Buyback of Shares by a Company

Buy back or repurchase of shares is a tool that enables the Companies to purchase its shares currently held by all its shareholders. There are a number of reasons companies buy back its shares, the main intention of the company to buy back shares is to reduce the number of shares in the open market. In fact, buy back of shares is an important method of capital restructuring.

The buying back of shares not only improves the shareholder value but also helps the company to use its funds in a better way.  The company utilizes its surplus fund to cancel a portion of its scares by purchasing either from the open market or by direct purchase from the shareholders.

In most of the cases, the company opts for the repurchase of its shares when the market value of such shares falls below the face value/book value.

                                         

The Objective

The primary object of the repurchase of the shares is to allocate the surplus fund available with the company to the shareholders, whereby the shares available with them are being purchased for cash.

The shares of the company are purchased for the reasons noted below:

  1. Improve shareholder value: The repurchase of shares reduces the total share count of the company resulting in higher earnings per share, so long as the earnings remain constant.
  2. Increase Promoter holdings: Buyback of shares result in the reduction of share count in the open market thereby provides a safeguard with the company from the threat of corporate takeovers, the buyback of shares increases the promoter’s holdings. Sometimes, the companies practice repurchase of shares as a defence mechanism.
  3. Distribute the surplus cash among the shareholders
  4. Increase the market price of the shares: Generally, the shares are repurchased by offering a premium over the existing value of shares in the open market. This will increase the share value of the company in the open markets.
  5. Thwart takeover bid
  6. Diminish the capital structure of the company by writing off capital which is not supported by assets
  7. Future use: The repurchased shares can be used in the future at the time of any merger and acquisition without raising the capital

 

 

Legal provisions for repurchasing shares

In India, the repurchasing of shares are governed under various rules and Acts. The legal frameworks having provisions governing the buyback of shares are the Companies Act 2013, Companies (Share Capital and Debentures) Rule 2014 and Securities and Exchange Board of India (Buy-back of Securities) Regulations, 1998 and Securities and Exchange Board of India (Buy-back of Securities) (Amendment) Regulations, 2013.
 

For a private company or an unlisted public company, Section 68, 69 and 70 of the Companies Act and Rule 17 of the Companies (Share Capital and Debentures) Rule 2014 are applicable. For a listed company, in addition to the above Act and Rules, the regulations from SEBI are applicable for the buyback of outstanding shares.

The relevant sections of the aforesaid Acts, Rules and Regulations have described certain conditions, prohibition and relaxation for the repurchase of shares of the company. Such details are consolidated and are described as below:

  1. The Conditions

    As per the provisions, the company is only allowed to repurchase it share if all the following conditions are satisfied

  2. The buyback is authorized by the Articles of Association of the company
  3. A special resolution has been passed in the general meeting of the shareholders, authorizing the company to buy back its own shares
  4. The amount of total payment towards buyback of equity shares in a year shall not exceed the aggregate of 25% of the paid-up equity capital and the free reserves of the company.
  5. The post-buy-back ratio of debt to equity capital and free reserves should not exceed 2: 1. However, the Central Government may prescribe a higher debt-equity ratio (more than 2: 1) to be applicable for a class or certain classes of companies
  6. All the shares or other specified securities for buy-back are fully paid-up, no partly paid-up shares are qualified.
  7.  If shares or securities are listed, the buyback will be in accordance with the regulations made by the Securities and Exchange Board in this behalf; and the buy-back in respect of unlisted shares or other specified securities is in accordance Share Capital and Debentures Rules, 2014.
  8. No offer of buy-back shall be made within a period of one year from the date of the closure of the preceding offer of buy-back if any.
      
  9. Prohibition and Relaxation

    In certain circumstances, the companies are prohibited to buy back its shares. The following are the conditions that restrict the company to repurchase its shares:

    1. (a) Through any subsidiary company or subsidiary of a subsidiary company; or
    2. (b) Through an investment company or group investment companies; or
    3. (c) If default is subsisted in respect of repayment of deposit accepted either before or after the commencement of this Act, interest payment thereon, the redemption of debentures or preference shares or payment of dividend to any shareholder, or repayment of any term loan or interest payable thereon to any financial institution or banking company. Provided that the buy-back is not prohibited if the default is remedied and a period of three years has elapsed after such default ceased to subsist.
    4. (d) In case it has not complied with Accounting Standards, no company shall repurchase its shares. If the company has failed in any of the following, it is not allowed to purchase its own shares:-

    a) Annual Return

    b) Declaration and Payment of Dividend

    c) True and Fair Statement submission

  10. Relaxation

    A special resolution is not required to be passed in the general meeting of the shareholders, authorizing the company to buy back its own shares if the buy-back is 10% or less of the total paid-up equity capital and free reserves of the company and if such buy-back has been authorized by the Board by means of a resolution passed at its meeting.

