With the fall in share prices, quite a few companies have announced share buy-backs. Most of these buy-backs are executed at a premium to the prevailing stock market price. While buy back price is one of the deciding factors, there are various other factors that one needs to consider when deciding whether to offer one’s shareholding in a buy-back. The likelihood of the shares being accepted considering the non-promoter shareholding, the likely movement of the shares after the buy-back, and the tax that one would incur are also relevant factors in making such a decision.
Kinds of buy-backs: Share buy-backs are of two kinds. One is executed on the stock market at the prevailing market price, but with an upper price limit, while the other is an offer made to the shareholders at a fixed price. Both these are offers made by the company, where the company buys back its own shares. There are also delisting and open offers made to the shareholders. These are not offers made by the company and not in the nature of share buy-backs, but are offers made by the promoters or acquirers of shares of the company to purchase your shares.
Buy-back at market price: In case of buy-back of shares from the stock market, the company purchases shares from the stock market, just like any other investor, though an announcement is made in advance by the company. The shareholder would be selling his shares on the stock market and paying securities transaction tax (STT) thereon, just like any other sale of shares. In fact, the shareholder would not even be aware of who the purchaser is in such a transaction—like in any other stock market sale, the purchaser’s name would not be known to the seller. As far as the shareholder is concerned, such a transaction is a sale on the stock market which has been subjected to STT and, therefore, the long-term capital gains arising on the sale of shares is exempt, and short-term capital gains on such sale is subject to tax at 15%.
Buy-back at fixed price: In the second type of share buy-back, the company makes a direct offer to the shareholders to buy back its shares. The shareholders transfer the shares to a demat account opened by the company or send the physical share certificates along with the signed transfer forms to the company and the company makes the payment directly to the shareholders. Such transfers are, therefore, not carried out on the stock markets but are off-market transactions and are not subjected to STT. The gains made on such sales made in buy-backs are, therefore, subjected to tax. The same position prevails with respect to open offers and delisting offers.
Taxation: Since the gains are in respect of listed shares, the long-term capital gains is subjected to a tax, which is the lower of 10% of the gains computed without cost indexation, or 20% of the gains computed with cost indexation. There is no concessional treatment for short-term capital gains arising due to such buy-backs and such gains are taxed at your slab rates, like any other income. You, therefore, need to evaluate whether it is worthwhile selling your shares in the stock market at a slightly lower price or offering the shares to the company in the buyback/delisting/open offer and paying tax on the gains.
Consider the example of Siemens, where the promoters are making an offer to buy the shares of the company at Rs930 and the current market price is about Rs850. Assume that you are holding 1,000 shares and that 60% of the shares are likely to be accepted in the open offer. If the shares are long-term capital assets, whose cost is Rs200, the gains (without indexation) on sale of 600 shares at Rs930 would be Rs4,38,000, and the tax thereon would be a maximum of Rs43,800, leaving you with a net gain of Rs3,94,200. On the other hand, if you were to sell 600 shares on the stock market, your tax-free gains would be Rs3,90,000. You may, therefore, be slightly better off by offering the shares in the open offer.
Of course, the solution would be different for each shareholder, depending upon the cost and period of holding. For instance, if the same shares have been held by you for less than a year, assuming you are in the 30% tax slab, selling 600 shares on the stock market would yield a post-tax gain of Rs3,31,500 (Rs3,90,000 less 15% thereof), while selling the shares in the open offer would give a net of tax gain of Rs3,06,600 (Rs4,38,000 less 30% thereof). In such a case, you are clearly better off selling the shares in the stock market, rather than tendering them in the open offer.
Knowing your potential tax liability, therefore, helps you to maximize your gains by taking the right decision. Of course, tax is just one aspect and there are other factors that you need to consider while making your decision. For instance, you may decide that the stock concerned is a good long-term holding and, therefore, you may just hold on to the shares.
Gautam Nayak is a chartered accountant.
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