When it comes to rewarding shareholders, the first thing striking one’s mind is cash dividend. As ways of doing businesses are evolving, so are corporate approaches when it comes to rewarding their shareholders. Bonus shares (equity and preference shares), bonus debentures, buyback, etc., are new fashionable ways in which shareholders are being rewarded.
The mode using which a company wants to reward shareholders depends on the commercial objectives of the company. While dividends and buyback involve immediate payout by the company, bonuses involve issuance of additional equity/ preference shares or debentures leading to no immediate cash outflow.
Tax outflow is another important consideration for decision making. Dividend distribution tax (DDT) of 20% is payable by the company, and 10% has to be borne by shareholders (other than the company) if their dividend income exceeds Rs. 10 lakh.
Buyback of shares by listed companies entails nominal outflow of 0.125% in the form of securities transaction tax (STT) unless the shares are held for short-term, which leads to capital gains tax of 15%. Buyback of shares by unlisted companies results in tax of 20% payable by the company, whereas the proceeds are not taxable in the hands of shareholders.
Buyback helps in improving return on assets and return on net-worth and additionally provides an exit route to shareholders when shares are undervalued or thinly traded.
Bonus instruments are issued to shareholders free of cost in proportion to their shareholding by capitalizing reserves. Issue of bonus equity shares increases the total share capital of the company, keeping the net worth intact. However, issue of bonus debentures/ redeemable preference shares (RPS) increases liability of the company, thereby impacting its net worth. The issue of bonus debentures/ RPS enables the company to provide a steady stream of returns to its shareholders over the tenure of the instrument. Shareholders can also create immediate liquidity by selling the bonus instruments if the same are listed.
The table below helps to assess the divergence between different ways of remunerating shareholders:
|Basis||Bonus equity shares||Bonus RPS||Bonus debentures||Buyback|
|Mechanics||Reduce the amount of reserves and surplus and increase the amount of share capital.||Reduce the amount of reserves and surplus and increase the amount of debt.||Reduce the amount of reserves and surplus and increase the amount of debt.||Reduce bank balance and share capital.|
|Net worth of the company||No impact||Reduced||Reduced||No impact|
|Income-tax implications||On issuance –
|On issuance – No implications
Dividend paid, if any, is subject to DDT in the hands of the company; taxable in the hands of the shareholders if dividend receipt exceeds Rs.10 lakh.
On transfer/ sale – Entire consideration taxable in the hands of the shareholder since cost is NIL.
On redemption – Liable to DDT @20.367%Online GST Certification Course by TaxGuru & MSME- Click here to Join
Listed companies may consider buyback of the RPS (on market) depending on its commercial objectives.
|On issuance – DDT liability in hands of the company
As debentures carry interest, investors are eligible to receive interest payment, which is a tax deductible expense for the company. However, interest is taxable in the hands of the shareholders.
Subsequently, when debentures are redeemed/ sold, the redemption/ sale price is not taxable to the extent of debenture value taxed as dividend at the time of issuance of debentures. The redemption premium, if any, is taxed as interest/ capital gains.
|In case of listed shares where STT is paid –
Long term capital gain is exempt.
Short term capital gain is taxable.
In case of unlisted shares –
Buyback tax of 20% payable by the company, and no implications in hands of the shareholders.
|Cash outflow||No outflow||Cash outflow on redemption and payment of dividend.||Immediate outflow in the form of DDT, periodical interest and on redemption.||Cash outflow to the shareholder and payment of buyback tax (in case of unlisted shares).|
There is no general rule on the mode of rewarding shareholders, and it depends on the company’s intentions, strategy, future business plans, position it wants to create in the market, etc. If the company intends to maintain liquidity and provide staggered cash flow to the shareholders, it may opt for bonus RPS or debentures.
Cash rich companies clubbed with less meaningful deployment options, such as funds that are over and above the ordinary capital requirement, may opt for buyback of shares. Considering interest is a tax deductible expense, a company (which is under leveraged) may opt for bonus debentures.
However, one has to remember that there is DDT liability when bonus debentures are issued, unlike in the case of bonus equity shares/ RPS.
Like shares, companies can also list debentures on the stock exchanges, providing debenture holders marketability of the instruments and creating the requisite liquidity for them.
Besides the above strategy calls, the company may also need to consider procedural issues. Issuance of bonus debentures is not expressly covered under the provisions of the Companies Act, and hence they have to be issued under the scheme of arrangement. This is subject to approval of the Tribunal and other statutory approvals from various regulatory authorities. Again, for issuance of bonus RPS and debentures, the Reserve Bank of India mandates that such issuance to non-residents/ foreign shareholders through the scheme of arrangement is subject to obtaining no objection from the Tax Authorities. This is not the case for the issuance of bonus equity shares. In case of buyback, the buyback process laid under the Companies Act and the Securities and Exchange Board of India (for listed shares) must be complied with. The lengthy and time-consuming procedures may dissuade the company from opting for issuance of bonus debentures/ RPS or buyback.
Moreover, the investor’s perception on the mode of distribution would be a determining factor for the management. Typically, an investor’s perception towards cash dividend is more favourable than the newer ways of rewarding. However, it needs to be noted that other modes of distribution could definitely prove to be more efficient than conventional distribution.
As there are no straightforward answers, the management may have to weigh the pros and cons if it decides to remunerate or distribute profits to its shareholders in ways other than through the traditional way of cash payout.
(The views expressed in this article are personal. It includes inputs from Siddhi Udani, Manager, M&A Tax, PwC India, and Aradhana Singh, Associate, M&A Tax, PwC India.)