Buyback of Shares in India – Meaning, Reason, Types, Taxability

Introduction

In the dynamic world of corporate finance, the buyback of shares has emerged as a significant tool for companies to optimize their capital structure and reward shareholders. Simply put, a buyback of shares happens when a company repurchases its own shares from the market or its shareholders, usually at a higher price than issue. This action reduces the number of outstanding shares, effectively consolidating ownership and potentially enhancing shareholder value. Consequently, buyback of shares is subject to strict legal frameworks.

The concept of buyback of shares plays a pivotal role in India’s evolving corporate landscape, where businesses increasingly use this mechanism as an exit strategy to strengthen investor confidence and showcase financial stability. Whether you’re an investor keen on maximizing returns or a company exploring strategic financial moves, understanding the meaning and relevance of buybacks is crucial.

What is Buyback of Shares?

Definition and Meaning

A buyback of shares is a corporate action whereby a company reacquires its own outstanding shares from the market or existing shareholders. This reduces the number of shares available in the market, thereby increasing the proportional ownership of remaining shareholders and often boosting key financial metrics like Earnings Per Share (EPS).

Example:
Imagine a company has 1,000 outstanding shares, and its total profit is ₹1,00,000. The Earnings Per Share (EPS) would be ₹100 (₹1,00,000 ÷ 1,000 shares). If the company repurchases 200 shares through a buyback, the outstanding shares are reduced to 800. The EPS now becomes ₹125 (₹1,00,000 ÷ 800 shares), which enhances the value for the remaining shareholders.

Importance of Buyback of Shares for Companies and Investors

In India, buybacks have gained prominence due to their dual benefits:

For Companies

1. Enhanced Financial Ratios:
   A buyback increases EPS by reducing the number of shares in circulation, which can improve the perception of the company’s profitability.
2. Efficient Use of Surplus Cash:
   Companies with excess reserves often prefer buybacks over dividends, as it avoids tax on dividends and optimizes shareholder returns.
3. Signaling Confidence:
   By repurchasing its shares, a company conveys that its stock is undervalued, boosting market confidence and stabilizing share prices during volatility.
4. Capital Structure Optimization:
   Companies use it to optimize their capital structure under the regulatory framework of the Companies Act, 2013, and SEBI guidelines.

For Investors

1. Opportunity for Higher Returns:
   Shareholders participating in a buyback often receive a premium over the prevailing market price, providing an attractive exit option.
2. Ownership Consolidation:
   Fewer shares outstanding mean that each share represents a larger ownership stake in the company, benefiting long-term investors.
3. Tax Benefits:
   Shareholders may find buybacks more tax-efficient compared to receiving dividends, especially in jurisdictions with high dividend taxes.
4. Market Perception:
   A buyback of equity shares is often perceived as a positive move, signaling that the company is confident about its future prospects.

The primary reasons behind a buyback include:

• Reducing the number of outstanding shares to increase Earnings Per Share (EPS).
• Signaling confidence in the company’s intrinsic value.
• Utilizing surplus cash in a tax-efficient manner.
• Providing investors with an exit mechanism (especially when no other exit options are consummated).

Buybacks are commonly executed in the Indian securities market, including by corporate giants like Infosys Ltd., Tata Consultancy Services Ltd., and Wipro Ltd., emphasizing their importance in today’s financial ecosystem. The buyback of shares in India is a confidence-building measure for all stakeholders involved. This is not just a tactical financial decision; it is also a tool for strengthening a company’s relationship with its investors. From improving financial ratios to boosting shareholder value, the buyback of shares meaning extends beyond just repurchasing shares it reflects a company’s commitment to optimizing its capital structure and instilling market confidence.

Reasons for Buyback of Shares 

The buyback of shares has become a popular financial strategy for companies seeking to strengthen their market position and enhance shareholder value. Here are the key reasons for buyback of shares and the strategic benefits they offer:

1. Efficient Use of Surplus Cash

One of the primary reasons for buyback of shares is to utilize surplus cash reserves effectively. Instead of letting idle cash accumulate, companies use buybacks as a way to reinvest in their own stock. This helps optimize their capital structure and deliver returns to shareholders. This strategy is derived from limitations prescribed under the Indian law as to the source of funds for the buyback of securities by a company.

