Investment in shares is done primarily to earn returns. The returns are higher than the traditional investment options like Bank FDs, Post Office Schemes, etc. These returns from the equities or mutual funds market are mainly in the form of capital gains when the investment is redeemed or dividends paid by the company or the fund house. Apart from these obvious ways to get returns from the investment in equities, another way to gain funds from companies is in the form of buyback.
Given below are a few details of the buyback and dividends options and which is better for investors.
What are dividends?
Dividends are the payouts given to the shareholders of the company out of the company profits. The dividend payout ratio is proposed by the Board of the company and passed as a resolution by the shareholders of the company.
Prior to the budget of 2020, companies had to pay tax on the dividends paid to the shareholders in the form of Dividend Distribution Tax (DDT) at an effective rate of 20.5%. Post an amendment in the budget of 2020, DDT has been abolished and dividends are taxable in the hands of the investors at their applicable slab rates. When a company pays a dividend of more than Rs. 5,000 to any investor, they are liable to deduct TDS at the rate of 10%.
Issue of dividends to the shareholders are subject to certain conditions laid down under the Companies Act 2013. Dividends are a portion of profits made by the company which is shared with the shareholders. Therefore, dividends can be paid to the shareholders through any of the following resources.
- From current year’s profit
- From previous year’s profit
- From both of the above
- From the funds provided by the Central or State Government for payment of dividends under any guarantee given by the government for the same.
What are the advantages of dividend paying stocks/funds? Who should invest in them?
Dividends paid by the companies to their shareholders have always attracted more investors for the company. A company regularly paying dividends is viewed as a cash-rich company that also has a stable business model in most cases. While there are also cases of companies using dividend payment as a form of window dressing, the risk of such misrepresentation is lower in the case of big names in any industry. Some advantages of dividend paying stocks or funds are,
- It makes a good source of alternate income
- It is beneficial at the time of redemption of units or exiting the stock as the price of such investment will be higher due to the declaration of dividend.
- It is ideal for conservative investors or investors having a moderately high-risk appetite who prefer some form or regular returns from their investment.
What are buybacks?
Buybacks are another form of providing returns to investors. Through buybacks, the companies announce the repurchase of their shares in the market at a slightly higher price than the prevailing market price of such shares. This is to reward the shareholders for their investment in the company. This exercise will reduce the number of outstanding shares of the company in the market. The company is liable to pay a tax at the rate of 20% on such buyback while the investors have to pay capital gains tax on their gains depending on the period of holding.
Buyback of shares can be done through shareholders or through stock exchanges. When buyback is done through stock exchanges, they will be liable for the levy of STT.
What are the conditions for buyback?
Buyback of shares is subject to certain conditions as per the Companies Act, 2013. Following are the basic sources of a buyback.
- Buyback can be done only out of free reserves of the company
- Another option for the buyback is out of the securities premium account
- It can also be done from the proceeds of any shares or other specified securities
A few conditions to be adhered to for a buyback are mentioned below,
- The primary condition is that the articles of the company have to authorize such buyback. If the articles do not authorize it then a special resolution has to be passed to make such an amendment in the articles.
- The maximum number of shares allowed for the buyback is 25% of the paid-up share capital (including free reserves)
- The maximum debt-equity ratio cannot exceed 2:1.
- The buyback can be allowed only for fully paid-up shares.
What are the differences between dividends and buyback?
Dividends and buyback are both excellent forms of rewarding the shareholders. However, there are a few basic differences between the two. Some of such differences are detailed below.
| Category | Dividends | Buyback |
| Applicability | The dividend income is applicable for all the shareholders as of the applicable date of declaring the dividend. | Buyback is optional for the shareholders and not mandatorily applicable like dividends. Shareholders can opt for the buyback of shares at their discretion |
| The time interval for a buyback | Companies can declare dividends at regular intervals like annual basis, one-time dividend, or regular or special dividend | As per SEBI, buybacks are allowed only at an interval of approximately 14 months from the previous buyback |
| Impact on shares | There is no impact on the number of outstanding shares of the company in the market | Buyback directly results in a reduction of the number of outstanding shares of the company in the market |
| Taxability | Dividends are taxed in the hands of the investors at their applicable slab rates | Buyback is subject to a tax at the rate of 20% to be paid by the company. |
| Frequency of income | Dividends are paid more regularly and frequently to the shareholders. | Buyback of shares is an occasional event. |
Which is a better option for investors?
Dividends are an excellent source of regular alternate income for investors. Buyback although less frequent provides a chance of an increase in the shareholder wealth by a net increase in the earnings per share (EPS). Also, the tax paid by investors for the buyback of shares is capital gains which are lower as compared to tax on dividends which is higher in case the investor belongs to a higher tax bracket. Hence, buyback seems to be a better option for the investors as compared to dividends in case they have to choose between the two.
Conclusion
Dividends and buybacks both have their own set of advantages and limitations that are to be considered while selecting between the two. When the aim of the investors is to have a regular income through their investment, dividends seem to be a better option. Buyback of shares, on the other hand, helps in gaining better returns in the long term.
FAQs
1. How is dividend income taxed?
A. Dividend income is taxed in the hands of the investor at the applicable slab rates.
2. What is the effective taxable rate for the buyback of shares?
A. The effective rate of taxation on buyback of shares is 20% plus surcharge and cess.
3. What is the maximum amount of buyback that is allowed under the Companies Act, 2013?
A. There are many conditions related to the allowable amount of buyback. Among many conditions, one of the prime conditions for maximum buyback allowed is 25% of the total paid-up share capital.
4. Is buyback applicable to all classes of shareholders?
A. Buyback of shares is applicable only for fully paid up shares. Whereas dividends are applicable to all shares whether fully paid or partly paid shares.
