Budget 2019: Buybacks No Longer An Option To Avoid Dividend Distribution Tax

Companies resorting to buybacks to avoid dividend distribution tax received a setback while Finance Minister Nirmala Sitharaman offered relief to unitholders of alternative investment funds and to option traders.

Here are three key Budget 2019 proposals related to trading in capital markets:

To discourage the practice of preferring buybacks over dividends, the finance minister has proposed a 20 percent tax on buyback of shares by listed companies.

Earlier, the tax liability during a buyback by listed companies used to rest with the investor, who paid 10 percent tax on gains. The budget proposal has exempted investors from any gain they earn from buyback and shifted tax liability to the company.

There’s a catch. The company’s tax liability will be on the difference between buyback and issues price of the shares.

Maulik Doshi, partner at SKP Group, explained how the proposal would take effect with an example. “For instance, if an investor purchases a share for Rs 200 in the open market and the company offers buyback of share at Rs. 300. The gain of Rs 100 was earlier taxed at 10 percent.”

But with the budget proposal, while the investor will be exempted from paying tax, the company will be required 20 percent tax on the difference between the buyback price and the issue price, which could be as low as Rs 10, he said.

While the budget proposal may have made buybacks costlier, there will be instances of double taxation, Doshi said. “An investor selling the share at Rs 200 to another investor, would have already paid tax on his gains,” he said. “Now, with buyback tax, the same income will be charged to tax from companies.”

Lower Securities Transaction Tax

The finance minister has, in the budget, proposed changing the tax base for charging securities transaction tax, which will lead to reduced tax outgo for traders.

As per the proposal, the tax will now be charged on the difference between the strike price—price of the underlying security at a level where the call or put option is bought—and settlement price, or the average price of the underlying security on the day of option’s expiry. Tax was earlier calculated on settlement price for the options exercised.

The current rate of securities transaction tax on the sale of an option in securities, where the option is exercised is 0.125 percent.

“The proposal to restrict the STT to the difference between settlement and strike price will make equity options traders happy with less tax and allow them to lock-in to the gains up to the settlement price of the option,” said Romesh Tiwari, head of research, CapitalAim Financial Advisory Pvt. Ltd. “We can see increased volumes in equity derivative trading in the near future.”

AIF Unitholders To Benefit

Investors in alternative investment funds will see reduced tax liability as the pass-through status—when income earned by the fund and tax liability is passed on to unitholders—is extended to losses, too.

While the earlier provision, only mandated pass-through of income, budgetary provision mandates pass-through of loss, allowing unitholders to set off future income against the loss.

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