Buybacks and Company Legislation

23rd October, 2024 - 7:03 am Categories: Company Act Company Law TAX 0 Comments

INTRODUCTION

Buybacks is a process or a mechanism where the company approaches the shareholders to buyback or repurchase the shares they hold of the existing company.[1] Buyback is a good way to do capital restructuring. It is a strategic corporate tool regulated under Companies Act, 2013 and Income Tax Act, 1961 which is used for ownership consolidation to maintaining and utilizing surplus cash, financial ratio etc. It is a relatively new concept in India when compared to developed countries, and it was introduced at the same time as buybacks in other emerging economies.[2] Given that it provided Indian corporations with an additional window to reorganize their capital requirements and make better use of their resources, it was a significant change in corporate law.

Buybacks in Companies Act, 2013

Buybacks of a share is given under Section 68 of Companies Act, 2013 which corresponds to Section 77 (Power of company to purchase its own securities) of the 1956 Act which has a minimal change like the definition of free reserve has been modified and the provision of penalty has enhanced. Section 68 prohibits the buyback of its own share unless reduction of capital is effected but section 77 dilutes this general prohibition which can then allow a public or private company to purchase its own shares or other securities which is according to section 68(1) of the 2013 Act-[3]

“a) Its free reserves; or

1. b) The securities premium account; or
2. c) The proceeds of any shares or other specified securities.

However, no buy-back of any kind of shares or any other specified securities can be made out of proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.”[4]

Thus, sufficient balance is a must of a company in any one or more of its accounts so that it can accommodate the total value of buyback of shares.

The companies allowed buyback through section 77A of Companies Act 1956 wef the year 1999. Prior to section 77A the only way to buyback was by following section 100 of 1956 act of capital reduction process and which was subject to the approval of tribunal.[5]

The main reason why buyback was not given to the company till 1999 is because it may give rise to some unfair practices like insider trading in their own shares which can results in unhealthy influences on stock price.

Section 77A allowed buy back of shares which is subject to tough requirements like passing of special resolution, maintenance of certain debt-equity ratio etc.[6]

When Companies Act, 2013 was passed buyback of shares shifted under section 68 which is very much similar to the section 77A of the previous Act.[7]

CONDITIONS FOR BUYBACK OF SHARES

It is given under Section 68(2) of the act which says no person to purchase its own shares without following the given conditions:

1. When its articles permits the buyback
2. At the company’s general meeting, a special resolution was approved to allow for a buyback that would not exceed 25% of the total amount of the company’s paid-up capital and free reserves. In cases where the buyback represents 10% or less of the company’s entire paid-up equity capital and free reserves, a Board resolution would approve the buyback.[8]
3. the buyback is 25% or less of the total paid-up capital and free reserves of the company; provided, however, that the term “25%” in this clause shall be interpreted with reference to the total paid-up equity capital of the company for the buy-back of equity shares in any given fiscal year;[9]
4. The debt equity ratio should be 2:1 means the paid up capital and free reserves should be half of the company’s secured and unsecured debts.
5. The shares of buyback should be fully paid up.
6. Buyback of shares or securities should be in accordance with the regulations of SEBI if listed on any recognized stock exchange.
7. If not listed on any recognized stock exchange then in accordance with Companies (Share Capital and Debentures) Rules, 2014.

Section 68(4) talks about the time limit of buyback of the shares which says that it should be completed within 1 year from the passing of the special resolution or the board resolution.[10]

Section 68(6) talks about the declaration of insolvency which has to be filed by the company before the buyback of the share is proposed to the registrar and SEBI. If the shares of a company are not listed on any recognized stock exchange then the declaration of insolvency shall not be filed with the board.[11]

ADVANTAGES OF BUYBACK SHARES

• Value Gain for Shareholders: Buybacks are advantageous to stockholders. Earnings per share (EPS) increases when the number of shares decreases. When the total number of shares outstanding declines, earnings per share will rise since earnings per share is determined by dividing earnings by the total number of outstanding shares.[12]
• Increased return on equity: The company’s cash holdings on the balance sheet decrease as a result of the cash used to buy back the shares. In the liabilities section of the balance sheet, the buyback will concurrently diminish owners’ equity by the same amount. Because of this, after the buyback, both the return on equity (ROE) and the return on assets (ROA) increase.[13]
• The approval of the NCLT or the court is not required as it can be an alternative way to reduce the capital without the approval of the court.

When stocks are undervalued the investors has the opportunity to exit.

PROCEDURE OF BUYBACK OF SHARES

• First the company which has been authorized have to file a letter of offer to the registrar of the companies under Rule 17(2) of Companies (Share Capital and Debenture) Rules, 2014 and such letter should be signed by the board of directors not less than two directors of a company.[14]
• Then the company has to dispatch the letter of offer to the various shareholders under rule 17(4) but not later than 21 days from filing with the registrar of companies.
• The company has to maintain a register of shares or other securities which have been bought.

METHODS OF BUYBACK

1. On proportionate basis from existing shareholders.[15]
2. It can be done from the Open market
3. From stock option or sweat equity[16]

WHEN CAN THE COMPANY IS NOT ALLOWED FOR BUYBACK PROVISION?

