Buyback of Shares India - Accounting Standard & Legal Issues

Buying its own shares seems to be crazy as the same were sold to obtain funds for the company. But with the time, there is acceptance that people may be allowed to buy back its own shares. It is an important financial strategy with many facets. It can be used for the benefit of the shareholders or for the benefit of the promoters alone. In view of the benefits of a buyback, both for the company as well as the investors, and the scope for manipulation and price rigging by unscrupulous promoters, the Government of India appointed a working group on the companies Act in the year 1996. The Government of India working group given many recommendations on the buyback of shares. Previously under section 77 of the companies Act, 1956, the legal position was that a company was prohibited to buy its own shares unless a reduction of capital is effected. Such reduction of capital is effected in pursuance of section 100-104 or section 402 of the Act. But now buyback of shares is allowed in India.

A) ACCOUNTING STANDARD- Buyback of Shares

The IFRS in this regard is more specific and the Indian GAAP have no provisions.

Repurchase of own share - IFRS-IAS-Indian GAAP

A.1 IAS 33 prescribes that contracts that require an entity to repurchase its own shares, such as written put options and forward purchase contracts, are reflected in the calculation of diluted earnings per share if the effect is to dilute.

A.2 AS 20 is silent on this aspect.

A.3 IFRS- if an entity repurchase its own shares, such shares are considered as treasury share and are shown as deduction from shareholders equity.

A.4 Indian GAAP - there is no specific standard for accounting of such transactions under Indian GAAP. When the share is repurchased they are cancelled and cannot be kept as treasury stock.

B) COMPANIES ACT- Buyback of Shares

Buyback of shares means that any company may purchase their own shares or other specified securities. According to section 77A(1) of the companies Act , a company may purchase its own shares or other securities out of:

(i) Its free reserves or
(ii) The securities premium account or
(iii) The proceeds of any shares or other specified securities.

Specified securities include employees stock option or other securities as may be notified by the Central Government from time to time. Buyback of shares of any kind is not allowed out of fresh issue of shares of the same kind. In other words, if equity shares are to be bought back, preference shares or debentures may be issued for buyback of equity shares. Companies are allowed to buyback their own shares if they fulfill certain conditions as given in section 77A (2) of the companies Act.

The restrictions imposed are as follows. No company shall purchase its own shares or other specified securities unless:

(B.1) The buyback is authorized by its articles.
(B.2) A Special resolution has been passed in general meeting of the company authorizing the buyback.
(B.3) The buyback is for less than 25% of the total paid up capital and free reserves of the company.
(B.4) It also provide that buyback shall not be exceed 25% of total paid up capital.
(B.5) The debt equity ratio should not be more than 2:1 after such buyback.
(B.6) All the shares or other specified securities for buyback are fully paid up.
(B.7) The buyback of the shares or other specified securities listed on any recognized stock exchange is in accordance with the regulations made by the Securities and Exchange Board of India in this behalf.
(B.8) The buyback in respect of shares or other specified securities other those specified in clause
(B.9) The buyback should be completed within 12 months from the date of passing the special resolution.

C) SEBI guidelines:

SEBI guidelines incorporates the following points:

C1. Buyback of shares cannot be from any person through negotiated deals whether on or after stock exchange or through spot transactions or through private management. Therefore a company is required to make public announcement in atleast one National Daily all with wide circulation where registered office of the company is situated.

C2. Public announcement among other things specify the following:

(C.2.1) Specified date i.e the date of the dispatch of the offer letter shall not be less than earlier than 30 days but not later than 42 days.
(C.2.2) SEBI shall be informed by the company with in seven working days from the date of public announcement.
(C.2.3) The offer for buyback shall remain open to the members for a period of not less than 15 days but not exceeding 30 days. However the opening date for the offer shall not be earlier than 7 days or later than 30 days from the specified date.
(C.2.4) The company shall complete the verification of offers within 15 days from the date of closure and shares lodged shall be deemed to have been accepted unless communication of rejection is made within 15 days from the date of closure.

In present times the ultra-low interest rates stimulate the corporate investment to buy back shares. Basically the buy-backs are not to blame. The companies are not prudent to alter their long-term investment plans just because long term interest rates have been artificially pushed down. The reason being that the firms are being sensible by restraining investment in the face of economic uncertainty. There is obviously the pressure to boost cash returns can contribute to low investment. Even the investors like executives to feel a creative tension between the pull of capital investment, dividends and buy-backs. Internationally fashion giant Exxon, the biggest spender on buy-backs thus far, has recently tempered them in favor of long-term projects. Amazon has poured $3-4 billion a year into its distribution network.Tesla, a maker of electric cars, said it would build a $5 billion battery factory in Nevada. Its share price rose in response. It was a reminder that shareholder capitalism is still capable of moments when acts of creation, rather than changes to capital structures, induce euphoria. Basically Share buybacks have an unpredictable effect on the share price. The Share buybacks are not at all a reliable way of returning capital to shareholders. Sometimes it magnifies any mispricing of the shares compared to the value to long-term shareholders. In such a situation to use company’s excess cash plus the present value of future earnings as dividends. Thus much care need to be taken so that the buybacks are not overpriced. These buy-back shares can cause much greater losses to long-term shareholders compared to the gains from buying back under-priced shares.