Buyback tax: Will it hurt minority shareholders?

KPR Mill is the first company to withdraw its buyback plan after the Union Budget imposed a tax on buyback of shares of listed companies, a tax that was until now imposed only on unlisted entities.

KPR Mill had proposed (on April 18) and approved (on April 30) buyback of 37.5 lakh shares, representing 5.17 per cent of the total equity capital, at ₹702 a share for a total consideration of ₹263.31 crore.

However, in a notice to the stock exchanges, KPR Mill said: “We have today (on Thursday) filed with SEBI our communication conveying that the increase in the amount of buyback obligation due to the tax proposal in the Finance Bill 2019 was neither contemplated nor prevailing at the time of the consideration and the approvals of the board and shareholders.”

As the company is not permitted to meet the buyback obligations beyond the amount approved by the board of directors and shareholders and the same can be effected only with borrowed funds, which is prohibited by law, KPR Mill was forced to withdraw its buyback plan, it further clarified.

Budget burden

In a move to crack down on companies avoiding dividend distribution tax and dividend taxation in the hands of their large shareholders, in the Budget last week, Finance Minister Nirmala Sitharaman proposed an additional tax of 20 per cent for listed companies proposing buyback of shares.

The buyback route was beneficial to shareholders till now, due to the non-applicability of additional dividend tax under Section 115 BBDA in the hands of the shareholders.

With the proposal, the advantage of buyback over dividend distribution is largely negated. Assuming a company having cash surplus of ₹100 for distribution to shareholders: Earlier the tax incidence would be just ₹10 (10 per cent long-term capital gains tax, for holding shares for more than a year). Under the new proposal, assuming the company has the same surplus, investors would get only ₹79, after a 20 per cent tax, including surcharge and cess paid by the company.

On the other hand, the effect of distribution tax on dividend, computed on grossed up basis, will work out to about 20 per cent on small shareholders (including surcharge and cess). For promoter shareholders though, the tax incidence is higher because of the additional 10 per cent tax on dividend receipts of over ₹10 lakh.

Needs clarity

However, the new proposal does not account for capital loss, i.e., if the acquisition price is higher than the buyback price. It needs clarity on whether long- or short-term capital loss on buyback in shareholders’ hands would be available for set-off in subsequent years.

The proposed tax might see many companies following KPR Mill’s example, which could negatively impact minority shareholders, as buybacks not only help shareholders receive surplus cash but also give stability to the company’s share price. Buybacks also help boost earnings per share of the company and thus, shareholder value.

What shape the distribution of surplus cash by companies will take from now, needs watching.

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