Investors may be in for more pain as buyback, public float norms set to bite

Mumbai: Union budget proposals to raise the public float of listed companies, a tax on stock buybacks and an increase in surcharge on high-income earners will weigh on stocks and affect returns of investors, analysts said.

While increasing public float in listed companies to 35% from 25% may prompt many multinational companies to delist their companies from Indian stock exchanges, stock buybacks may fall out of favour because of the 20% tax. Publicly traded firms had bought back shares worth ₹1.43 trillion in the past three years.

The increase in surcharge on income tax for the ultra-rich will lead to a steep rise in the tax incidence for investors, as the effective long-term capital gains (LTCG) tax rate would rise to as high as 14.25%.

Ambiguities related to the tax on share buybacks, the timeline for increasing public float, and surcharge levy on alternative investment funds and foreign portfolio investors (FPIs) established as trusts or non-corporate entities may add to the prevailing uncertainty.

The surcharge levy is on non-corporate entities; so, all funds established as trusts or any other non-corporate entity structure will attract the surcharge, affecting India’s attractiveness as an investment destination, said Bhavin Shah, partner at PwC India.

“The increase in surcharge will result in a steep rise in the tax incidence for foreign investors including FPIs set up as non-corporate entities. Effective tax rates will increase from 11.96% to 14.25% for long-term gains and from 17.94% to 21.37% on short-term capital gains on equities. Short-term capital gains on derivatives and debt securities will be taxable at 42.74%,” he added.

The pressure on Indian promoters would also continue as the top BSE 500 companies alone would need to sell shares worth ₹3.17 trillion to meet the proposed public float norm. Many of the companies that would need to increase their public float are large information technology firm.

Edelweiss Securities Ltd expects volatility in promoter-concentrated stocks such as Tata Consultancy Services Ltd, Wipro Ltd, L&T Technology Services and L&T Infotech.

HDFC Securities Ltd said that an increase in the minimum shareholding requirement could create a supply overhang in the markets limiting stock upside but if enough time were given for achieving this, then it might have limited impact.

While the budget impacted the attractiveness of buybacks as a way of returning cash to shareholders, some experts said it is still a more tax-efficient route than paying dividends.

“Currently, when dividends are paid, companies pay 20% tax and investors pay 10%. So, even at 20% tax rate, buybacks are cheaper,” said Girish Vanvari, founder of Transaction Square, a corporate advisory firm. “The companies can also resort to bonuses as these are taxed only when bonus shares are sold in the market. But the catch is bonus does not remove the cash from a company, so it will do very little in correcting the balance sheets of big IT companies.”

The surcharge on high-income groups is being viewed as a back-door increase in LTCG.

“Since increase in surcharge will apply on total tax levy, accordingly, even incomes such as capital gains, which are subject to special rate of tax, shall suffer the same additional surcharge,” said Riaz Thingna, director of Grant Thornton Advisory Pvt. Ltd.

Currently, 15 buybacks have been announced, including one by Wipro. The Finance Bill for 2019 said the buyback tax is applicable from 5 July.

“It is unclear whether it (buyback tax) kicks in for ongoing buybacks or for the ones that will be announced post 5 July,” said Vanvari.

“With regard to buyback, while we believe the impact on TCS and Infosys would be limited, Wipro’s ability to return cash to shareholders in the form of buybacks would be severely constrained,” said analysts at Edelweiss Securities Ltd.

Of the total cash returned to shareholders by TCS in the past two years, 60% was done through buybacks and the rest through dividends. Wipro has largely used buybacks after a continuous increase in dividend distribution tax, with nearly 90% of the payout in the form of buybacks in the past two years.