Example: If a company has significant cash reserves but limited high-yield investment opportunities, a share buyback is a strategic way to deploy that excess cash.

Benefits of Buyback of Shares:

• Avoids inefficient use of capital.

2. Boosting Earnings Per Share (EPS)

Reducing the number of outstanding shares through a buyback directly impacts a company’s EPS. A higher EPS often attracts investors by signaling improved profitability and financial health.

Example: A company earning ₹10,00,000 annually with 1,00,000 shares outstanding, results in an EPS of ₹10. If the company buys back 20,000 shares, the EPS increases to ₹12.5 (₹10,00,000 ÷ 80,000 shares).

Benefits:

• Enhances shareholder value.
• Improves valuation metrics like Price-to-Earnings (P/E) ratio.

3. Indicating Stock Undervaluation

A buyback often signals that the company believes its stock is undervalued in the market. By repurchasing shares, the company reinforces confidence in its intrinsic value, which can help stabilize or boost stock prices.

Strategic Decision: This move not only supports the share price during market downturns but also builds investor trust.

4. Strengthening Market Perception

Buybacks are seen as a positive indicator of a company’s financial strength, particularly in case of public listed companies. Investors interpret this move as a vote of confidence from the management about the company’s future growth and profitability.

Benefits:

• Improves investor sentiment.
• Attracts long-term investors.

5. Adjusting Capital Structure

Companies often aim to maintain an optimal balance between equity and debt. A buyback helps reduce equity capital, leading to better leverage ratios and overall financial efficiency.

Strategic Financial Decision: By reducing equity, companies can enhance returns on equity (ROE) and improve their capital structure for sustainable growth.

6. Preventing Hostile Takeovers

In some cases, public listed companies use buybacks as a defensive strategy to reduce the number of shares available in the market. This limits the potential for hostile takeovers by external entities. Buyback can also be offered as an exit strategy for investors in order to ensure that the share capital is brought back into the company, and not sold to a third party buyer – especially when such a move would be strategically advantageous for the company.

Example: By repurchasing shares, the company consolidates ownership and control, strengthening its position against unwanted acquisitions.

Types of Buyback of Shares

The buyback of shares can be executed in different ways, depending on the company’s objectives and regulatory requirements. Under law, buyback can be executed through: (i) open market; (ii) tender offers; (iii) odd lots; and (iv) purchase of ESOP or sweat equity options. Of these, the most commonly used methods are Open Market Buybacks and Tender Offer Buybacks. Each has its own procedures, advantages, and implications for companies and shareholders. Let’s explore these types and compare them to understand their strategic significance.

1. Open Market Buybacks

In an open market buyback, a company repurchases its shares directly from the stock exchange. The process is gradual, with the company buying shares over a specified period, depending on market conditions and availability.

How They Work:

• The company announces a buyback plan specifying the maximum price and the total number of shares it intends to repurchase.
• Shares are bought back at prevailing market prices.
• The process can extend over several months to achieve the desired share quantity.

Key Features:

• Flexible and cost-efficient.
• Shareholders are not obligated to sell their shares.

Example: A company like TCS or Infosys may execute an open market buyback to boost shareholder value and stabilize stock prices over time.

Critical Conditions for Buyback of Shares:

• Must comply with SEBI regulations for listed companies.
• A maximum of 25% of the total paid-up capital and free reserves can be used for buybacks in a financial year.

2. Tender Offer Buybacks

In a tender offer buyback, the company offers to buy shares directly from its existing shareholders at a specified price, which is usually at a premium to the market price.

How They Work:

• The company issues a public offer, inviting shareholders to tender (sell) their shares.
• Shareholders can choose to accept or reject the offer.
• Once the buyback is completed, the tendered shares are canceled, reducing the total outstanding shares.

Advantages of Tender Offers:

• Offers a premium price, making it attractive to shareholders.
• Ensures a quicker and more predictable process compared to open market buybacks.

Example: Wipro conducted a tender offer buyback, providing shareholders with a lucrative exit option while optimizing its capital structure.

Critical Conditions for Buyback of Shares:

• Companies must ensure that the buyback price is fair and justifiable.
• Shareholders holding equity in dematerialized form must tender shares electronically.

