Buyback of Shares – A Judiciary Prospective

[Mandar Rane]

                                                                                                                       

 

 

 

 

 

Buyback of Shares – A Judiciary Prospective

•   Introduction

When a Company has excess cash they may either use it for Investment, Acquisition of another company, repay debt or Buyback of shares. Buyback of shares in common parlance may be described as a procedure followed by a Company wherein it offers to purchase shares from its shareholders. Buyback of share is an indicator that a company believes its shares are undervalued and is very coherent strategy to give money back to its shareholders.

Section 68 Companies Act 2013(“Act”) deals with Buyback of securities. The section commences with a non- obstante clause i.e. “Notwithstanding anything contained in this Act, ….”.This would imply that, it gives an overriding effect to the said provision and is a complete code for buy-back of shares. Therefore the company desiring to buy-back its equity shares must follow procedure as set down in the provision. The section provides a detailed framework for a Company to Buyback its own shares. There is a clear distinction of the fund from which a buy-back can be financed.  A buy-back exercise can be carried out only up to an amount up to 25 per cent of the paid-up equity capital in that financial year of the Company and the debt to paid up capital and free reserves ratio should not go beyond 2: 1.The shares to be bought back should be fully paid. There should be authorization in the articles of the company, a declaration of solvency and it shall be authorized by a special resolution of a company at its general meeting so as to ensure shareholder protection.

• Objectives of Buyback of Shares 
• Increase promoters stake:-Increase of promoter’s stake shows their confidence in the Company. Promoters holdings is diluted if, allotted ESOPs are exercised by employees .Due to dilution of their holdings the entity is prone to unwelcome takeover bids. Thus Buyback of shares assist in consolidating the stake and averting such bids.
• Exit opportunity to shareholders:-Buyback of shares would provide an exit opportunity to institutional shareholders/large retail shareholders, which may otherwise not be available whilst at the same time safeguarding the interest of continuing shareholders as provided in Re: Abbott India Limited¹ buyback casein 2007 where price at which the buy-back is proposed is ₹ 650/- and is higher than the book value of ₹ 141.65 per share
• Increase in Earning per share:-Buyback of share lead to a reduction in the number of Shares outstanding, which can lead to improvement in earnings per share as earnings is  being distributed to few shares and an overall enhancement of value for shareholders continuing with the Company. For instance, if we consider a case of Deepak Industries Limited where the Company had proposed Buyback of 13,24,500 paid up equity shares. They projected EPS would surge from ₹ 34.06 to ₹ 45.42 as on March 31,2015 assuming full acceptance of Buyback offer.
• Return to shareholders:- If there is no profitable utilization of the reserves, returning back its money to the shareholders out of its surplus funds and if the best possible price is being paid, than it would benefit the shareholders who would opt to divest their shares in the buy back.
• Pitfalls in Buyback of shares
• Lack of Growth:-Buyback of shares is a signal to the Investors that there are no more profitable opportunities of Growth available in Business , rather than using excess cash for reinvesting or acquisition the Company adopts Buyback exercise and diverts it to shareholders.
• Misleading Buyback Announcement:-Several Buyback of shares announcements are issued to generate investor interest and later disseminate the information regarding rejection of the Buyback of shares. It was held in In Re: Shalibhadra InfoSec Ltd²case in March 2008 where their Key personnel were is charged with having issued misleading and unsubstantiated advertisements regarding buyback of shares even when the company was not performing well. The announcement was issued with a view to create investor interest in the scrip even though the Company did not have sufficient resources to meet the buyback obligations.
• Procedural Aspect:-The procedure set out in the Act shall be adhered strictly to protect the stakeholders. In case if any provision are not adhered to than it would attract penalty and officer in default are punishable with imprisonment. In Essar Bulk Terminals case³ in 2011 wherein the only observation raised by Regional Director was pertaining to the compliance with the procedure prescribed under Sec. 77 A of the Companies Act, 1956 for the buyback of the shares by the company.
• Insider trading:-The most important concern is that Buyback of share is presumed as an indirect form of Insider Trading. In Continental Controls Ltd.’s case⁴wherein Buyback proposal was approved and later the said proposal was deferred. In the said case a close accomplice (i.e. person acting in concert) of the Managing Director of the Company heavily traded using the Buyback information after issuance of advertisement causing spurt in pricing of shares.Favourable conditions were created to operate in the market in the backdrop of such advertisements and sell the shares of the Company to the gullible public thereafter, another aspect that was pointed out was that the whole funding of Buyback was been accrued in future from a proposed technology transfer deal. It was held that such a said method of funding was not acceptable as per provision of Section 77A and such an information being a price sensitive information should have been disclosed to SEBI.

 

• Judicial decisions

Buyback of shares –Evasion of Tax?

