POWER OF A COMPANY TO BUY ITS OWN SHARE
Before knowing about the power of a company to buy its own share, we must first know that why does a company wants to buy its shares back from the general public from the stock markets. The reason is simple because it wants to have more share or ownership of the company with itself, because shares of a company gives ownership of the company to the amount of shares a person holds, to have more power in its hands the company buy its shares back from the stock markets. The other reason could be that the company feels that the share market has discounted the share prices of that company too steeply, there could be many other reasons like, for example a company now has ample amounts of funds so now it could buy back some of its shares as a company feels that there is no better investment than in itself, and it also leads to an increase In the share prices of the company.
The section 68 of the Companies Act 2013 deals with the power of a company to buy its own shares ( its also called buy back of shares ). There are certain pre-defined set of rules and regulations for the purchase of own shares of a company and these are defined and written in the memorandum and article of association of a company as a company could not perform any function which is not defined in its memorandum and article of association. The buy back of shares of a company is only done through the excess funds like its free reserves which are not being used for any other purposes and some other reserves like the security premium reserves, or the funds from the proceeds of issue of any shares or other specified securities could be used for the buy back.
For the buy back of shares of a company, a special resolution at the general meeting of the company must be passed, so as to authorize and take the agreement of the people. The subsection (2) of section 68 of the companies act defines that the buy back of the shares must be completed within a period of one year of the passing of the special resolution. Before the buy back of shares, the company has to submit a file declaring the solvency position of the company to prove that they are capable of buying these shares back to the Securities and Exchange Board of India (SEBI) and the file must contain minimum 2 signs of the board of directors of the company and one of them must be the managing director of the company.
The sub section (1) of section 68 of the companies act 2013 defines a set of rules that from where the buy back of shares could be done. It defines that the buy back of shares could only be done from the open share market, or from the existing shareholders or stakeholders on proportional basis, or the company could also purchase the securities from the employees which were issued to them earlier at a lesser price than the markets.
Only a company whose stocks are registered at a recognized stock exchange, like Bombay stock exchange or National stock exchange, could only file for the buy back of shares under the Securities and Exchange Board of India (SEBI), no company who is not registered under a recognized stock exchange could file for the buy back of the shares under it.
Earlier the stocks used to be on papers and after the buy back of shares or a company the company had to destroy those shares physically and extinguish those shares 7 days before of the completion of the period of the buy back. Now, as the shares are not shared physically, they are transferred digitally, the company just removes the number of extra shares digitally from the demat accounts or dematerialization accounts,in which the shares are stored digitally
After the buy back of the shares of a company is complete, as now there are less number of shares available in the market, the earning per share and the return on equity of the shareholders increases as compared to what it used to be earlier, as the number of available shares decreased.
RETURN ON EQUITY is simply the annual net income of the company divided by the total number of share holders, as the number of share holders dropped, the return on equity goes up.
So now as we all know what buy backs of shares are, so now we must know that why do company does buy back of shares and what are its advantages:
The Government of India in the Union budget of 2016 announced a 10% tax in the hands of shareholders, if the annual dividend exceeds 10 lakh rupees, which now led to dividends being taxed virtually at 3 levels, first as the dividends are post tax appropriations, which means dividends are calculated after the tax is deducted, then secondly it is taxed when the dividend is distributed to the share holders which is called dividend distribution tax (DDT). And then finally on the part of the share holders which they have to pay on their gains. Buy back of shares leads to a relief of tax on those extra shares which were earlier lying in the market.
Buy backs also leads to improvement of valuations of the company as people tends to think that the company has surplus funds for its buy back and with less availability of shares in the market it leads to a increase in the demand which leads to an increase in prices of the shares of the company, but sometimes it does not happen as people tends to think that the company now has not much to do and has no more future growth possibilities because of which it is returning the extra funds with it, instead of applying those funds for future growth.
Author: Harsh Chaudhary,
LLOYD LAW COLLEGE 1st year