BUY BACK OF SHARES

Buy-back is a procedure that enables a company to purchase its shares from its
existing shareholders, usually at a price near to or higher than the prevailing market
price. When a company buys back, it reduces its outstanding shares in the market,
which increases the percentage shareholding for the remaining shareholders. In a buy-
back, the company generally offers its shareholders an option to tender a portion of
their shares within a certain time frame and at a specified price (maybe at a premium
to the current market price). This price compensates the shareholders for tendering
their shares rather than holding on to them. Sometimes, companies buy back shares on
the open market over an extended period of time.

The reasons for buy-back are obvious — they improve the earnings per share and
longterm shareholder value, provide an exit route to shareholders when shares are
undervalued or are thinly traded, help achieve optimum capital structure and, of,
course, help return surplus cash to the shareholders. Another reason why this mode of
capital reduction is preferred by Indian corporates is that it does not require any
approval of the court or the National Company Law Tribunal (NCLT). Share buy-
back is also considered more tax-efficient than dividends to distribute a company’s
earnings: While companies have to pay dividend distribution tax (DDT) on the total
amount distributed and dividends above INR10 lakh are taxable in the hands of the
shareholders, listed companies are exempt from buy-back tax (BBT) and there is no
capital gains tax in the hands of, even large, shareholders in case shares are held for
more than one year and the buy-back is routed through a stock exchange where
Securities Transaction Tax has been paid. Further, in case of unlisted companies, BBT
is chargeable in the hands of the company on the “net amount distributed” (i.e., after
reducing the amount received by the company for the issue of such shares), while the
amount received is exempt in hands of the shareholders. So, there is a clear tax benefit
to the extent of the amount received by the unlisted company from its shareholders
(including securities premium), as it is not subject to BBT.

Source of buy-back
• Buy-back should be funded from free reserves, securities premium, proceeds from
any shares or other specified securities (not of the kind to be bought back).
Recipients of buy-back
• Buy-back can be from existing shareholders/security holders on a proportionate
basis or from open market or purchase of shares issued to employees under ESOP.
Quantum of buy-back
• The buy-back should not exceed 25% of the aggregate of the paid-up capital and
free reserves held by the company, subject to authorization by a special resolution in
the general meeting. In case of equity shares, the reference to 25% should be
construed with respect to its total paid-up equity capital in that financial year.
• However, in case the buy-back does not exceed 10% of the total paid-up equity
capital and free reserves of the company, there is no requirement of a special
resolution in the general meeting; authorization by a board resolution will suffice.

Other conditions
• The buy-back needs to be authorized by the articles of association.
• After buy- back, the debt-equity ratio of the company should not be more than 2:1.
• No offer of buy-back should be made by a company within a period of one year
from the date of the closure of the preceding offer of buy-back.
• The buy-back should be completed within a period of one year from the date of
passing of the special resolution or board resolution, as the case may be

REDUCTION ALTERATION AND DIMUNITION UNDER CA 2013

In the following cases, the diminution of share capital is not to be treated as reduction
of the capital. In all these cases, the procedure for reduction of capital as laid down in
Section 66 is not attracted.

(i) Where the company cancels shares which have not been taken or agreed to
be taken by any person [Section 61(1)(e) Companies Act, 2013];
(Cancellation of unsubscribed part of share capital)
(ii) Where redeemable preference shares are redeemed in accordance with the
provisions of Section 55 [Explanation to section 55(3) Companies Act,
2013];
 (iii) Where any shares are forfeited for non-payment of calls and such
forfeiture amounts to reduction of capital;
(iv) Where the company buys-back its own shares under Section 68 of the Act;
(v) Where the reduction of share capital is effected in pursuance of the order
of the Tribunal sanctioning any compromise or arrangement under section
230.

SOME ARRANGEMENTS IN SHAS

(a) Right of First Refusal (ROFR): ROFR permits its holders to claim the transfer
of the subject of the right with a unilateral declaration of intent which can either be
contractual or legal. No statutory recognition has been given to that right either in
the Indian Company Law or the Income Tax Laws. Some foreign jurisdictions
have made provisions regulating those rights by statutes. Generally, ROFR is
contractual and determined in an agreement. ROFR clauses have contractual
restrictions that give the holders the option to enter into commercial transactions
with the owner on the basis of some specific terms before the owner may enter
into the transactions with a third party. Shareholders' right to transfer the shares is
not totally prevented, yet a shareholder is obliged to offer the shares first to the
existing shareholders. Consequently, the other shareholders will have the privilege
over the third parties with regard to purchase of shares.

(b) Tag Along Rights (TARs): TARs, a facet of ROFR, often refer to the power of
a minority shareholder to sell their  shares to the prospective buyer at the same
price as any other shareholder would propose to sell. In other words, if one
shareholder wants to sell, he can do so only if the purchaser agrees to purchase the
other shareholders, who wish to sell at the same price. TAR often finds a place in
the SHA which protects the interest of the minority shareholders.

(c) Subscription Option: Subscription option gives the beneficiary a right to

demand issuance of allotment of shares of the target company. It is for that reason
that a subscription right is normally accompanied by ancillary provisions including
an Exit clause where, if dilution crosses a particular level, the counter parties are
given some kind of Exit option.

(d) Call Option: Call option is an arrangement often seen in Merger and
Acquisition projects, especially when they aim at foreign investment. A Call
option is given to a foreign buyer by agreement so that the foreign buyer is able to
enjoy the permitted minimum equity interests of the target company. Call option is
always granted as a right not an obligation, which can be exercised upon
satisfaction of certain conditions and/or within certain period agreed by the grantor
and grantee. The buyer of Call option pays for the right, without the obligation to
buy some underlying instrument from the writer of the option contract at a set
future date and at the strike price. Call option is where the beneficiary of the action
has a right to compel a counter-party to transfer his shares at a pre-determined or
price fixed in accordance with the pre-determined maxim or even fair market
value which results in a simple transfer of shares.
(e) Put Option: A put option represents the right, but not the requirement to sell a
set number of shares of stock, which one do not yet own, at a pre-determined
strike price, before the option reaches the expiration date. A put option is
purchased with the belief that the underlying stock price will drop well before the
strike price, at which point one may choose to exercise the option.

(f) Cash and Cashless Options: Cash and Cashless options are related arrangement
to call and put options creating a route by which the investors could carry out their
investment, in the event of an appreciation in the value of shares.