IT companies' buybacks might lose appeal after Budget shifts tax burden to investors

Buybacks from information technology (IT) companies might lose their appeal following the Budget 2023-24 announcement that income from the buyback of shares will be chargeable to the recipient investor as a dividend. Analysts predict this change will make buybacks less attractive to investors because of the compliance burden and possibly higher taxes.

The current regime states that buyback will be charged as an additional income tax in the hands of the company. Now, payment from the buyback of shares shall be charged to income tax at applicable rates, come October 1, 2024.

“So I think overall for an investor in India, this will have implications for IT companies. They are creating hurdles from both a tax perspective and a compliance perspective," said Pareekh Jain, Founder and CEO, EIIRTrend.

Top IT companies have bought back shares worth over 1 lakh crore in the last five years in at least 12 buybacks between 2020 and 2024, according to data.

Jain highlighted that the intention behind this move seems to be aimed at curbing speculative investment. However, he noted that this could also hurt genuine investors. "Earlier it was hurdle-free for investors, now they have to consider all these implications. Dividend income is taxed at a higher rate compared to capital gains, too. These are unnecessary complications.”

The government explained the rationale behind the move, stating in the Budget memorandum that both dividends and buybacks should be treated similarly as they are methods for the company to distribute accumulated reserves.

At present, investors pay long-term capital gains (LTCG) and short-term capital gains tax (STCG) on the sale of shares, depending on the holding period. Holding period of 12 months attracts LTCG tax while anything less than that would attract STCG.

The Budget, with effect from July 23, has increased LTCG to 12.5 percent from 10 percent while also increasing the short-term capital gains tax from the current 15 percent to 20 percent.

The increase in tax on both long-term and short-term capital gains is a bit disappointing and could have been avoided, Sanjay Sanghvi, Partner, Khaitan & Co, told Moneycontrol.

Institutional investors manage to handle the compliance burden and cash flow issues, but retail investors can’t afford a tax compliance team, says Sujith Kumar A, founder, of CFINANCIO Consulting. “Many retail investors are not aware of the tax regulations, which opens up the scope for non-compliance.”

The IT industry, known for its significant contribution to India's exports, may see a decline in buyback activities as investors might grapple with the new tax burden, experts said. As analysts and investors navigate these new regulations, the full impact on the sector remains to be seen.

Also read: LTCG rejig – making asset classes, other than equities, attractive?