A buyback of securities has typically been regarded as one of the key modes of providing an exit to financial investors from their portfolio investments in India companies. Usually effected through a contractual stipulation in the investment agreement, the buyback exit right creates an obligation on the part of the promoters and the target company to cause a buyback of the investor’s shares on or before defined timelines, or on the occurrence of certain events.
However, with the current regulatory trends, the buyback mode of an exit may just have become a lost cause. The perpetrators of these ‘current trends’ are the recently introduced measures under the Finance Act, 2013 (applicable to unlisted companies); the SEBI amendments to the buyback regulations issued in early August (applicable to listed companies); and certain proposals under the proposed Companies Bill, 2012, currently pending presidential assent (applicable to all companies).
The Finance Act, 2013 introduced a withholding tax on buyback of shares (not being shares listed on a recognised stock exchange) much like dividend distribution tax. The tax rate that came into effect from June 1, 2013 is 20% of the income distributed by a domestic company on a buyback of its shares (along with a surcharge of 10 % and education cess of 3 %).
Distributed income is defined as the difference between the amount paid by the company as a consideration for buying back unlisted shares and the original consideration that had been paid by the shareholders on issuance of such shares.
Additionally, the tax on the distributed income will be treated as final payment of tax and no further credit will be allowed to be claimed by the company or by the shareholders. Moreover, the income tax on a buyback is to be paid within two weeks starting from the date of payment of consideration to the shareholder, and a penal provision has been inserted for any default in such payment of tax by Indian companies. While the purported rationale behind this move was to bring about a parity between distribution of dividend and distribution of money by way of buyback of shares by unlisted companies, and to also check against tax avoidance by certain truant companies which would resort to buybacks merely to distribute untaxed dividends to their shareholders, the flipside of this withholding tax is that it is likely to deter unlisted companies from causing a buyback of shares, thereby also impacting ability of financial investors to make exits from their investments through this route. Hitherto, buybacks were taxed as capital gains in the hands of a non-resident investor, and if such investor was a resident of a favourable treaty jurisdiction, capital gains would also be exempt. Therefore, the withholding tax on buyback also reduces the net gains an investor would make post a buyback of its shares.
As far as listed companies are concerned, the SEBI had, last month, introduced changes to the SEBI (Buy back of Securities) Regulations, 1998 applicable to buybacks through open market purchases. As per the recent amendments, SEBI has now made it mandatory for companies to buy back at least 50% of the proposed offer size. There is also a requirement for companies to mandatorily keep 25% of the buyback amount in a separate escrow account, which may in certain cases be forfeited up to a maximum of 2.5% of the amount earmarked for buyback, in the event of non compliance with the amended regulations. The SEBI has also directed listed companies to complete the process of buyback within six months as compared to erstwhile time limit of one year, which is also in contrast with the provisions of the Companies Act, 1956 and the Companies Bill, 2012 (both, allowing for a time period of one year to close a buyback). In much the same way, the SEBI has restricted listed companies to raise further capital for a year from the closure of a buyback offer, in contrast to six months mentioned in the Companies Act, 1956 as well as the Companies Bill, 2012 (with the company laws also excluding bonus issues and shares issued under subsisting obligations from this prescription) though It would be interesting to see how the SEBI will be able to enforce provisions which are stricter than the existing (as well as the proposed) company law principles governing the same subject.
The current provisions of the Companies Act, 1956 provide for a cooling off period of a year between two successive buybacks, in cases where each of the buybacks had been authorised by the board of directors. However, a dominant interpretation under the Act favoured a buyback of up to 10% of the paid up equity capital and free reserves of the company by way of a board resolution, immediately followed by another buyback of up to 25% of the total paid up equity capital and free reserves by way of shareholders’ resolution. Interestingly, under the Companies Bill, 2012, no buyback will be allowed for a year from the date of a preceding buyback, irrespective of which authority authorised such buyback (i.e. board or shareholders, as the case may be), thereby reducing the ability of a target company to give a timely exit to investors in a staged manner, even where the company may be sitting on surplus cash.
With an IPO as an exit option drying up in the current market, it will be interesting to see how exits will be structured in times to come with the multitude of questions facing the buyback exit route.
(Sidharrth Shankar is a partner and Vatsal Gaur is an associate with JSA.)
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