Comparison: Open Market Buybacks vs. Tender Offer Buybacks

Aspect	Open Market Buybacks	Tender Offer Buybacks
Execution Method	Shares purchased gradually via stock market.	Shares purchased directly from shareholders.
Price Offered	Market price at the time of purchase.	Premium price fixed by the company.
Timeframe	Extended period, often months.	Limited duration, usually a few weeks.
Shareholder Participation	Voluntary, no obligation to sell.	Voluntary, but a direct invitation.
Cost Efficiency	Cost-effective due to market-driven pricing.	Higher cost due to premium pricing.

Legal Framework and Procedure for Buyback of Shares in India

The buyback of shares in India is governed by a well-defined regulatory framework to ensure transparency, fairness, and compliance. The key regulations include provisions under the Companies Act, 2013 and guidelines from the Securities and Exchange Board of India (SEBI). Here’s a detailed overview of the legal framework and the step-by-step process for buybacks in India.

Legal Framework: Companies Act, 2013 and SEBI Regulations

1. Companies Act, 2013
   • Section 68 of the Companies Act, 2013 primarily governs the buyback of shares by a company, read with Rule 17 of the Share Capital and Debenture Rules, 2014. 
   • Companies can buy back shares out of:
     • Free reserves;
     • Securities premium account; or
     • Proceeds of any earlier issue of shares. No proceeds from an earlier issue of shares / securities of the same kind that are sought to be bought back can be used.
   • The buyback must not exceed 25% of the total paid-up share capital in a financial year.
   • The company is required to follow certain corporate processes in this regard, including obtaining approval of the buyback by the board of directors and/or the shareholders (as may be required). 
   • Company cannot make a buyback offer for a period of one year from the date of the closure of the preceding offer of buy-back.
   • For a period of 6 months, no fresh issue of shares is allowed.
   • Post buyback the debt equity ratio cannot exceed 2:1.
2. SEBI Regulations
   • SEBI (Buyback of Securities) Regulations, 2018 govern buybacks for listed companies.
   • Companies must file a public announcement with SEBI before initiating a buyback.
   • The buyback price must be justified, and adequate disclosures must be made to protect investor interests.

Step-by-Step Process for Buybacks in India

1. Board Approval

• The Board of Directors discusses and approves the buyback proposal.
• For buybacks exceeding 10% of paid-up capital and free reserves, shareholder approval is required through a special resolution.
• The buyback should be completed within a period of 1 year from the date of such resolution passed.

2. Public Announcement

• In case of a public listed company, the company makes a public announcement detailing:
  • The buyback price.
  • The number of shares to be repurchased.
  • The timeline and reasons for the buyback.

3. Filing with SEBI

• Listed companies file the offer document with SEBI within five working days of the public announcement.

4. Appointment of Intermediaries

• In case of a listed company, a merchant banker shall be appointed to oversee the buyback process and ensure compliance with SEBI regulations.

5. Execution of Buyback

• Open Market Buyback:
  • The company purchases shares through stock exchanges at prevailing market prices.
• Tender Offer Buyback:
  • Shareholders tender their shares electronically through their broker.

6. Completion and Reporting

• After completing the buyback, the company extinguishes the repurchased shares.
• A compliance certificate is submitted to SEBI within seven days of the buyback closure.

7. Filing with ROC/MCA

• Through the buyback process, the company will also be required to file certain forms with the Registrar of Companies (under Ministry of Corporate Affairs) including Form SH-8 (where a special resolution has been passed), Form SH-9 (declarations by the directors including managing director), Form SH-10 (statutory register), Form SH-11 (return of buyback) and a compliance certificate in Form SH-15.

How to Apply for Buyback of Shares Online

For shareholders looking to participate in a buyback of shares of a public listed company, this can be pursued online:

1. Check Buyback Details:
   • Review the company’s public announcement to understand the buyback price, eligibility criteria, and timeline.
2. Tender Shares via Broker:
   • Log in to your trading account.
   • Navigate to the corporate actions section.
   • Select the buyback offer and enter the number of shares you wish to tender.
3. Confirmation and Settlement:
   • After submitting your application, you will receive a confirmation.
   • If accepted, the buyback amount will be credited to your bank account within the stipulated timeline.

