The practice of a company buying back its own shares is a relatively modern development in Indian corporate law. When the Companies Act, 1956 was enacted, it did not contain any provision for share buyback. At that time, companies were strictly prohibited from repurchasing their own shares, as lawmakers believed it could be misused to manipulate share prices or reduce the protection available to creditors. However, over time, the corporate sector in India expressed a strong need for flexibility in managing capital and utilizing surplus funds efficiently.
After years of demand from the industry, the government responded by issuing an ordinance on 31st October 1998, which permitted companies to buy back their shares. This was followed by the Companies (Amendment) Act, 1999, which incorporated the concept into the legal framework with retrospective effect from 31st October 1998. With this reform, Indian companies were officially allowed to repurchase their own shares and specified securities, subject to prescribed conditions and safeguards.
In the same year, the Securities and Exchange Board of India (SEBI) introduced regulations to govern buyback of securities for listed companies. These regulations were designed to ensure investor protection, prevent misuse, and enhance transparency in the process. Later, the Companies Act, 2013 included Section 68, which consolidated the law on share buybacks and provided statutory authority to companies for undertaking such actions.
Since then, share buyback has become a common financial strategy in India. Many large corporations, including prominent IT companies and conglomerates, have utilized buybacks to restructure their capital, support stock prices, and return surplus cash to shareholders.
Meaning of Share Buyback
A share buyback refers to the process where a company repurchases its own shares from its existing shareholders. Once the company buys back its shares, it must extinguish and cancel them. This results in a reduction of the company’s share capital. The practice differs from treasury share systems in some countries where bought-back shares can be held for reissue. Under Indian law, once shares are repurchased, they cannot be retained and must be destroyed.
A company cannot repurchase its shares for investment or trading purposes. Instead, the main reason for a buyback is to manage the company’s capital structure efficiently and return excess funds to shareholders. Companies usually consider buybacks when they have surplus cash, when growth opportunities requiring large reinvestments are limited, or when the management feels that the company’s shares are undervalued in the stock market.
By reducing the number of shares in circulation, a buyback can improve key financial metrics, increase shareholder wealth, and provide better returns on equity. At the same time, it can serve as a tool for signaling confidence in the company’s performance and prospects.
Objectives of Share Buyback
The decision to undertake a buyback is usually driven by multiple objectives. It is not merely a way of returning money to shareholders, but also a strategy to influence ownership structure, earnings, and market perception.
Increase in Promoters’ Holding
When a company buys back a portion of its outstanding shares, the shares are cancelled. As a result, the percentage holding of promoters automatically increases without them having to purchase additional shares. For example, if promoters hold 40 percent of the total shares and the company repurchases 10 percent of its outstanding shares, the promoter holding rises proportionately. This increase strengthens the promoters’ control and voting power, making it harder for other parties to challenge their authority.
Enhancement of Earnings Per Share
Earnings per share (EPS) is calculated by dividing net earnings by the number of outstanding shares. When buyback reduces the number of shares in the market, the same earnings are distributed over fewer shares, thereby increasing EPS. A higher EPS is often interpreted positively by investors, as it reflects improved profitability per share. This can increase market valuation, improve investor confidence, and make the company more attractive to institutional investors.
Support to Share Price
Sometimes, a company’s stock may trade below what management considers its fair value. To address this undervaluation, companies often repurchase shares. The announcement and execution of a buyback serve as signals to the market that the management believes in the company’s growth and intrinsic value. This assurance helps stabilize the share price and may lead to appreciation in the short or medium term.
Prevention of Hostile Takeovers
Hostile takeovers occur when an outside party tries to gain control of a company by purchasing a significant portion of its shares from the open market. A buyback reduces the number of shares available for such acquisitions and simultaneously increases the proportion of shares held by promoters. This reduces the risk of losing control to an outside acquirer and strengthens the company’s defense against hostile bids.
