Buyback tax: A loophole fixed or an anomaly made worse? | Mint
Active Stocks
Tue Feb 27 2024 15:57:55
  1. State Bank Of India share price
  2. 749.70 -1.23%
  1. Tata Steel share price
  2. 144.15 1.09%
  1. Power Grid Corporation Of India share price
  2. 292.50 1.65%
  1. Sun Pharmaceutical Industries share price
  2. 1,579.10 1.42%
  1. ITC share price
  2. 411.15 0.48%
Business News/ Opinion / Columns/  Buyback tax: A loophole fixed or an anomaly made worse?

Buyback tax: A loophole fixed or an anomaly made worse?

In the past three fiscals, Indian firms bought back shares at an average rate of ₹47,800 crore

Photo: MintPremium
Photo: Mint

In the past three fiscal years, Indian companies bought back shares at an annual average rate of 47,800 crore. In the ten years before that, buybacks were far less popular, averaging about 4,100 crore per year.

What changed in fiscal 2016-17 was an increase in dividend tax, even though it applied only to those receiving dividend in excess of 10 lakh per year. While the multiple taxes on dividends had become burdensome, and even invited a mild protest from then RBI governor Urjit Patel, buybacks done through stock exchanges were tax free.

Using buybacks to avoid taxes was a no-brainer. Until finance minister Nirmala Sitharaman plugged the gap in budget 2019. Companies that choose to return cash through the buyback route will also now have a pay a 20% tax similar to the dividend distribution tax.

Investors have naturally revolted, since the move eats materially into their post-tax return expectations for equity investments. As Aswath Damodaran, professor of finance at New York University’s Stern School of Business says in a research paper, “To the extent that investors are taxed on the income that they make on their equity investments, they will have to demand a higher pre-tax return." A higher return expectation is another of way of saying investors will price those assets at relatively lower levels. Some experts say that Sitharaman has merely plugged a loophole. If India’s stand is to tax the distribution of cash to shareholders, then the tax should apply regardless of the method used for the disbursal. It’s difficult to argue with that.

But a moot question here is if it makes sense to tax dividends in the first place. Rather than seeing tax-free buybacks as a loophole that needed to be fixed, many experts rather see taxation of dividends as an anomaly that should have been corrected.

View Full Image

The argument that taxation of dividends amounts to double taxation of the same income is well known. A company first pays corporation tax on its income, and when that post-tax income is distributed to its owners, it needs to deduct a dividend distribution tax. In India, there is a third level of taxation, where shareholders who receive dividend income over 10 lakh in a year are taxed further.

In contrast, debt capital is treated very differently, which gives further weight to complaints that equities are given the step-brotherly treatment. The interest paid on debt is deductible from the income companies report to tax authorities. To bring parity, some countries allow a similar deduction for dividends paid. India, however, is an outlier, with multiple levels of taxes on equity shareholders.

As Patel had argued, these multiple levels of taxation obviously have an effect on investment and savings decisions. As such, the argument for removing the dividend tax anomaly isn’t merely to please equity shareholders, per se, but ultimately to encourage capital formation.

Of course, given India’s constraints on the revenue front, it isn’t entirely surprising that new taxes are being introduced, rather than revisiting taxes that can be counter-productive.

Still, as William Churchill’s famously said, “I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle."

The finance ministry can close all the loopholes it likes and attempt to increase its revenues, but whether it leads to prosperity is another matter altogether.

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Check all the latest action on Budget 2024 here. Download The Mint News App to get Daily Market Updates.
More Less
Published: 11 Jul 2019, 12:57 AM IST
Next Story footLogo
Recommended For You
Switch to the Mint app for fast and personalized news - Get App