Dividend vs Buyback: Which is better?
What are Dividend Shares?
Dividend payout shares provide profits that the company decides to share with its shareholders. The dividend is a sum of money which is paid out by the profits the company is going to make over a time period. Some companies decide to payout dividends on a yearly basis while some payout on a quarterly or bi-annual basis. One must note that dividend payouts are never guaranteed as they are dependent on the profits that the company is going to make.
The board of directors of the company reserves all the rights to decide if the company is going to pay out any dividends. Even if the company makes profits, the dividends may not be paid out. Instead, the profits earned can be invested in growth and expansion of the company. Dividends in excess of Rs 5,000 per company will be subject to TDS at the rate of 10% in the hands of receivers effective from 1 April 2020. Previously, dividends received by investors were made tax-free in their hands as the company paying out dividends was subject to paying dividend distribution tax (DDT).
What are Buyback Shares?
Buying back of shares is a corporate action. Under this, a company will buy back the shares it issued to its stockholder. The shares are bought at a slightly higher price than the market price. This is a way in which the company is going to reward its stockholders. This premium will encourage the shareholders to opt for the buyback process.
When the company goes onto buyback the shares, the number of outstanding shares in the market will go down. On doing this, the company will pay a tax at the rate of 20%, and the investors are taxed for the capital gains they record. Buyback of shares will happen in the following two ways:
i) Directly from shareholders: Under this process, there will be no implications of securities transaction tax (STT). However, capital gains tax will be levied. If the capital gains are short-term, then the shareholder will be taxed as per his or her income slab. In the case of the capital gains being long-term, then LTCG tax at a flat rate of 10% will be levied if the gains exceed Rs 1 lakh.
ii) Through stock exchanges: Under this process, the short-term capital gains shall be taxed at a flat rate of 15% as per Section 111A. This transaction is subject to paying the securities transaction tax. If the gains are long term, then they are taxed at a flat rate of 10% if they exceed Rs 1 lakh a year.
Which is better: Dividends or Buybacks?
After discussing in detail we can conclude that both dividend payouts and buybacks are seen as an indication of a company who does not have any productive investment opportunities available in the market.
Corporate buybacks may be regarded as a tax-efficient way of rewarding shareholders but timing is very critical for buybacks to be effective.
Buying back its own shares could be a sign of confidence of a company in its prospects but if the shares subsequently slide, then that confidence could be misplaced.
Also, dividend payouts do not have the flexibility that share buybacks have, as investors can choose the timing of their share sale and tax payment.
In dividend payouts, the investor has to pay taxes on them while filing tax returns.
But, it doesn’t mean that dividends payouts are a bad way of rewarding shareholders. In fact, there are some areas where the dividends are better than buybacks.
For starters, dividends offer complete transparency as information about the dividend payments are easily available through financial websites and corporate investor relations sites however the info on buybacks are very difficult to find.