Taxability and Financial Implications of Buyback of Shares

Understanding the tax on buyback of shares is crucial for both companies and investors, as it impacts the overall financial outcome of the transaction. The tax implications for buybacks differ depending on whether the shares are listed or unlisted. Under the Income Tax Act, 1961, share buybacks historically attracted company-level buyback taxation, exempting shareholders from buyback tax liability. However, effective October 1, 2024, the regime has shifted the buyback taxation regime to the proceeds in the hands of shareholders.

1. Tax on Buyback of Shares for Companies

• Previous Regime:

• Companies were liable to pay a buyback tax under Section 115QA at an effective rate of 23.296%, including surcharge and cess.
• Shareholders were exempt from tax on buyback proceeds under Section 10(34A).
• Current Regime (Post-October 2024):

• The buyback tax under Section 115QA has been abolished.
• Companies must now deduct Tax Deducted at Source (TDS) on buyback proceeds: (i) 10% TDS for resident shareholders; and (ii) TDS at applicable rates under Section 195 for non-residents, considering relevant DTAA benefits.

• Example: If a company buys back shares worth ₹10 lakh from a resident shareholder, it must deduct ₹1 lakh (10% TDS) before disbursing the amount.

2. Tax on Buyback of Shares for Investors

• Tax Treatment for Shareholders:

• The proceeds are now treated as deemed dividend under Section 2(22)(f) and taxed under “Income from Other Sources.”
• Tax rates applicable to the shareholder’s income slab apply to the buyback proceeds.
• No Deductions Allowed:
• As per Section 57, shareholders cannot claim deductions for any expenses incurred in relation to the buyback.

• Example: If a shareholder in the 30% tax slab receives ₹10 lakh in buyback proceeds, they will pay ₹3 lakh as tax.

3. Capital Gain on Buyback of Shares

While buybacks now fall under the “deemed dividend” category, their impact on capital gains is significant:

• Capital Loss Recognition:

• Shareholders can declare the original cost of the bought-back shares as a capital loss since the consideration for capital gains computation is deemed NIL.
• This loss can be carried forward for 8 assessment years and set off against future capital gains.
• Financial Implications:
• Shareholders with a substantial cost base may face capital losses, impacting their overall tax position in future years.

• Example: If a shareholder purchased shares for ₹5 lakh and sold them back under buyback, they could recognize a ₹5 lakh capital loss to offset against future gains.

Financial Implications

1. For Companies:
   • Eliminating the buyback tax reduces the immediate tax burden but increases compliance due to TDS requirements.
2. For Shareholders:
   • Taxing proceeds as deemed dividends may result in higher tax liabilities, particularly for those in higher income brackets.
   • The introduction of capital loss provisions adds complexity but can be leveraged for long-term tax planning.

The tax on buyback of shares plays a significant role in determining the financial viability of a buyback for companies and its attractiveness to investors. 

Advantages and Disadvantages of Buyback of Shares

Advantages of Buyback of Shares

1. Increase in Shareholder Value
   • A buyback reduces the total number of outstanding shares, boosting key financial metrics like Earnings Per Share (EPS).
   • This leads to higher valuations and returns for long-term investors.
2. Signal of Undervalued Stock
   • Companies repurchase shares to signal that their stock is undervalued, restoring investor confidence and stabilizing prices.
3. Efficient Use of Surplus Funds
   • Instead of letting idle cash accumulate, companies use buybacks to optimize their capital structure and reward shareholders.

Key Benefits:
The advantages of buyback of shares include enhanced shareholder returns, improved financial ratios, and positive market perception.

Disadvantages of Buyback of Shares

1. Misallocation of Funds
   • Companies may prioritize buybacks over investing in growth opportunities, potentially harming long-term profitability.
2. Impact on Liquidity
   • Large buybacks can strain a company’s cash reserves, reducing financial flexibility in times of need.
3. Short-Term Focus
   • Buybacks may artificially inflate stock prices, prioritizing short-term gains over sustainable growth.

Key Concerns:
The disadvantages of buyback of shares revolve around potential financial strain, taxation liability on shareholders and missed investment opportunities.