The company is not allowed either directly or indirectly to buyback its own shares when it had not complied with the following provisions:

• Annual Return under Section 92
• Declaration and the Payment of Dividend under Section 123
• Failure to Pay Dividend under Section 127, and
• Failure in providing True and Fair Statement under Section 129.[17]

PROCEDURE AFTER POST BUYBACK

FILING OF RETURN: According to sub-section (10), a return must be submitted to SEBI and the RoC within 30 days of completion. According to rule 17(13), the firm must file a return in the form of FORM NO. SH.11 along with the required fee with the Registrar after the buy-back is completed. If the company is listed, it must also file a return with the Securities and Exchange Board of India.[18]

EXTINGUISHMENT OF SHARES: Pursuant to subsection (7), all shares and securities so bought back must be physically destroyed within seven days of the final day the repurchase was completed.[19]

Regardless of whether the Board of Directors or the shareholders approve, there must be a minimum of one year between two buybacks of securities. According to the 1956 Act, no additional buyback offer could be made within 365 days following the Board of Directors’ acceptance of the buyback if it was carried out with their consent.[20]

Purchases of shares are a common tool of corporate restructuring. In terms of taxation, buybacks have changed over time. Prior to 1999, they were treated as dividends under the Income Tax Act; following Section 77A, they were treated as capital gains; however, with the 2013 Act, a corporate dividend tax was imposed on companies; and finally, the Finance Act, 2024, further shifted the tax burden to shareholders by classifying buyback proceeds as “Income from Other Sources” and permitting capital loss adjustments.[21] This evolution reflects the ongoing changes in law to address the complexities of buybacks in corporate and tax regulations.

Buybacks of shares are a common tool of corporate restructuring. The main goals of buybacks are to consolidate ownership, preserve stock prices, return stock prices to real value, boost financial ratios, or lower the cost of capital by using the excess cash available with the company.[22]

CONCLUSION

Share buybacks have emerged as a vital corporate restructuring tool under Indian law, offering companies a mechanism to consolidate ownership, optimize capital structure, and return value to shareholders. The Companies Act 2013, particularly Section 68, provides a clear legal framework for executing buybacks, imposing conditions that ensure transparency and protect shareholder interests. The procedural requirements, such as board resolutions, debt-equity ratio maintenance, and compliance with SEBI regulations, safeguard the interests of both the company and its stakeholders.

The advantages of buybacks, including increased earnings per share (EPS), enhanced return on equity (ROE), and the flexibility they provide in capital restructuring without the need for court approvals, make them a preferred option for companies seeking to efficiently manage excess cash and improve financial ratios. The document also highlights the evolving tax treatment of buybacks, reflecting ongoing legal efforts to address the complexities of this practice.

As buybacks continue to play a crucial role in corporate governance and capital management, adherence to legal provisions and strategic execution remains essential for companies aiming to balance shareholder value with long-term financial stability. The insights gained from this project provide a comprehensive understanding of how share buybacks are regulated, executed, and utilized to achieve corporate objectives in India’s dynamic business environment.

Author: Arya Bhatt, Co-Authore: Samriddhi Seta 4th Year Dharmashastra National Law University (DNLU), Jabalpur, MP, in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney.

[1] Phale R, “Buyback of Shares under Companies Act, 2013” CAclubindia (December 14, 2023) https://www.caclubindia.com/articles/buyback-of-shares-under-companies-act-2013-38825.asp

[2] Ibid

[3] Ibid

[4] Kumar N, “Legal Background of Buyback of Shares under the Companies Act 2013” (Enterslice, December 2, 2020) https://enterslice.com/learning/buyback-of-shares-companies-act-2013/ Section 68 of Companies Act, 2013

[5] Srikant, “Buy-Back of Shares: Analysis under Companies Act and Income Tax Act” (TaxGuru, September 5, 2024) https://taxguru.in/company-law/buy-back-shares-aeanalysis-companies-act-income-tax-act.html#:~:text=Summary%3A%20The%20buyback%20of%20shares%20is%20a%20strategic,Act%2C%201956%2F2013%2C%20and%20the%20Income%20Tax%20Act%2C%201961.

[6] Ibid

[7] Ibid

[8] Phale R (n1)

[9] Ibid

[10] Ibid

[11] Ibid

[12] Phale R (n1)

[13] Ibid

[14] Ibid

[15] Lakhtariya NG, “Buy-Backs under Companies Act 2013 | Provisions & Process” (TaxGuru, April 22, 2024) https://taxguru.in/company-law/buy-backs-companies-act-2013-provisions-process.html

[16] Ibid

[17] Kumar N, “Legal Background of Buyback of Shares under the Companies Act 2013” (Enterslice, December 2, 2020) https://enterslice.com/learning/buyback-of-shares-companies-act-2013/

[18] Phale R (n1)

[19] Ibid

[20] Ibid

[21] Srikant, “Buy-Back of Shares: Analysis under Companies Act and Income Tax Act” (TaxGuru, September 5, 2024) https://taxguru.in/company-law/buy-back-shares-aeanalysis-companies-act-income-tax-act.html#:~:text=Summary%3A%20The%20buyback%20of%20shares%20is%20a%20strategic,Act%2C%201956%2F2013%2C%20and%20the%20Income%20Tax%20Act%2C%201961.

[22] Ibid