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The Ghost of Buy-Back Tax Continues to Haunt Corporates

The government has introduced a slew of tax measures in the union budget 2019 directed at taxing rich individuals and entities. One of these measures was the proposal to levy a tax on listed companies when they buy back shares from the shareholders. The imposition of 20% tax on share buyback which was earlier applicable only to unlisted companies drew in a lot of flak and concerns from corporate giants.

The stipulation was brought in as an anti-abuse provision to discourage buyback of shares and encourage dividend distribution to shareholders in case of surplus earnings by a company. There was a feeling that listed companies took to the buy-back route to avoid paying the dividend distribution tax (DDT) pegged at an effective rate of 20.5576%. Therefore, it was deemed essential to plug this loophole that corporates were exploring to evade taxes. However, it is unfair to look at the corporate action of share buyback from such a narrow perspective. Apart from being a tax saving option, buyback also increases earnings per share of the company, avail positive debt-equity ratio and facilitates an exit route to shareholders. On that account, the government needs to issue a clarification regarding the applicability of the announcement to existing buyback proposals and other legal implications of the same.

 

What Constitutes Buyback?

 

The corporate action of a share buyback is a route for companies to return the extra income earned to the shareholders while potentially boosting their earning per share and value of the share over a long term. In a share buyback a company will extinguish the shares bought back or treated as treasury stock as permitted under IND AS.

 

Section 115QA of the Income-Tax Act, 1961 which provides for the imposition of tax on distributed income of a domestic company for buy-back of unlisted shares would now be amended to include shares listed on a recognized stock exchange. As a consequence, over and above the tax on income chargeable in respect of the total income of a domestic company for any assessment year, any amount of distributed income by all corporates on buy-back of shares from a shareholders is to face an additional tax at 20% on the distributed income.

 

The Tax Impact

 

Prior to the Budget announcement, a listed company had to pay corporate tax at 30% plus applicable surcharge and cess and the profits after tax when distributed among shareholders in the form of dividend attracted an additional effective tax rate of 20.56% in at the hands of the company. In addition, a specified assessee is required to pay income tax of 10 % when the amount of dividend received by him exceeded 10 lakh rupees as provided u/s 115BBDA of the Income Tax Act.

 

So the option for listed companies was to go for buyback of share which would not attract any additional tax apart from the corporate tax so that it could benefit the shareholders most.

 

Whereas now, in case of buyback of shares, entities will have to pay 20% on the difference of the initial value of the share and the buyback tender offer. Here it is pertinent to note that shareholders were exempted from capital gains tax arising in case of buyback of unlisted shares by companies u/s 10(34A).  Now the budget amendment has extended similar exemption to shareholders of a listed shares of companies u/s 10(34A).

 

Further, questions such as what happens when there is a market-based buyback and not a tender offer buyback needs to be clarified. Also, what would be the status if there is a capital loss in the hands of the shareholder and not a gain? Whether the capital loss would be allowed to be set off in subsequent years needs to be addressed.

 

 

Application of the proposal

 

As per the Union Budget, 2019 any Buyback implemented post-July 5th, 2019 by listed Companies is subject to an additional tax @20%.  Therefore, another relevant question that needs to be addressed immediately is whether the intention is to offer prospective or retrospective tax levy. A lack of clarity on this has pushed KPR Mill Limited, a prominent player among listed companies, to withdraw its offer to buy back its securities. Another listed entity facing the dilemma, SKP Securities, has brought its concern regarding the same to the attention of the market regulator and has also enquired whether it could withdraw its call for a buyback. Therefore, whether a Corporate can withdraw its offer to buy back while the scheme is announced and open needs to be elucidated. It is vital to comprehend and evaluate what the regulator and the governing laws offer to address this dilemma. 

 

Governing Statute

 

Corporates listed in the Secondary market are governed by the SEBI (Buy-back of Securities) Regulation 2018. The regulations in this regard unambiguously state that once a corporate submits the offer letter pertinent to the scheme with the regulator, or in this regard, a public announcement is made, the Corporate cannot withdraw the said scheme.

 

It is worth noting that in this regard, the Companies law also offers similar provisions by way of Companies (Share Capital and Debentures) Rules 2014. The rules are clear: Post the announcement of an offer to its shareholders, one cannot withdraw the scheme. 

 

Consequently, KPR mills could only withdraw after citing difficulties in getting shareholder approval for the enhanced disbursement and the legal impediment in availing funds to cover it.

