Market regulator Sebi has invited public comments and suggestions on a proposal to bring about certain changes to its buyback regulations. The proposed changes, suggested by a panel headed by veteran banker Keki Mistry, include moves to ensure parity between the incidence of tax on dividends and share buyback. In other words, it aims to shift the tax implication from the company to shareholders — as the case is with dividends.

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Companies have two main ways to transfer surplus cash to investors: by dividends and buybacks. While dividends are taxed in the hands of recipients, buybacks are taxed in the hands of companies. Even the tax burden of the exiting shareholders — or investors who wish to use a buyback offer to book profits — is borne by the remaining shareholders — or investors who want to hold on to their holdings by not participating in the buyback.

So what does Sebi want to achieve?

Sebi aims to modify the buyback rules to shift the incidence of tax on buybacks from the company to the shareholders to protect the interest of investors who wish not to exercise the offer.

To put things in perspective, certain changes to the income tax laws in 2019 brought the incidence of tax from the hands of shareholders to that of the company. A separate set of changes to tax laws abolished the dividend distribution tax — or the tax on a company for doling out dividends to its investors, in effect shifting the incidence of taxation in dividends into the hands of recipients at applicable rates.

Here’s what the latest proposal means for companies and shareholders:

The current rulebook appears to be tilted in favour of investors who tender their shares in a share buyback either partially or fully — that is, either the shareholder sells a part of the company's stock held or sells in whole. Because of this, even shareholders who don't want to exercise a buyback offer have to bear the tax caused by investors who participate. This is simply because all the continuing shareholders have to collectively share the burden of tax payable by the listed company on the buyback proceeds.

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According to the proposed changes, the market regulator will ensure that only those exercising a buyback have to bear the burden of the tax incidence.

Sebi has invited feedback and suggestions from the public on the consultation till paper till December 1.

A study conducted by the Mistry-led panel collated data on share buybacks by 68 listed firms from April 2019 to March 2020 to find that in 19 such instances, promoters tendered shares more than their pre-buyback shareholdings. Companies actually paid buyback tax not only on the shares tendered by promoters as per their pre-buyback shareholding but also on additional shares tendered as some of the existing public shareholders did not tender their shares.

In these 19 cases, the total tax paid by the companies aggregated to Rs 2,988.8 crore, out of which the tax paid by these companies on shares tendered by the promoters was Rs 2,734.4 crore. In other words, the companies ended up paying tax from their free reserves on behalf of the existing shareholders and promoters at the cost of continuing shareholders — or the shareholders that did not tender the shares.

Among other proposed changes, the panel has suggested gradually trimming the limit on buybacks from 15 percent of the company's paid-up capital and free reserves to five percent, and reducing the time limit to complete the offer from the current six months to 22 days from April 2024.

This means that companies will be allowed to make smaller surplus cash payouts to shareholders through buybacks and will have a much shorter window to complete a proposed buyback.