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As buyback gets taxing, IT companies may switch to dividends

Govt looks to plug a loophole in buybacks as these are not taxed like dividend payouts.

, ET Bureau|
Updated: Jul 08, 2019, 03.37 PM IST
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This proposal would impact the stock performance of these companies over the next few days, say equity analysts.
BENGALURU: Cash-rich Indian IT services companies may now offer more dividends to return cash to shareholders, against the recent norm of share buybacks that have become less attractive with the budget proposing to introduce a new tax.

“Buyback is the most efficient way to return capital in India because it was not taxed earlier. It also helps companies improve the value when they think the market is not fairly pricing the stock,” said V Balakrishnan, a former finance chief of Infosys. “Suddenly you tax buyback, companies will shift to dividend because buyback comes with its own hassles.”

Share buybacks by listed companies aren’t taxed currently, but there is a 15% tax on dividend payment. To discourage companies from using this loophole, the budget has proposed a 20% tax on the money spent on share buybacks. Technology services companies have been rewarding shareholders by buying back shares and issuing dividends. Top companies such as Tata Consultancy Services, Infosys, HCL Technologies and Wipro returned more than Rs 40,725 crore to stockholders through share buyback in the past one year.

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Infosys has a stated strategy of returning 70% of free cash flow to shareholders, while TCS returns most of the cash flow to its shareholders. The most aggressive in using the buyback route in recent years has been Wipro, as it repurchased 14% of shares with three buybacks done over the past four years.

Equity analysts said the proposed tax would impact the stock performance of these companies over the next few days. “With the new buyback tax, the government would gain Rs 8,145 crore (based on last fiscal year’s total buyback of Rs 40,725 crore in the IT sector),” Madhu Babu, an IT analyst at Centrum, wrote in a note to clients. “Select midcaps like Persistent Systems, Cyient (and) Mphasis which could have been companies with potential regular buybacks stand impacted sentimentally.”

The brokerage also expects higher negative sentimental impact on Wipro. It was understood that such a proposal to tax distribution of capital through buyback would come sooner or later, said Kuldeep Koul, lead analyst (IT services), at ICICI Securities. “Companies may still go for a buyback, the impact will be on effective return. But between a dividend and a buyback, buyback will still be beneficial,” Koul said.

Brokerage firm Prabhudas Lilladher wrote in a note it would retain its “underweight” stand on IT, citing the impact of the proposed tax on buyback of shares.

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