 

 

Conclusion

 

Although it seems that another objective that the government sought to achieve through this measure was to ensure investment by listed companies in furtherance of its business or diversification of its operation which would lead to job opportunities and boost the economy. Also, taxing rich corporates would supplement the government’s financial requirements which would help in running welfare schemes and achieving the goal of the 5 trillion USD economy that we hope to achieve by the year 2024. Rather than taxing individuals, this route would help tax corporates that have the means to pay for it. Also, it gives a level playing field to unlisted and listed companies.

 

However, the measure drives one to question whether it is possible to achieve an effective tax administration in the presence of such loopholes and grey areas in the tax system.  In addition, the announcement flouts the well-known “Canons of Taxation, “ which prescribe Canon of Certainty and Canon of Convenience among the other prescribed canons. Till the regulator or the government addresses the afore-mentioned dilemmas, it seems that the said proposal is contrary to the world-known principles of taxation.

 

 

 

 

Image Credits: Photo by rawpixel from Pixabay 

the measure drives one to question whether it is possible to achieve an effective tax administration in the presence of such loopholes and grey areas in the tax system.  In addition, the announcement flouts the well-known “Canons of Taxation, “ which prescribe Canon of Certainty and Canon of Convenience among the other prescribed canons. Till the regulator or the government addresses the afore-mentioned dilemmas, it seems that the said proposal is contrary to the world-known principles of taxation.

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SEBI’s Insider Trading Tentacles Reach (Overreach) “fiduciaries”

Recurrent cases of insider trading in eminent corporates has necessitated periodic updation of regulations to meet the needs of the ever-evolving market. The social culture of casually discussing or watsapping Unpublished Price Sensitive Information (UPSI), that is not only difficult to track but also poses evidentiary challenge in the court, needed immediate overhauling. Further, placing all the investors trading in the secondary market on equal footing to ensure symmetrical flow of information among them is exemplar of the non-partisan philosophy that the regulatory authority strives to establish. Towards this objective, the Securities and Exchange Board of India (SEBI), on the recommendations of Shri T. K. Vishwanathan’s Committee on Fair Market Conduct, introduced a myriad of changes through an amendment to the SEBI (Prohibition of Insider Trading) Regulations, 2015 which came into effect in April 2019. Notwithstanding the earnest intention behind the modifications, the amendments are not infallible and could encounter a lot of implementation challenge.  

Major Changes brought about by the amendments to the SEBI Insider Trading Regulations: 

 
Fiduciaries: 

The amendments have brought in various new concepts affecting entities such as law firms, auditors, consultants etc. who, by the very nature of the work carried on for listed company, either get access to UPSI or expressly receive them for specified purposes. UPSI is not generally available to the public and if exposed, would materially affect the price of the securities being traded in the secondary market. Therefore, the role of these entities in stifling leakages was considered crucial and nomenclated as fiduciaries under these amendments through the following concepts: 

Connected Person: 

Individuals associated with the work related to listed company in the last six months, directly or indirectly in any capacity, are considered insiders. The fiduciaries i.e. professional firms such as auditors, accountancy firms, law firms, analysts, insolvency professional entities, consultants, banks etc., assisting or advising listed companies are also covered under the definition of “insider” as connected persons.  

Legitimate purposes: 

Although the regulations allow the use of USPI for legitimate purposes, such as in furtherance of the scope of work assigned by listed company, it cannot be communicated to any other person including other connected persons who are not part of the assignment. The information should be shared only on a need to know basis within the organization.   

Duty to frame code of conduct and recognize Designated Persons: 

The fiduciaries are required to frame code of conduct for regulating, monitoring and reporting trading by Designated Persons (one who is in possession of UPSI or likely to have access to UPSI) and to appoint a compliance officer to implement such code of conduct.  

The amendments also envisage to include immediate relatives of Designated Persons and persons having financial relationship with Designated Persons as insiders requiring compliance with the code of conduct.  Generally, they include partners, retainers at all levels, support staff such as IT Staff and Secretaries and those having access to UPSI.   