Dividend vs. Share Buyback: Key Differences Explained

Dividends and share buybacks are two common methods companies use to return value to their shareholders, but they have distinct characteristics. Dividends involve the direct distribution of a company’s profits to all shareholders, typically on a regular basis, and are taxed at multiple levels. In contrast, share buybacks occur when a company repurchases its own shares, reducing the number of outstanding shares, which can potentially increase the earnings per share (EPS) and the stock price. While dividends offer immediate income to shareholders, buybacks are seen as a signal of undervalued stock and efficient capital use. The tax treatment of buybacks is more favorable, as they are subject to a single tax on the company’s earnings, unlike dividends, which face taxes at both the corporate and shareholder levels.

Aspect	Dividend	Share Buyback
Definition	A portion of a company’s earnings distributed to all shareholders.	A company repurchases its own shares from shareholders.
Beneficiaries	All existing shareholders.	Shareholders who choose to sell their shares back to the company.
Effect on Share Count	The total number of outstanding shares remains unchanged.	The total number of outstanding shares decreases.
Frequency	Often periodic (e.g., annual, quarterly) or special in nature.	Typically irregular and less common in markets like India.
Tax Treatment	Taxed at multiple levels (e.g., corporate tax, dividend tax for high earners).	Taxed through a buyback tax paid by the company (20% in India), with no further tax for shareholders.
Signal to Market	Indicates stable profits and cash flow.	Can signal undervalued stock or efficient use of surplus cash.
Types	Various types (e.g., regular, special, one-time).	No distinct types; generally a single mechanism.
Impact on Shareholder Value	Provides immediate income to shareholders.	Increases earnings per share (EPS) and potentially share price over time.

Wrapping things up, the buyback of shares in India is a vital corporate strategy that allows companies to repurchase their own shares from shareholders, offering various advantages like boosting earnings per share (EPS) and signaling confidence in the company’s valuation. The process involves adhering to legal frameworks such as the Companies Act, 2013, and SEBI regulations. Buybacks can be carried out through open market purchases or tender offers, with both having distinct implications for companies and investors. The tax treatment of buybacks in India is relatively favorable, with capital gains tax applicable on the sale of shares, making it a tax-efficient alternative to dividends. Understanding the reasons, types, legal requirements, and taxability of buybacks is essential for investors and companies to leverage this tool effectively in their financial strategies

Frequently Asked Questions (FAQs) on the Buyback of shares in India

1. What is a buyback of shares in India?

A buyback of shares in India refers to the process where a company repurchases its own shares from the existing shareholders, typically through the open market or a tender offer. This can help improve the company’s financial structure, enhance shareholder value, or use excess cash.

2. Why do companies buy back their shares?

Companies buy back shares to increase the value of remaining shares, improve financial ratios like earnings per share (EPS), return surplus cash to shareholders, or signal confidence in the company’s future performance.

3. How does a buyback of shares affect shareholders?

Shareholders may benefit from a buyback if the company repurchases shares at a premium, leading to an increase in the stock’s market value. However, if a shareholder’s shares are bought back, they will no longer hold those shares.

4. What are the different types of buyback of shares in India?

In India, buybacks can be conducted through:

• Open Market Buyback: Shares are purchased from the open market.
• Tender Offer Buyback: Shareholders are invited to offer their shares back to the company at a fixed price.
• Book Building Buyback: A price range is set, and shareholders can offer their shares within that range.

5. What are the tax implications of a buyback of shares in India?

Effective October 1, 2024, the Finance Act, 2024, abolished the buyback tax under Section 115QA. Instead, the proceeds received by shareholders during a buyback are taxed as deemed dividends under Section 2(22)(f) and taxed in the hands of shareholders under “Income from Other Sources”.

6. What are the advantages of a share buyback for a company?

A share buyback offers several advantages, including a reduction in the number of outstanding shares, an increase in earnings per share (EPS), enhanced shareholder value, and improved market perception of the company.

7. Can a company buy back its shares at any time?

A company can buy back shares only during specific windows or as per regulatory approvals. It must comply with the Companies Act, 2013 and/or guidelines from the Securities and Exchange Board of India (SEBI; as applicable) regarding the timing, method, and amount of buyback.