In the corporate financial, companies have multiple avenues to distribute surplus profits to shareholders. Many prominent methods are share buybacks and dividend payouts. Both strategies offer distinct advantages to investors, but their effectiveness varies based on individual financial goals and prevailing tax implications. 

This article explores the key differences, legal provisions, and implications of share buybacks and dividend payouts in India, helping investors make informed decisions.

Understanding Share Buyback and Dividend Payout

- Share Buyback

A share buyback occurs when a company repurchases its own shares from the existing shareholders. This reduces the outstanding shares in the market, potentially increasing the value of the remaining shares. Share buybacks can be done through tender offers, open market purchases, or buyback through book-building processes.

Legal Provisions for Share Buybacks in India:

• Governed by Section 68, 69, and 70 of the Companies Act, 2013.

• Must comply with SEBI (Buyback of Securities) Regulations, 2018 for listed companies.

• The buyback amount should not exceed 25% of the paid-up capital and free reserves.

• The debt-equity ratio post-buyback should not exceed 2:1.

• The company must extinguish the bought-back shares within seven days of the buyback closure.

- Dividend Payout

A dividend is a portion of profits distributed by the company to its shareholders. Dividends can be interim (declared before annual general meetings) or final (declared post-approval at AGMs).

Legal Provisions for Dividend Payout in India:

• Governed by Section 123 of the Companies Act, 2013.

• Dividends can only be declared out of accumulated profits or current profits after providing for depreciation.

• The company must transfer a portion of profits to reserves before declaring dividends, as per its dividend policy.

• Dividends must be paid within 30 days from the date of declaration.

• Non-payment within the stipulated period attracts penalties under Section 127 of the Companies Act.

Tax Implications: Buyback vs. Dividend

- Share Buyback Taxation

• Companies are liable to pay Buyback Tax at the rate of 20% under Section 115QA of the Income Tax Act, 1961.

• The tax is calculated on the difference between the buyback price and the issue price of the shares.

• For shareholders, the income from buyback is exempt under Section 10(34A).

- Dividend Taxation

• As per the Finance Act, 2020, the Dividend Distribution Tax (DDT) has been abolished.

• Dividends are now taxable in the hands of shareholders as per their applicable income tax slab.

• TDS (Tax Deducted at Source) is applicable at 10% if the dividend amount exceeds ₹5,000 under Section 194 of the Income Tax Act.

Which is Better for Investors?

- Tax Efficiency

• For shareholders in higher tax brackets, buybacks are more tax-efficient as the income is exempt.

• Dividends can lead to higher tax outgo for investors in higher income brackets.

- Capital Gains

• Share buybacks can lead to capital appreciation by reducing the total number of shares, thereby increasing Earnings Per Share (EPS) and market price.

• Dividends provide immediate income but do not impact the share price significantly.

- Company Signals

• A buyback signals that the company believes its shares are undervalued, which can attract investor confidence.

• Regular dividend payouts indicate consistent profitability and cash flow, appealing to income-focused investors.

- Long-Term Wealth Creation

• Buybacks can lead to long-term wealth appreciation by enhancing per-share metrics.

• Dividends provide short-term cash flow but do not contribute to long-term capital growth directly.

Differences Between Share Buyback and Dividend Payout

Frequently Asked Questions (FAQs)

- Which is more tax-efficient for investors, buyback or dividend?

Share buybacks are more tax-efficient for investors, especially in higher tax brackets, as the income from buybacks is exempt from tax.

- How does a company decide between a buyback and a dividend?

The decision depends on factors like available cash reserves, tax considerations, investor expectations, and market conditions.

- Is buyback always beneficial for shareholders?

Not necessarily. If the buyback price is lower than the market price, or if it results in cash flow constraints for the company, it may not be beneficial.

- Can a company conduct a buyback every year?

No, as per SEBI regulations, companies must wait one year before conducting another buyback after completing one.

- Is dividend income taxable for all investors?

Yes, dividends are taxable in the hands of investors as per their applicable income tax slab rate.

- What happens if a company defaults in paying dividends?

Under Section 127, the company and responsible officers may face penalties and imprisonment.

- How does buyback benefit long-term investors?

Buybacks reduce outstanding shares, enhancing EPS and potentially increasing the stock's market value over the long term.

- Can NRIs participate in buybacks?

Yes, but they must comply with FEMA guidelines and ensure tax compliance based on their residential status.

- Are dividends guaranteed?

No, dividends are subject to company performance and board decisions. A company can skip dividend declarations in weak financial years.

- How to receive dividends and participate in buybacks?

Dividends are credited to the shareholder’s registered bank account. For buybacks, shareholders must respond to company invitations or tender shares as per the buyback offer.

Inferences

Both share buybacks and dividend payouts are effective mechanisms for rewarding investors, but their impact varies based on individual preferences, tax considerations, and investment strategies. Investors seeking immediate cash flow may prefer dividends, while those focused on long-term wealth creation might benefit more from buybacks. Companies, on the other hand, should consider their financial position, market signals, and tax implications before deciding on the most suitable approach. Consulting with financial advisors can help investors align their strategies with their long-term goals.