Steps envisaged for prevention of insider trading by fiduciaries: 
  • Client information of Listed Companies have to be shared only on a need to know basis within the organization. Adequate and effective system of internal controls must be put in place to ensure compliance with the requirements given under the regulations to prevent insider trading. 
  • A code of conduct has to be framed and a compliance officer has to be appointed who would identify the Designated persons and implement the code of conduct. 
  • Details, including cell numbers of the insiders (Designated person, his relatives and individuals with whom he shares material financial relationship) must be maintained in a database. Further, past employment and educational institutions from where they passed out and their PAN should also be collected. Management must ensure maintenance of structured digital database for the same. 
  • A list of securities as a “restricted list” which shall be used as the basis for approving or rejecting applications for pre-clearance of trades must be maintained confidentially by the compliance officer. 
  • The management, in consultation with compliance officer, is required to determine the threshold value within which Designated persons need not take pre-clearance for executing trades. Any trading over the threshold would require pre-clearance from the compliance officer. 
  • The code of conduct shall stipulate the sanctions and disciplinary actions, including wage freeze, suspension, recovery, clawback etc. that may be imposed for violation of the same. 
  • Violations of insider trading needs to be reported to SEBI. 
  • Individuals must be sensitized regarding the duties and responsibilities attached to the receipt of inside information, and the liability that attaches to misuse or unwarranted use of such information. 
  • On an annual basis, management has to review the implementation of the code of conduct and make changes if necessary.  

 

Unsettled Issues Post-Amendment to the Insider Trading Regulations:

 

  1. Collection of details of past employment, educational institutions from where they passed out and PAN Details relating to fiduciaries and their immediate relatives. 

 

Collection by the compliance officer of a listed company or fiduciary, the details such as phone numbers, past employment, educational institutions from where they passed out and PAN of not only Designated Person but also their immediate relatives is a compromise of the privacy rights of individuals. It is empowering a company official to collect personal details of people who are not even remotely associated or aware of the UPSI or the work carried on by the Designated Persons. Herein “Immediate relative” means a spouse of a person, and includes parent, sibling, and child of such person or of the spouse, any of whom is either dependent financially on such person or consults such person in taking decisions relating to trading in securities. The data that compliance officer is collecting is personal data of many and purpose of such collection will not make much difference in compliance of insider trading law. If a relative denies sharing personal information, what should compliance officer do is also not clear. 

The Listed Companies are expected to sign confidentiality agreement with fiduciary and whereby it can bind fiduciaries with their code of conduct. SEBI also has the power to call for data while investigating a case of insider trading. While all these powers are available additionally empowering compliance officers to collect personal data and private information of relatives, without even having an allegation of commission of an offence is unjustified. Moreover, it seems SEBI has not made any prescriptions to prevent misuse of such personal data at the hands of a listed company.  

 

2. The regulations allow the compliance officer of a listed company to specify those working in a fiduciary as Designated persons under their code of conduct and make their code of conduct applicable. Thus, there is no requirement of a separate code of conduct, and this amendment is an attempt to overreach its powers on people over whom SEBI has no jurisdiction. 

 

The amendments impose overlapping obligations on listed companies and fiduciaries to frame and implement a code of conduct. A listed company would be in a better position to analyze and make the code of conduct applicable to partners, employees or persons who are given access to UPSI. It also creates ambiguity especially if the Designated persons, thresholds, pre-clearance requirements as recognized under the listed company’s code of conduct is different from those prescribed by fiduciaries in their code of conduct. 

Therefore, fiduciaries should not be placed at same footing as that of listed company or intermediary who access UPSI. This is the approach taken by the Vishwanathan committee as well.  Fiduciaries are not regulated under the SEBI Act, 1992. They include persons associated with the securities market within the meaning of Section 11B of the SEBI Act, 1992 and such association is only while handling UPSI received from a listed company or while carrying on statutory functions in connection with securities market. Thus, requiring fiduciaries to frame their own code of conduct and making all requirements of code of conduct as in the same manner that applicable to an intermediary seems to be an attempt to overreach by SEBI and indirectly bring all consulting firms (lawyers, accountants, management consultants) under its jurisdiction.   

Thus, it is inappropriate to have a separate code of conduct for regulating trading of Designated persons of fiduciary. Similarly, requiring private information of immediate relatives of fiduciaries to be procured by listed company or fiduciary is in violation of privacy rights of such persons. These are clear case of overreach of powers by SEBI.  

 

 

Image Credits Photo by nrd on Unsplash

 

It is inappropriate to have a separate code of conduct for regulating trading of Designated persons of fiduciary. Similarly, requiring private information of immediate relatives of fiduciaries to be procured by the listed companies or fiduciary is in violation of the privacy rights of such persons.

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