BUYBACK OF SHARES – AN INSIGHT INTO VALUATIONS
- Abhinav Agarwal
- Oct 22, 2020
- 5 min read
Updated: Oct 23, 2020
1. WHAT IS BUYBACK?
A Buyback, commonly known as a “share repurchase”, is when a company buys its own outstanding shares to reduce the number of shares available in the open market. The reasons behind buy back of shares by a Company could be:
To increase the value of remaining shares (shares left after repurchase) available by reducing the supply;
To prevent takeover by other shareholders;
A repurchase reduces the number of shares outstanding, thereby inflating (positive) Earnings Per Share (EPS) and, often, the value of the stock (if other conditions remains unchanged);
A repurchase can demonstrate to investors that the business has sufficient cash set aside for emergencies and a low probability of economic troubles.
A buyback allows companies to invest in themselves. Reducing the number of shares outstanding on the market increases the proportion of shares owned by investors. A company may feel its shares are undervalued and do a buyback to provide investors with a return. And because the company is bullish on its current operations, a buyback also boosts the proportion of earnings that a share is allocated. This will raise the stock price if the same price-to-earnings (P/E) ratio is maintained.
2. RECENT BUYBACK
Among many buy-backs the most talked about recent ones are:
JUST DIAL LIMITED: Buy-back amounting to 220Cr was approved by the Company on April 30, 2020
MPS LIMITED: Buy-back amounting to 34Cr was approved by the Company on August 11, 2020
RITES LIMITED: Buy-back amounting to 257Cr was approved by the Company on September 18, 2020 (buy back in process as on the date of this article!!)
WIPRO LIMITED: Buy-back amounting to whopping 9500Cr was approved by the Company on October 7, 2020 (buy back in process as on the date of this article!!)
TATA CONSULTANCY SERVICES LIMITED: Buy-back amounting to a mind-boggling 16,000Cr was approved by the Company on October 7, 2020 (buy back in process as on the date of this article!!)
3. TAX AND REGULATORY FRAMEWORK
Companies Act, 2013
Section 68-70 of the Act provides power to the Companies to purchase its own “securities” subject to certain conditions and restrictions laid down therein:
The buy-back is authorised by its articles;
A special resolution is passed at a general meeting of the company authorising the buy-back if the quantum of buyback is more than 10% of paid-up equity capital and free reserves of the company otherwise authorisation by way of Board Resolution is sufficient;
The buy-back is twenty-five per cent or less of the aggregate of paid-up capital and free reserves of the company;
The ratio of the aggregate of secured and unsecured debts owed by the company after buy-back is not more than twice the paid-up capital and its free reserves;
All the shares or other specified securities for buy-back are fully paid-up;
Income Tax Act, 1960
Section 115QA of the ITA introduced w.e.f. June 1, 2013 contains provisions for taxation of a domestic company in respect of buy-back of shares (within the meaning of Sec. 68 of the Companies Act). In effect, the incidence of tax stands shifted completely to the Company and not the recipient of the buyback proceeds.
Before the enactment of Finance Act (No 2), 2019, this section was not applicable to shares listed on a recognized stock exchange. The Finance Act (No 2), 2019 has amended section 115QA of the ITA with effect from 5th July, 2019 extending its provisions to cover distributed income on buy-back of equity shares of a company listed on a recognized stock exchange as well.
Presently the tax rate under Section 115QA is 20% + 12% surcharge + 4% cess thus making the effective tax rate to be 23.296% on the distributed income (As on the date of this article!!).
Section 10(34A) of the ITA provided for exemption to a shareholder in respect of income arising from buy-back of shares w.e.f. April 1, 2014 (i.e. Assessment year 2014-15). The Finance Act (No. 2), 2019 has also made consequential changes to section 10(34A) of the ITA extending the benefit of exemption of income from buy-back to shareholders in respect of shares listed on recognized stock exchange as well.
In short, buy-back amount received is tax exempt in the hands of shareholder and taxable in the hands of Company @ 23.296% on the distributed income.
SEBI Buy Back Regulations, 2018
These regulations are applicable for listed Companies. The same is required to be complied by the Listed entities over and above the provisions mentioned for the same in Companies Act, 2013.
A listed company can buy back its shares in any of the following manners:
i. From the existing shareholders on a proportionate basis through the tender offer;
ii. From open market through:
a. Book building process
b. Stock exchange;
iii. From odd lot holders.
During pendency of buy back, promoter group are restricted from dealing in shares on the stock exchange or off market, including inter se transfer promoters. Buy back through open market operations to be restricted to 15% of paid up capital + free reserves (both on standalone and consolidated basis). No public announcement of buy back can be made during the pendency of any scheme of amalgamation or compromise or arrangement pursuant to the provisions of the Companies Act. Company cannot not raise further capital for a period of one year from the expiry of buy back period, except in discharge of its subsisting obligations. However, SEBI has recently relaxed the cooling off period temporarily for raising further capital to 6 months until 31 December 2020.
4. VALUATION REQUIRMENT IN BUYBACK
In Listed Companies
No methodology prescribed under SEBI Regulations for listed companies, however the board needs to determine a fixed price in a tender offer or a maximum price in case of open market operations.
Typically, it is a premium to the prevailing market prices at the time of the announcement. Let us look at a comparative analysis of recent Buy-Backs through tender offer:
From the above analysis we may draw a conclusion that a Buy-Back is generally offered at a premium to the market value / book value per share but how much premium is a decision vested completely with the board.
In Unlisted Companies
As per Income Tax Act: No methodology prescribed for fixing the buy-back price however reference check to Rule 11 UA valuation / Fair Market Valuation principles to be kept in reckoning from a good governance perspective.
It is imperative to note that Section 115QA of ITA speaks about taxation on distributed income under buy-back which is calculated on consideration paid by the company on buy-back of shares as reduced by the amount which was received by the company for issue of such shares. Though the law may be silent on calculation of buy-back price but Rule 40BB of Income Tax Rules does speak about the second part of the equation viz., amount received by the company in respect of issue of share.
As per Companies Act, 2013: No methodology prescribed for fixing the Buy-Back price but generally will be the Fair Market Value as per International Valuation Standards. Further Section 68 read along with its rules require a disclosure in the explanatory statement of the notice to shareholders meeting for the basis of arriving at the buy-back price. Ordinarily a valuation report may be obtained from a Registered Valuer to compute the same.
We may now draw a conclusion that pricing mechanism for buy-back may not be explicitly stated anywhere but from good governance perspective and from the Taxation and Regulatory angle, a valuation report is sufficient to justify the basis of buy-back price. The buy-back price may become a price point for tax purposes for future transactions like fresh issue or internal restructurings.
Disclaimer: The entire contents of this article are solely for information purpose and have been prepared on the basis of relevant provisions and as per the information existing at the time of the preparation by the Author. The Author of this Article does not constitute any sort of professional advice or a formal recommendation. You are kindly requested to verify and confirm the updates from the genuine sources before acting on any of the information’s provided hereinabove.
About the Author:
Name: Abhinav Agarwal (ACS, LL.B., B.Com (H), RV(IBBI))
Qualification: Registered Valuer (IBBI – Securities & Financial Assets), Company Secretary
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