Here we analyze a landmark judgement In Re : Capgemini India Private Limited [2015 (4) TMI 1069 - BOMBAY HIGH COURT]⁵ which was decided by High Court of Bombay in April 2015.

Capgemini India Private Limited (“Company”) decided to buyback 221,231 equity shares in accordance to provision of Section 391 read with Sections 100 to 103 of Companies Act 1956,which constituted 30% of issued , subscribed and paid up capital of the Company.

The Regional Director via an affidavit dated October 1, 2014 had raised objection and opposed sanction of the Scheme. Regional Director raised objection on grounds that buyback of shares can be effected only under Section 77A of Companies Act 1956/Section 68 of the Companies Act 2013.

The Regional Director further stated that, if the company effected buyback of shares via Section 77A/Section 68 of Companies Act 2013 than distributed income of would be chargeable to tax in accordance with Section 115QA of the Income Tax Act, thus the Scheme shall be rejected as it would amount to evasion of income tax and outflow of foreign exchange amounting to ₹ 248 crore.

The Company i.e. Petitioner contented, Regional Director has no locus standi in respect of tax matter particularly when Income Tax authorities have not broached any objections. Further it was argued that it is open for the Company to follow either of the procedure out of two available to effectuate Buy Back of shares and since the Company wants to buyback 30% paid up capital and free reserve it would not be possible under Section 77A/Section 68 as it is only permissible to buyback 25% of paid up capital and reserves of the Company, thus the Company can buyback only by following the procedure under Section 391 read with Sections 100 –104 of the 1956 Act.

The petitioner placed reliance upon the case of High Court Bombay,SEBI vs Sterlite Industries (India) Ltd., [ 2002 (7) TMI 728 - HIGH COURT OF BOMBAY ] ⁶wherein it was held that, The legislative intention behind the introduction of section 77A is to provide an alternative method by which a company may buyback upto 25 per cent of its total paidup equity capital in any financial year subject to compliance with Subsections (2), (3) and (4). Section 77A is a facilitating provision which enables companies to Buyback their shares without having to approach the court and Prior to the introduction of section 77A, the only manner in which a company could buyback its shares was by following the procedure set out under sections 100 –104 and section 391 of Companies Act 1956.

Thus Hon’ble High court sanctioned the Scheme of Arrangement with clarification the issues relating to Income tax that may arise out of the Scheme are left open to be dealt with and decided by the Income tax Authorities in accordance with law.

Noting’s: - Section 115QA was inserted via Finance Act 2013 wherein amount of distributed income (i.e. consideration paid by the company on buy-back of shares as reduced by the amount which was received by the company for issue of such shares) of the company on buy-back of shares was chargeable to tax. Buy Back of shares in accordance to Section 77A of Companies Act 1956.Thus if the Buyback of shares was carried out through Section 391 of Companies Act 1956 the said tax obligation was not triggered. Thus, Finance Act 2016 has amended Section 115QA of Income Tax wherein the provision will be applicable to buy back of unlisted share undertaken by the company in accordance with the provisions of the law relating to the Companies and not necessarily restricted to section 77A of the Companies Act, 1956.

Buyback of shares – Unilateral Purchase of Shares?

Here we analyze Godrej Industries Ltd.’s Case⁷ adjudicated at National Consumer Disputes Redressal Commission , Godrej Industries Limited (“GIL”) laid down a scheme for buyback of 40% of paid up capital of GIL.After sanction from High Court, GIL sent letter of offer to all its shareholders.

The Complainant held 45 shares, paid up value ₹ 6.The Complainant was in receipt of a Cheque amounting ₹ 810 (45 shares of ₹ 18) but was returned. The Complainant than sent a letter to GIL stating that she did not receive any buyback offer and nor did she exercise any option of buy back of shares. The Complainant further stated such an act amounted to a unilateral purchase of share and amounted to compulsory acquisition of shares.

The Complainant had stated that option form stated by GIL has not been received thus question of intimation would not arise and there is no evidence of actual delivery of the form. The Complainants counsel further argued that holding shares in Company is similar to possessing a property and the same could not be purchased by GIC in the manner, stated by them. They further stated that after Scheme was sanctioned no public notice was issued and implied consent for Buy-Back.

GIL counsel referring to Scheme of Arrangement stated unless the shareholder expressed its desire in written intimation to Company within 30 days of record date it is presumed that consent is accorded for Buyback of shares. They further stated that meeting of shareholders was convened via publication of notices and still the Complainant did not prefer any objection to the Scheme.GIC further contended that The Company had, therefore, acted in accordance with provisions of the Scheme and the procedure laid down in the Companies Act.

The decision was in favour of GIC wherein it was directed to make the payment along with interest.