 

Buy back of shares with Board’s approval will be allowed only once in a period of 12 months. This means that buyback process with only Board’s approval will be allowed to repeat year after year.


The procedure

The step by step process of buying back of shares is described as below:

  1. Obtaining of Auditors Report stating maximum amount permissible for buyback
  2. Obtaining Board of Directors Affidavit regarding Solvency of company for one year
  3. Further obtaining the above two, a Board Meeting is convened for considering the buyback proposal.
  4. Issuance of notice with Explanatory Statement to all members.
  5. Passing of special resolution, if required by holding an Extra Ordinary General Meeting
  6. Obtaining the Declaration of Solvency
  7.  Filing draft letter of Offer with the ROC
  8. Filing of e-form for registration of such resolution with the Ministry of Corporate Affairs through their online portal
  9. Letter of offer to all members notifying the offer for repurchase
  10. Closure of the offer
  11. Paying shareholders whose offer has been accepted
  12. Physically destruction of the share certificates of shares bought back
  13. Filing of requisite return forms with Ministry of Corporate Affairs through their online portal
     

Means for buy back its own shares

The company can buy back its shares in any of the following manners:

  1.  From the existing shareholders on a proportionate basis through the tender offer by offering a premium to the prevailing share value
  2. From the open market through:
    1. Book building process
    2. Stock exchange
  3. From odd lot holders
  4. From employees of the company, as the shares are issued to them pursuant to a scheme of a stock option (ESOP)

 

As per the provisions of Section 68 of the Companies Act, the buyback can be made out of the free reserves of the company and/or the securities premium account. The repurchase can also be made out of the proceeds of the issue of any shares or other specified securities.  However, the repurchase shall not be made out of the proceeds of an earlier issue of the same kind of shares or securities.

 

Important Points to remember for the purchase of its own shares

 

  1. The buy back process shall be completed within a period of one year from the date of passing of the resolution or the special resolution.
     
  2. If the repurchase is made out of the free reserves or securities premium account, a sum equal to the nominal value of the shares so purchased shall be transferred to the capital redemption reserve account and details of such transfer shall be disclosed in the balance sheet. Section 69 of the Companies Act made the provision that the capital redemption reserve account may be applied by the company, in paying up unissued shares of the company to be issued to members of the company as fully paid bonus shares.

 

  1.  Further to the repurchase of its shares, the company has to file a declaration of solvency with the Registrar of Companies. The Solvency Declaration shall be signed by at least two directors of the company, among them ones should be in the capacity of Managing Director. The affidavit in the prescribed format carries the message that the Board of Directors of the company has made a full inquiry into the affairs of the company and have formed an opinion that it is capable of meeting its liabilities and will not be rendered insolvent within a period of one year from the date of declaration adopted by the Board.

 

  1. The Company shall extinguish and physically destroy the shares or securities so bought back within seven days of the last date of completion of buy-back.

    Further to the completion of the buyback of its shares, the company is not allowed to issue new shares for a period of 6 months. However, the company is exempted from issuing new shares by way of a bonus issue or in the discharge of subsisting obligations such as conversion of warrants, stock option schemes, sweat equity or conversion of preference shares or debentures into equity shares.

  2. The company shall be punishable with a penalty if the company made any default in complying with the provisions of the Act, Rules or Regulations to which it is bound to. The penalty would be not less than one lakh rupees but which may extend to three lakh rupees and every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to three years or with fine which shall not be less than one lakh rupees but which may extend to three lakh rupees, or with both.
     
  3. As per the provisions of the Act, the company should maintain a register of share buy nack in Form No. SH.10 and such register shall be kept with Company Secretary or any other person authorized by the board in this behalf.  It is also important to note that the entries in the register shall be authenticated by the Company Secretary or any other person authorized by the Board.

 

Tax Implications

 

An additional 10% tax was introduced in the 2016-17 Union Budget to those who earn more than 10 lakhs of annual dividend income over and above the 15% Dividend Distribution Tax paid by companies.

 

As per the Income tax Act, repurchasing of shares shall not be seen as dividend if it is in accordance with the provisions of the Companies Act.  Consequently, the amount paid by the company to its shareholders in buyback would not attract dividend distribution tax. 

 

The gains on buyback would be generally regarded as capital gains in the hands of the shareholders. In short, the buyback rewards its shareholders. In the other hand, buybacks are subject to securities transaction tax (STT) in which the tax is exempted for long term capital gains on transfer of shares which held for more than a year and thus the company does not pay any tax on such buyback of shares. This has led to a surge in companies announcing buyback offers.

 

To take advantage of this, several companies resorted to the buyback of shares instead of distributing dividends. In view to fix this loop hole of garbing the buyback advantage, the new provisions in income tax law has been proposed.

 

The minority share holders will not have any tax implication, but the promoter shareholders or any shareholders having equity dividend of more than 10 lakhs would be the beneficiary of the prevailing rules in Income Tax Act.


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