Why are so many companies coming up with buybacks?

Now a question may flock into your mind that why does a company come up with buyback?

Companies resort for a buyback for many reasons. However, there are two big reasons in most cases

1. Companies with excess cash can spend it to buy their shares back which improves the investor confidence in the company
2. They want to reward existing shareholders for their trust in the company When the company feels that that their shares are undervalued, a buyback can boost their value.
3. When the company feels that that their shares are undervalued, a buyback can boost their value.

The question still remains unanswered that why is that now so many companies are coming up with buybacks?The reason is Budget 2024 presented in Jul’24 which changed the way buybacks are taxed, before the budget, companies used to pay a 20% tax when they buy back their shares. But from October 1st, this tax has to be borne by shareholders and not the company. In fact, the entire proceeds received from buyback will be treated as a dividend income.Let us understand this by way of an example, let us assume that Mr. Chandu is a wealthy person and falls in the highest tax bracket and Mr. Bandhu is a middle-class person and falls in 10% tax bracket, now let us understand the impact of this change on both of them.
In case of Mr. Chandu, the tax is more as compared to the tax applicable to the company, however the tax is lesser in case of Mr. Bandhu.

As you can see how the new buyback tax rules are unfavourable for high-income investors, increasing their tax burden by about. On the flip side, low-tax bracket investors benefit making buybacks more attractive for them.

And this effectively means that the new tax rule will be hurting the higher-income shareholders the most, with the top shareholders like promoters and big investors of companies getting taxed at a higher rate. And that would also make companies prepone their buy back plans, if any, before October.

In order to avoid higher taxes for their most valued shareholders, and bring in more shareholder value when they can, companies are trying all they can to complete their buybacks before October.

Now, if you have carefully read till now, you would have noticed that the buyback receipt will be taxed as dividend, now a natural question arises is what will happen to the purchase price of these shares, this cost would be considered a loss. You can adjust it against your other capital gains to lower your taxable income.

For example, if you have a capital gain of ₹60,000 in the same year, you won’t pay any tax on that gain since it’s offset by the ₹1,00,000 capital loss from the buyback and the remaining ₹40,000 loss can be carried forward and used to offset future gains for up to eight years until it’s fully utilised.

This new rule would may also encourage companies to pursue buybacks only when they feel that their shares are genuinely undervalued.