What you must know as an investor about the TCS buyback?

: While the finer details of the buyback are being worked out and the postal ballot is yet to be conducted, there are some basic questions that investors have about the buyback of shares. Should they participate in the buyback and what are the tax implications?

Oct 09, 2020 07:10 IST India Infoline News Service

When TCS announced its financial results for the Sep-20 quarter, it also announced a buyback worth Rs16,000cr. The buyback was public knowledge because TCS had already filed its intent for buyback at its board meet on 07 October. While the finer details of the buyback are being worked out and the postal ballot is yet to be conducted, there are some basic questions that investors have about the buyback of shares. Should they participate in the buyback and what are the tax implications?

What is the buyback announcement about?

There seems to be a familiar ring to the Rs16,000cr buyback amount. The previous two buybacks that TCS did in 2017 and 2018 were also worth Rs16,000cr. Here are the basic details of the latest TCS buyback offer.
Details Amount
Total Number of shares to be bought back by TCS (A) 5,33,33,333 shares
Total Paid up capital of TCS 375,23,84,706 shares
Percentage of shares being bought back 1.42%
Closing Price of TCS on 06 October Rs2,714
Buy back price proposed by TCS on 07 October (B) Rs3,000
Premium to last closing price 10.54%
Value of the Buyback Offer (A x B) Rs16,000cr
 Data Source: Company Filings / NSE

As of March-20, TCS has Rs35,000cr in cash and short term investments so funding the buyback should hardly be an issue. The big question is what happens to the capital structure after the buyback and will the promoter holding remain the same?

Will the promoter holdings change post buyback?

That will largely depend on whether the main shareholder, Tata Sons, participates in the buyback or not. If Tata Sons participates in the buyback in the same proportion then the impact on the post-buyback holding structure will be nil. However, the promoter stake in the company could go up if they choose to skip participating in the buyback issue.
Particulars Amount
Promoter holding in TCS (A) 270,35,42,000 shares
Total shares outstanding (B) 375,23,84,706 shares
Promoter stake prior to buyback (A/B) 72.048%
Number of shares to be extinguished by buyback (D) 5,33,33,333
Total shares outstanding after buyback (B – D) 369,90,51,373
Stake of Tata Sons in TCS post buyback (#) 73.087%
Data Source: Company Filings
(#) – Applicable if Tata Sons does not participate in the buyback.

If Tata Sons does not participate in the buyback then its stake in TCS will increase by 104 bps to 73.087%. This looks a likely scenario considering the imminent exit of Pallonji Mistry family from the Tata Sons board. Of course, Tata Sons may also choose to participate in the buyback; either fully or in part.

Tax implications of the buyback under new rules

Budget 2019 saw important changes to the buyback tax rules and Budget 2020 saw significant changes to the taxation of dividends. Both these announcements have a significant impact on the attractiveness of buybacks in tax terms. Prior to July 2019, buyback was treated as capital gain and taxed in the hands of the investor. However, post July 2019, buyback will be taxed on the company as a distribution. The catch, however, is that this 20% tax on buyback is payable on the difference between the issue price and the buyback price.

Budget 2020 scrapped the concept of Dividend Distribution Tax (DDT) and made dividends taxable in the hands of investors at the peak rate. That means; promoters and super-rich investors would find it more tax efficient to use the buyback route than the dividend route. That explains the interest in buybacks this year.
Particulars Dividends Paid Buyback done
Distribution of income Rs.100 Rs.100
Tax Rate (income above Rs.5 crore) 30% 20%
Surcharge 37% 12%
Cess Levied 4% 4%
Effective Tax Rate 42.74% 23.30%
Post Tax retention Rs.57.26 Rs.76.70

Clearly, the buyback is a lot more tax efficient in the above case, especially if you are in the higher income super-rich category. However, that need not be the case for small investors

Small investors must adopt a different perspective

One of the problems of the buyback taxation model is that the tax impact is on all shareholders whereas the dividend taxation model is based on income. There is also another significant issue. For example, if you had bought TCS over a year ago at Rs2100, your capital gains will be Rs900 (3000-2100) on which you pay 10% LTCG tax. Now if there is a buyback at Rs3000, the company will pay tax on the difference with the original price.

TCS IPO in 2004 was at a price of Rs850. Subsequently, it issued bonuses in the ratio of 1:1 in the years 2006, 2009 and 2018. That makes the effective issue price Rs106.25. In the buyback, the company will end up paying 23.30% buyback tax on Rs2893.75 (3000-106.25). In this case, since he bought the shares at Rs2100, he would be better off selling the shares in the market and paying LTCG tax on Rs900. Remember, even though the buyback tax is paid by the company, it eventually reduces your distributable surplus.

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