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20% tax puts question mark on ongoing buybacks

The move will have a negative impact on the IT sector, says analysts

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The Union Budget has put paid to plans of IT (information technology) companies looking to buy back their shares. The Finance Bill 2019 has introduced a tax of 20% on distributed income for buyback of equity shares listed on a recognised stock exchange. The move may not have any major impact for IT majors in the immediate term, but has made buybacks an unattractive proposition.

While Infosys has already received a bulk of its shares under its current Rs 8,260 crore buyback programme,

Among the BSE100 firms, Wipro and Adani SEZ & Ports have ongoing buybacks.

While Wipro has fixed June 21 as the record date for its Rs 10,500 crore share buyback programme, Adani SEZ & Ports is looking to buy back shares worth Rs 1,960 crore.

Indian IT majors stepped up payout of free cash flow through a mix of dividend and buyback of shares, which is more tax efficient in the past three years. The tax-efficient route of buyback has been constrained by the change. Effectively, the cost of distribution of cash to shareholders stands a minimum of 20%.

"A domestic company shall be liable to pay additional income tax at the rate of 20% on the distributed income on buyback of shares listed on a recognised stock exchange from a shareholder," the amendment to the Finance Bill said. This amendment will take effect from July 5, 2019.

Effectively, buyback of equity shares will attract tax at the rate of 20% (plus surcharge). Incidentally, dividend distribution also attracts a tax of 20.56%. The rationale of imposing this tax is a belief that companies are using buyback to circumvent payment of dividend distribution tax (DDT). The tax on buyback of equity shares does not differentiate between the mode—tender or open market route, implying tax liability on both modes of a buyback.

The move will have a negative impact on the IT sector, analysts said. "The amendment leads to the taxation of at least 20% on the payout to shareholders. This tax is effectively an alternative form of income tax. The imposition of the tax makes the buyback difficult," Kawaljeet Saluja and Sathishkumar S of Kotak Institutional Equities said.

"Buyback is done by most of the IT companies so as to avoid dividend distribution tax," according to Amnish Aggarwal of domestic stock brokerage firm Prabhudas Lilladher. Indian IT companies stepped up pay-out ratio in the past three years and used a mix of dividend and buyback as compared to largely dividends in earlier years.

For example, of the total cash returned to shareholders by TCS in the past two years, 60% was done through buyback and 40% through dividends. TCS has bought back shares to the tune of Rs 16,000 crore while Wipro announced buyback programme in April this year, its third in four years. Infosys, which had returned around Rs 13,000 crore to shareholders, announced a Rs 8,260 crore buyback programme in January this year.

Wipro has largely used buybacks after a continuous increase in DDT with nearly 90% of the payout in the form of buybacks in the past two years. IT companies started using buybacks after the consistent increase in DDT, the imposition of tax on dividends at the rate of 10% in hands of individuals, partnerships, etc, for dividend in excess of Rs 10 lakh and the government allowed tender buyback to be done through the stock exchange route.

The tender buyback route was important since there was no long-term capital gains (LTCG) tax imposition on shares sold through a recognized stock exchange by shareholders. The LTCG was introduced only in FY2019 at the rate of 10%.

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