Buy-backs have been the topic of discussion in corporate corridors in India since Budget (No. 2) 2019 has extended the existing tax on buy-back of shares to listed shares. Earlier, listed companies used buy-backs as an alternative to reward shareholders, as dividend was proving an expensive alternative from a tax perspective.
A buy-back is a scheme by which a company repurchases a certain number of its outstanding shares usually at a price higher than the prevailing market price/ fair value of the shares. In this article, we have tried to capture the implications of buyback under various regulations and certain open issues.
As per section 115QA of the Income-tax Act, 1961 (Act), a domestic unlisted company carrying out buy-back of shares has to pay tax of 23.96% on the difference between the buy-back amount and the amount received by it on the issue of such shares. Consequently, the shareholders are exempt from paying tax on such difference under section 10(34A) of the Act. These provisions have now been extended to listed entities as well. Therefore, for a listed company, buy-back is no longer an attractive opportunity as compared to dividend on which dividend distribution tax has to be paid at 20.56%. These provisions have resulted in an array of issues. This is because the shares of a listed entity are traded frequently on a stock exchange and are fungible. Therefore, it is a challenge for listed companies to determine the amount received on issue of shares bought back for calculation of tax. In addition, in a situation involving multiple re-organisations, such as mergers, demergers, etc., it is difficult to trace the amount received by the company on the issue of such shares. Therefore, the ensuing Finance Bill should bring out some clarifications in this regard.
Quantum v. Number
Section 68 of the Companies Act, 2013 (Companies Act) deals with provisions pertaining to share repurchases. As per the said section, a company can undertake buy-back of shares only up to 25% or less of the aggregate of paid-up share capital and free reserves of the company. Further, if the buy-back is of equity shares, the reference to paid-up share capital shall be construed as paid up equity share capital of the company. The question that emanates is, does the Companies Act limit only the quantum of funds for buy-back or the number of shares which can be bought back. Unlike the erstwhile Companies Act, 1956, there is no specific restriction on quantum of buy-back—hence, a view can be taken that the quantum of shares that can be bought back has no limit.
Another condition is that when a company completes buy-back of shares, it cannot make further issue of the same kind of shares or other securities or allot new shares or specified securities for a period of six months, except by a bonus issue or conversion of pre-existing warrants, etc. The language creates confusion on whether the restriction is on the issue of the same kind of shares or any shares at all. The reference across section 68 of the Companies Act is “shares or other securities” can be bought back, etc.; therefore, the restriction should be read as limiting the ability of issuing the same share/ security within a period of six months of buy-back of share/ security only.
The buy-back of convertible securities has always been a topic of debate. Section 68 enables the repurchase of shares or other “specified securities.” Explanation I to Section 68 of the Companies Act defines “specified securities” to include employees’ stock option or other “securities” as may be notified by the Central Government. Until date, the Central Government has introduced no notification in this regard. Therefore, whether securities such as convertible debentures can be bought back on “as is” basis or first converted into equity shares and then bought back, remains unanswered. In addition, a view can be taken that buy-back of such convertible debentures is akin to their redemption and there are precedents of such transactions being carried out in the case of non-residents also.
Another issue is that of the debt-equity ratio. Section 68 provides that the debt to equity ratio post buy-back should not be more than 2:1. Generally, the ratio must be applied based on the standalone financials of the company. The SEBI, in a recent ruling, rejected the buy-back offer of an engineering major citing that the debt-equity ratio would have to be tested based on consolidated basis and not on standalone basis. However, this view may not impact unlisted companies.
Capital Redemption Ratio (CRR)
As per section 68 of the Companies Act, buy-back can be carried out by utilising securities premium and free reserves or through the proceeds of a fresh issue of shares. The company, under section 69 of the Companies Act, is also obligated to create CRR to the extent of face value of shares bought back by utilising free reserves and securities premium. The question here is—can CRR be created from balance in securities premium? Section 52 of the Companies Act prescribes the utilisation of securities premium balance and includes only usage of securities premium for buy-back of shares as per section 68 of the Companies Act. There are no enabling provisions for creation of CRR, specified under a different provision. Further, transfer of securities premium to CRR results in transfer from one restricted reserve to another and seems against the intent of the Companies Act. By implication, it means that a company cannot carry out buy-back through internal accruals, unless it has free reserves.
Another muddled area is the quantum of fresh issue of shares for buy-back. Buy-back can be done through proceeds of a fresh issue of shares or internal accruals. In a situation where the company has surplus cash but inadequate free reserves, the question in hand is – can fresh issue of shares be undertaken to the extent of the face value of shares being bought back or for the entire buy-back quantum? As CRR is required to be created to the extent of only face value of shares being bought back—the need for fresh issue of shares can be restricted to face value only.
The above analysis shows that buy-backs are easier said than done. One would have to consider the tax and regulatory nitty-gritties before deciding to undertake a buy-back.
Author: Amithraj AN –Partner and Hemanth Danda– Associate Director, MnA Tax, PwC India
The views expressed in this article are personal. The article includes input from Aaditi Kulkarni – Assistant Manager and Malavika Agarwal – Assistant Manager, M&A Tax, PwC India.