buybacks worth Rs 38,000 crore.

In the US, when corporate rate tax was cut in 2017, companies had chosen to reward their shareholders through buybacks. However, it is to be noted that gains on buyback were not taxed in the US, and so this was a tax-efficient way to return money to shareholders. That said, the fear that the corporate tax stimulus in India now could also end up in shareholders’ pockets through dividends and stock buybacks seems overdone.

That’s because the relief in buyback tax for listed companies announced by Sitharaman is only for those buybacks that were announced by companies before July 5, 2019. The Finance Minister has not acceded to demands from some quarters to roll back the buyback tax altogether. So, with the buybacks announced after July 5 to be taxed at 20 per cent, there is no arbitrage in distributing profits to shareholders through buying back shares vis-à-vis dividends. Dividends distributed by listed companies are taxed at 20 per cent

This means that if companies pass on all the corporate tax cut benefit to shareholders through dividends or buyback to shareholders, about one-fifth of any such dividend payout or buyback gains to shareholders will go to the central exchequer.

Seen together, the corporate tax cut and the move to only exempt buybacks that were announced before the July 5th Budget might act as a nudge to companies to invest more into building capacity or cut prices to boost demand.

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Published on September 24, 2019
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