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Which is more tax-efficient for shareholders: Stock Buybacks or Dividends?
The way corporations reward their shareholders has seen a substantial transformation in the Indian stock market in recent years. These days, repurchasing shares is preferred above paying out dividends.
Buybacks have emerged as a tax-efficient option for shareholders in the highest tax bracket to optimize their post-tax earnings, and this shift is driven by a clear economic advantage. “From large-cap giants to small and mid-cap players, buybacks are becoming prominent, and even promoters are seen to leverage this strategy without facing backlash from the market.”
Why is this developing pattern occurring? Is it as a result of how these two categories are treated tax-wise? Which tax laws are at play here?
The investment landscape has significantly changed as a result of the Indian tax legislation, especially for high-income shareholders. The main distinction is in how buybacks and dividends are treated tax-wise. A company’s distributed income is subject to a flat tax rate of 23.296% when it undertakes a repurchase. Conversely, owners who receive dividends are subject to a 37% tax rate (surcharges excluded). For individuals in the highest tax rate, buybacks are an appealing alternative due to the significant tax discrepancy.
Does Buyback benefit people in higher tax brackets more than others?
A corporation that chooses to repurchase rather than pay out dividends will have an almost 45% higher post-tax realization for investors in high tax brackets. Buyback activity has increased as a result of this financial incentive as businesses strive to maintain the satisfaction of their high-earning shareholders.
What is the current trend in the small- and mid-cap space regarding dividends versus buybacks? What are the benefits for those in lower tax brackets?
Large-cap corporations aren’t the only businesses embracing the buyback trend; small and mid-cap firms are also embracing this tax-saving tactic. Due to their limited resources, smaller companies used to be reluctant to engage in buybacks, but these days they see buybacks as a good way to reward shareholders and reduce their tax liability.
According to data, buybacks are becoming a more popular financial tool for small and mid-cap corporations looking to increase shareholder value. There are two causes for this trend:
1. Regardless of the market capitalization of the company, the first reason it appeals to shareholders in the highest tax bracket is the tax benefits.
2. Second, optimizing capital allocation is a smart strategic decision for businesses, especially when they have extra cash on hand.
What are the benefits for those in lower tax brackets? Is dividend the only option available to them?
The repurchase corporation is subject to a flat tax rate of 23.296% [20% of dispersed income plus a 12% surcharge and a 4% health and education cess] in addition to other taxes. If you are a person and your income tax bracket is lower than this rate, you will benefit more from dividends.
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