Look for a better deal in that buyback offer

Monsoon brings cheer far and wide. Farmers are excited about their crop, shoppers are delighted about the retail sales. This year a shower of different kind is drenching investors – that of buyback offers.

There aren't just a handful of offers, unlike every year. Since the start of the year, sizeable companies such as Dr Reddy's, Wipro, Excel Industries, Bharti Infratel and Bharti Airtel, Novartis, Nalco, NMDC, MOIL, Coal India, On Mobile and Sun Pharma have announced buyback offers.

As per Prime Database, just three offers during the start of the financial year 2016-17 have totalled to buybacks worth Rs 1,600 crore, as compared to 16 offers which involved merely Rs 1,834 crore during the previous financial year.

While the public sector units have announced buyback offers to help the government meet its disinvestment target and offload stake, leading private names are resorting to buybacks to save on the tax bill post the Union Budget 2016 announcement of taxing dividends exceeding Rs 10 lakh in the hands of the investors.

"Buyback is another way of paying back shareholders. After the tax imposed by the government on dividends above Rs 10 lakh, companies are using the buyback way to reward shareholders," points out Deven Choksey, managing director of KRChoksey Shares and Securities.

Promoters receive a sizeable portion of dividends, which would overshoot the Rs 10-lakh limit. For them, it would mean double taxation if one takes into account the 20% dividend distribution tax apart from tax on high value dividends. That explains why a majority of the buybacks offered during the year are tender buybacks where promoters can participate and not open market offers which are led by non-promoters.

A buyback rewards investors in a way akin to dividends and isn't hard hitting on the tax front too, say experts. When a company buys back, the number of shares outstanding in the market reduces and hence the market capitalisation. Not just promoters, but lay investors too benefit from a buyback as the stock price tends to move in tandem with the buyback price.

Take for instance the price of Sun Pharma, which announced a 7.5 million-share buyback at Rs 900 per share on June 23, 2016, when the stock closed at Rs 752. The stock stood firm post the Brexit revelation and traded at a price as high as Rs 775.3 before closing at Rs 773.75 on Monday, more than a fortnight away from the record date of July 15, 2016.

"Buyback is a good opportunity in terms of the price offered. However, quantity of shares that can be sold during the buyback would be limited," says Choksey.

But before you consider using the buyback opportunity to profit from your investment, you should consider the impact of taxation on the gains. Dividends below Rs 10 lakh are tax-free in the hands of investors, so are the gains made on selling shares after holding them for at least 12 months. But the same isn't true about shares being sold to a company under a tender offer.

Under a buyback where one sells the shares to the company, Securities Transaction Tax is not paid as shares aren't sold in the open market.

"When you don't sell on the exchange, no STT is paid and hence long-term capital gains tax is applicable, if you have held the shares for more than one year and short-term capital gains tax of 15% is applicable if you are tendering it earlier," says chartered accountant Mehul Sheth.

Taxation can tilt the balance for you under buybacks. "Typically, investors are better off not tendering their shares in a buyback as STT of 0.01% is hardly anything, when you compare with a long-term capital gains tax which would be 10% without indexation and 20% with indexation," adds Sheth.

But there are situations where you would have to weigh your gains and act. A back of the envelope calculation would help you make the decision.

"You need to do your math ahead of tendering as to whether you are better off selling shares in the open market and paying no tax or offering shares at a higher price in the buyback and paying tax," says Choksey.

Consider a situation where you purchased 200 Sun Pharma shares at Rs 500 five years ago and a buyback is being offered at Rs 900 through buy back, while the trading price is Rs 773. If you tender shares in the buyback, you would be paying Rs 8,000 worth of tax without indexation on the gains of Rs 80,000. If you sold it in the open market at a trading price of Rs 773, you would make tax-free gains of Rs 54,600. So, if the share price in the open market doesn't move much then you are better off paying the tax and opting for buyback as your benefit would be Rs 25,400.

But this isn't the scene usually. As seen in the stock of Excel Industries, which rallied 36% in four trading sessions from Rs 171 after the company announced that it would buyback 1.15 million shares at a price not exceeding Rs 275 per share. The buyback was announced in March 2016. Today the stock has crossed the buyback price barrier.

This apart, Choksey indicates there is also an arbitrage opportunity available, wherein you sell off shares in a buyback at a higher price and buy in back in the open market at a lower rate.