Bangalore/Mumbai: The Union Budget’s proposed levy of a 20% withholding tax on share buybacks by unlisted companies will make fund-raising tough and investment sales costlier for real estate developers and funds, analysts said.
Finance minister P. Chidambaram on Thursday proposed to tax profits distributed in the form of share buybacks saying several companies were using this route instead of paying dividends to avoid paying taxes. Domestic companies are liable to pay a dividend distribution tax of 16.22% on distributed profits.
With other exit options unviable in the present market, real estate firms have been relying on share buybacks in their projects to pave the way for private equity (PE) firms to sell their investments. Buybacks accounted for at least 90% of such exits in the past three years, analysts said.
As a result, the 20% withholding tax could make fund-raising from offshore investors costlier for real estate developers as the funds will want to factor in the additional levy in their expected returns, said Gaurav Karnik, tax partner, real estate practice, Ernst and Young.
“The proposed 20% tax on share buyback will impose an additional cost that will proportionately diminish returns to investors that are seeking an exit through the buyback route,” said Darius Pandole, partner at Asia-focused PE firm New Silk Route Partners Llc. “In the current scenario for private equity, where achieving exits is a critical imperative for investors, this proposal may have adverse effects on the industry.”
The new tax will especially affect PE funds based in countries that have tax treaties with India and were using share buybacks to repatriate surplus profits from Indian businesses without paying taxes.
So far, such profits have been treated as capital gains in the foreign country, allowing shareholders to get away with paying zero or a very low rate of tax in India. Under the new norm, buybacks will be treated as dividends and will attract significant tax on investors.
India has double-taxation avoidance agreements with 84 countries including Mauritius, Cyprus and Singapore.
“Tax on buyback of shares of unlisted domestic companies will have adverse effect and will lead to double taxation in some cases,” said Vipul Jhaveri, partner, Deloitte Haskins and Sells. “Exits by offshore funds in real estate companies is one such case where buyback can result in double taxation.”
Mint spoke with a number of fund executives who said the new tax has negative implications for real estate businesses in India.
Investors in real estate projects will now begin considering secondary sales (of stakes to third party buyers) more often, said Amit Bhagat, chief executive and managing director, ASK Investment Property Advisors Pvt. Ltd, which is set to raise its first offshore fund of around $250 million registered in Singapore.
“For project-related investments by offshore funds, the latter will factor in that buybacks may not happen, which would create some uncertainty and impact fund-raising,” said Bhagat.
V. Hari Krishna, director, Kotak Realty Fund, said the new tax will have a significant effect on offshore investors. As an alternative, funds may ask a real estate firm’s promoter rather than the firm itself to buy back the shares. The new tax will not apply to such deals involving promoters, he said.
But developers are unlikely to bear this new tax entirely by themselves and will want to share the levy with the investor fund, said Pragnya Advisors Pvt. Ltd’s chief executive T. Srinagesh. Property analysts say while funds may start working on alternative ways to get around the tax levy, other exit mechanisms may not be as easy as buybacks.
Ambar Maheshwari, managing director, corporate finance, at property advisory Jones Lang La Salle, said the impact of the new tax will be negative only to a limited extent and funds and developers will find ways to structure their transactions and exits differently.