TCS Buyback analysis

Headquartered in Mumbai, Maharashtra, India, TATA Consultancy Services is an Indian multinational information technology (IT) services and consulting firm. It is a Tata Group affiliate and operates in 149 locations across 46 nations. By market capitalisation, TCS is the second largest Indian firm. Tata consultancy services are now among the world's most successful IT services brands. TCS was rated 64th overall in the Forbes World's Most Innovative Companies ranking in 2015, making it both the highest ranked IT services company and the top Indian company. It is the world's largest provider of IT services.

Details of TCS buyback

TCS announced a buyback worth Rs16,000cr when it announced its financial results for the Sep-20 period. Since TCS had already filed its plan to buyback at its board meeting on October 07, the buyback was of public knowledge. Although the finer aspects of the buyback are being worked out and the postal ballot has yet to be carried out, there are some fundamental concerns regarding the buyback of shares that investors have such as, Can they participate and what are the tax consequences of the buyback?

The Rs16,000cr buyback number seems to have a familiar sound. The previous two buybacks that TCS made were both worth Rs16,000cr in 2017 and 2018. The basic details of the new TCS buyback offer are here.

   1 -  Total number of shares to be bought by TCS (A) – 5,33,33,333 Shares

  2 -  Total paid up capital of TCS- 375,23,84,706 Shares

  3 -  Percentage of shares to be bought back- 1.42%

  4 -  Closing price of TCS as on 6th October- Rs2,7144

  5 -  Buy back price proposed by TCS as on 7th October (B) – Rs3,000

  6 -  Premium to last closing price – 10.54%

  7 - Value of buyback offer (AxB) – Rs16,000 cr

TCS has Rs35,000cr in cash and short-term investments as of March-20, so financing the buyback should hardly be an issue. The big question is what happens to the structure of capital after the buyback and will the holding of the investor stay the same?

Will the ownership of the promoter change after the buyback?

That will largely depend on whether or not the primary shareholder, Tata Sons is interested in the buyback. The effect on the post-buyback holding structure would be null if Tata Sons participates in the buyback in the same proportion. However, if they want to miss participating in the buyback question, the promoter's stake in the business could go up. If Tata Sons aren’t interested in the buyback, then its TCS stake would increase to 73,087 percent by 104 bps. Considering the imminent departure of the Pallonji Mistry family from the Tata Sons board, this looks like a possible scenario. Tata Sons can of course, also choose to participate in the purchase, either in full or in part.

The tax effects of buying back under new laws

Budget 2019 saw major adjustments in the buyback tax laws and Budget 2020 saw substantial changes in the taxation of dividends. Both of these announcements have a substantial effect on the tax attractiveness of buybacks. Buyback was viewed as capital gain prior to July 2019, and taxable in the investor's hands. However, as a distribution, buyback will be taxed on the business after July 2019. The catch, however is that the difference between the issue price and the buyback price is payable by this 20 per cent buyback rate.

Budget 2020 abolished the Dividend Distribution Tax (DDT) principle and made dividends taxable at the peak rate in the hands of investors. That means it will be more tax-efficient for promoters and super-rich investors to use the buyback route than the dividend route. That explains this year's interest in buybacks.

A distinct viewpoint must be embraced by small investors

One of the issues with the buyback tax model is that all shareholders are impacted by the tax effect, whereas the dividend tax model is focused on profits. Another critical problem still exists. For instance, if you purchased TCS at Rs2100 over a year ago, your capital gains would be Rs900 (3000-2100), on which you pay 10% LTCG tax. Now the firm would pay tax on the difference with the original price if there is a buyback at Rs 3000.