Noting’s: - The basic issue in the said case revolved around whether a shareholder can be made to sell shares of a Company without consent and is the scheme unfair and against the interest of the shareholders. For the first instance in given case , as per the scheme if the shareholder did not exercise the option to retain shares within specified time limit , it was assumed that shareholder accorded for buying back the shares and the shareholder did not prefer any objection when scheme was known to shareholders through notices and publication. For second instance, since the scheme has been duly approved by the Court, the Company is well within their rights to proceed with the approved scheme and the Company has taken appropriate steps to apprise shareholders about the Scheme.

Buyback of shares – Reduction of Capital?

In the present case of Income Tax Appellate Tribunal – Mumbai, Goldman Sachs (India) Securities on 12 February, 2016 [ 2016 (3) TMI 118 - ITAT MUMBAI ]⁸which was a wholly owned subsidiary of Goldman Sachs (Mauritius) LLC. The Indian entity of Goldman Sachs had remitted certain amount to its parent entity under Buy Back of Shares Scheme which was over and above the face value as approved in General Meeting.

The Tax authorities contented that Buy Back carried out by the Company amounted to reduction of Capital. The tax authorities were of view that, such a remittance of an amount which is above face value represents income by way of Dividend and hence tax at source should be deducted. Following queries were deliberated in the said case:-

Does Buy Back Deal be termed as Colourable Device?

Since the deal entered in by the Entity is in compliance to applicable laws and does not violate any provisions of the Act. Even If the Buy Back transaction in said scenario leads to non-payment or lesser payment of Tax it cannot be held as a Colourable transactions.

Can Assesse be held in default for non-deduction of Tax at source?

Profit arising out of Buy Back is taxed as Capital Gain, the said Capital Gain arised is taxable at hands of parent company in Mauritius however under Indo – Mauritius Treaty capital gain is not taxable to parent Company. Since the Assesse is not liable to deduct tax as per provision of Income Tax Act it cannot be held as Assesse in Default, thus the penal provision of Income Tax would not be applicable.

Can Buy Back of share be equated to reduction of Capital?

Here we have to consider two provisions Section 2(22) (d) and Section 46A of Income Tax Act. As per Section 2(22) dividend is defined inclusively and as per sub-section (d) “dividend is any distribution to its shareholders by a company on the reduction of its capital…”to the extent to which the company possesses accumulated profits. Section 46A on other hand asserts the difference between the cost of acquisition and value of consideration received by the shareholder or the holder of others specified securities, as the case may be, shall be deemed to be the capital gains arising to such shareholder or holder of specified securities. Thus we conclude after considering both sections of the Act that Buyback of shares and reduction of capital are two different concepts and Buyback of shares by Corporate Entity cannot be characterized by deemed dividend but profits arising out of Buyback is taxed under the head Capital Gain.

Noting’s: -In the said case two important issues were highlighted, firstly does Buyback of shares be considered as a colourable device, wherein it was stated that Non-payment of taxes by an entity in given circumstances could be a moral or ethical issue, however entities can be penalised only if any provision of law has been violated. Secondly, Is Buyback of share and Reduction of shares one and the same, it is pertinent to note that there is a vast difference between both. In addition to difference mentioned above, in case of Buyback of shares there are limitations on quantum of Buyback, the sources of funding and conditions as specified for Buyback. In Buyback of shares consent of members in suffice, however in case of Reduction of Capital must be approved by the Court, Creditors and Members.

             Conclusion

As we have seen objectives and pitfalls of buyback of shares along with few judicial pronouncement pertaining Buyback of shares. Shareholders need to be extra vigilant in Buyback of shares proposal and scrupulous examine the Company’s financial position, even the regulatory authorities are trying their best to protect the interest of investors by issuing clarification on tax and procedural aspects of Buyback of shares.

References:-

1 In Re: Abbott India Limited on 24 January, 2007, Securities Appellate Tribunal, Bench - G Anantharaman

2 In Re: ShalibhadraInfosec Limited on 3 March, 2008, Securities Appellate Tribunal, Bench - V Chopra

3 High Court Gujarat, Essar Bulk Terminal Ltd,Company Petition No. 50 of 2011, Coram – Honourable Mr. Justice Anant S. Dave

4 SEBI vs Continental Controls Ltd. on 14 February, 2008, Securities Appellate Tribunal, Bench - V Chopra

5 High Court Bombay, Capgemini India Private Limited,Company Petition No. 434 of 2014, Coram – S.J. KATHAWALLA, J. [2015 (4) TMI 1069 - BOMBAY HIGH COURT ]

6 High Court Bombay,SEBI vs Sterlite Industries (India) Ltd., [ 2002 (7) TMI 728 - HIGH COURT OF BOMBAY ]

7 National Consumer Disputes Redressal ,Ritu Bhargava vs Godrej Industries Ltd &Ors on 23 January, 2014

8 Income Tax Appellate Tribunal – Mumbai, Goldman Sachs (India) Securities on 12 February, 2016 [ 2016 (3) TMI 118 - ITAT MUMBAI ]