May 08 2013
Under Section 77 of the Companies Act 1956, no company incorporated under the act could buy its own securities or shares, except for the purpose of reducing its share capital. This principle was largely accepted, since it was felt that allowing a company to buy back its own shares could grant it excessive influence over stock prices and possibly result in insider trading and other market-manipulation practices.
However, this general prohibition was diluted by the Parliament and the Companies (Amendment) Act (21/1999), through which companies could purchase shares from their shareholders at a certain price, thereby returning the share capital to such shareholders, under the guidelines issued by either:
A 'buy-back' is defined as the process by which a company can buy back its own outstanding shares from the shareholder. The shares so bought back effectively reduce the issued share capital of the company. This is achieved by cash outflow from the company, which equals the quantum of shares bought multiplied by the price at which such shares were bought. Buy-back of shares results in the shareholders whose shares are bought ceasing to be shareholders of the company or reducing their shareholding, depending on the number of shares bought back.
The Companies (Amendment) Act was introduced to allow companies to buy back their own shares, with the main object of boosting the Indian capital market. The advantages of this introduction were manifold, for example:
However, this power may also be abused, since it provides management with a tool to interfere with the ownership of the company.
Section 77-A of the act begins with a non obstante (ie, notwithstanding) clause that allows companies to repurchase their shares, notwithstanding any other provisions contained in the act. However, the section also imposes a limitation on the company's right to buy back its shares, through dual limitations that must be fulfilled by a company when repurchasing its own shares.
A buy-back exercise can be carried out only up to 25% of the paid-up equity capital of the company for that financial year. Furthermore, the funds for this purpose may not exceed 25% of the paid-up capital and free reserves of the company. There is also a clear demarcation of the fund from which a buy-back can be financed. Conditions to be fulfilled include the following:
For public listed companies, the buy-back should also comply with the SEBI guidelines. These include daily advertisements, daily disclosure of purchases and a declaration by promoters of the upfront pre-buy-back and post-buy-back holding, in order to prevent manipulation. The government issues rules and notifications on the subject from time to time for unlisted public companies and private companies.
According to Section 77A of the 1956 act, a company can buy back its own shares only once in 365 days, if the shares are bought back pursuant to board approval. Furthermore, Section 77-AA states that when a purchase is made out of free reserves, a sum equal to the nominal value of the share purchased must be transferred to the capital redemption reserve account. Section 77-B prohibits a buy-back through any subsidiary company or investment company. Furthermore, a company that is in default of payment of deposits, redemption of debentures or preference shares or repayment of a term loan to any financial institution is prohibited from undertaking a buy-back exercise.
The Companies Bill was introduced in the Lok Sabha (the lower house of Parliament) in 2012 and is now pending approval by the Rajya Sabha (the upper house). The bill introduces drastic changes that curtail the powers of a company to buy back its own shares.
Clauses 67 to 70 of the bill deal with the power of a company to buy back its own shares. The major difference between the Companies Act 1956 and the Companies Bill 2012 is the time restriction on a second buy-back offer. The bill addresses the ambiguity in the act regarding the time restriction on a second buy-back offer if the shares to be bought back exceed 10% of the paid-up share capital of the company. The bill states that no second buy-back offer may be made for a period of one year from the date of the last offer. Other restrictions imposed by the bill include:
The existing law allows a company to undertake two consecutive buy-back offers, provided that the number of shares being bought back does not exceed 25% of the paid-up equity capital in that financial year. As a further limitation, the funds being employed for the buy-back should be from free reserves, a securities premium account or proceeds of shares (or any other specified securities), and should not exceed 25% of the paid-up equity capital and free reserves of the company. However, with the introduction of the bill, a company will be restricted to buying back its shares only once in 365 days, whether the number of shares being bought back is less than or greater than 10%, where it falls within 25% of the paid-up capital.
The inclusion of a securities premium account in the free reserves will effectively increase the amount of money that may be utilised to buy back these securities. The number of shares to be bought back essentially remains unchanged; however, the funds employed to buy them back will increase.
The Finance Bill 2013 proposes to tax an otherwise tax-free mechanism available to global investors for the repatriation of profits without paying tax in India. It has been proposed that an additional income tax be levied on the distribution of income by way of the buy-back of shares by unlisted companies. The company implementing the buy-back scheme will be liable to pay taxes at a rate of almost 20% on the difference between the considerations received by the shareholder on buy-back, reduced by the amount received by the company for the issuance of such shares. The 2013 Budget proposes to charge a tax at 20% of the net consideration on the company buying back its securities. The net consideration is the difference in the price of the shares when being bought back from that at which the shares were issued.
Before the introduction of the bill, out of the two modes of disbursement of surplus cash available to a company (ie, paying dividend or buy-back of shares), the latter mode was preferred as this was tax free. The tax imposed on the issue of dividends (the dividend distribution tax) was imposed at a rate of approximately 15%, exclusive of surcharge or education cess. The company was exempt from paying tax on the buy-back of shares, as the buy-back did not result in payment of a dividend, as defined under Section 22(d) of the Income Tax Act 1961. The only tax payable was by the shareholder from which such shares were bought back, since capital gains would arise under Sections 46A and 48 of the act.
With the proposed introduction of a tax on buy-back and the increased restrictions introduced by the Companies Bill 2012, companies may be discouraged from buying back shares as a method by which to disburse excess cash or increase the value of shares. Through these changes, the Companies Act will no longer be a route to avoid tax and reduce share capital while avoiding the need for a protracted court process.
For further information on this topic please contact Sunil Kumar or Ankita Chatterjee at Singhania & Partners LLP by telephone (+91 11 4747 1414), fax (+91 11 4747 1415) or email (firstname.lastname@example.org or email@example.com).
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