Mumbai: The decision to impose the buyback tax of 20% on listed companies is a negative for Indian investors. Buybacks are earnings accretive and increase shareholder value, thereby raising interest in equity investments. So, this move is feared to drive investors away from Indian equities.

For instance, HSBC Global Research which has raised its China rating from neutral to overweight and lowered India to neutral from overweight. The foreign brokerage stated slew of factors that make Chinese equities an attractive bet over Indian stocks.

"Growth and valuations look better in China than they do in India, so too do its demographics," it said in a report on 10 July. Buyback is also one of the factors which HSBC has considered while making this switch of ratings between the two countries.

"Overall, average investor return is likely to decline by around 1% due to this tax," HSBC said in a report on 10 July.

A buyback tax is being imposed to discourage the practice of listed companies avoiding Dividend Distribution Tax (DDT) through share buybacks. Sector-wise, it is expected to hit IT companies the most who have been frequent users of this mode of returning cash.

“While this will increase the cash outflow for IT services companies that have been announcing buybacks, we understand that this may still be preferred over dividends (at least for companies where the promoter stake is high) as dividends are taxed in the hands of the company and the shareholder, while buybacks will be taxed only in the hands of the company," another foreign brokerage Morgan Stanley said in a report on 5 July. In the case of dividend, a separate tax applies to those earning dividend income over 10 lakh in a year.

Deepak Jasani, head of retail research, HDFC Securities Ltd says that buyback will be preferred by promoters who have large stakes.

“So, to that extent, dividend will become a little more acceptable form of distribution. For now there will be some halt to distribution of surpluses till companies figure out pros and cons. This temporary halt on distribution will impact efficient capital allocation in many companies," he added.

Apart from the buyback tax, other proposals such as increase of minimum public shareholding limit and higher taxes on foreign portfolio investors via a surcharge also hit investors’ sentiment hard.

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