Efficient Utilization of Surplus Funds
Companies that generate significant cash flows often find themselves with more liquidity than required for immediate operations or expansion. Keeping excess funds idle is not productive, as they yield low returns and may attract pressure from shareholders for distribution. A buyback allows the company to deploy this surplus cash efficiently. By returning money to shareholders through repurchase, companies avoid overcapitalization and optimize their balance sheet.
Rewarding Shareholders
In many cases, companies offer to repurchase shares at a price higher than the prevailing market rate. This premium benefits shareholders who participate in the buyback, providing them with immediate gains. Even shareholders who do not sell indirectly benefit from a higher EPS and stronger market position of the company. Thus, buybacks are often regarded as a shareholder-friendly measure.
Other Strategic Objectives
Apart from these primary goals, buybacks may also serve secondary objectives. They can provide flexibility compared to dividends, as buybacks are discretionary and do not create long-term obligations. They can also improve financial ratios such as return on net worth and return on capital employed by reducing equity base.
Advantages of Share Buyback
The objectives discussed above naturally lead to a number of advantages for the company and its shareholders. Some of the notable advantages are:
- A stronger capital structure due to the reduction of excess equity.
- Increased confidence in the company’s management, as buyback demonstrates their belief in future performance.
- Better alignment of financial ratios, including higher EPS, return on equity, and book value per share.
- Greater flexibility in distributing surplus funds, without committing to regular dividend payouts.
- Reduction of free float in the market, which may support long-term price stability.
Limitations of Share Buyback
Despite its many advantages, buyback is not without risks and limitations. Companies and investors must be aware of potential downsides before undertaking or supporting such actions.
First, there is the risk of misuse. Some companies may announce buybacks merely to create a short-term rise in share prices, even if they lack genuine long-term benefits. If insiders exploit such movements, it may amount to unfair trading practices.
Second, buybacks can reduce public shareholding to levels that attract regulatory restrictions. In India, listed companies are required to maintain a minimum of 25 percent public shareholding. Excessive buybacks that raise promoter holding beyond permissible limits may conflict with this requirement.
Third, companies sometimes overpay for their shares during buyback, especially if the shares are already trading at high valuations. This results in destruction of value, as cash is spent without adequate benefit to long-term shareholders.
Fourth, frequent buybacks may signal to investors that the company lacks profitable investment opportunities. While this may not always be true, it can create negative perceptions about growth prospects.
Finally, large buybacks reduce the liquidity of shares in the market, making it harder for investors to trade them actively.
Legal Basis of Share Buyback in India
The primary legal foundation for share buyback in India is contained in Section 68 of the Companies Act, 2013. This section provides statutory authority to companies to repurchase their own shares or specified securities, subject to conditions.
The Act specifies permissible sources of financing for buyback, including free reserves, the securities premium account, and proceeds of an earlier issue of different types of shares or securities. Importantly, proceeds from the same kind of shares cannot be used for buyback.
When buyback is funded through free reserves or securities premium, the company must transfer an amount equal to the nominal value of repurchased shares to the Capital Redemption Reserve Account. This safeguard ensures that the creditors’ position is not weakened. The Capital Redemption Reserve can later be used only for issuing fully paid bonus shares.
Other conditions include ensuring that only fully paid shares are repurchased, obtaining authorization from the company’s articles of association, passing a special resolution by shareholders (or a board resolution in certain cases), and completing the process within twelve months of authorization.
The company must also declare solvency, file necessary returns with the Registrar of Companies, and extinguish the repurchased shares within seven days of completion. For listed companies, compliance with SEBI regulations is mandatory.
Sources of Financing Buyback
Section 68 of the Companies Act, 2013 specifies the sources from which a company can finance a buyback. These include:
- Free reserves of the company
- Securities premium account
- Proceeds of an earlier issue of shares or securities other than the same kind being bought back
A crucial restriction is that the proceeds of the same type of shares or securities cannot be used for buyback. For example, a company cannot issue new equity shares and then immediately use the proceeds to repurchase existing equity shares. This ensures that buybacks are not funded through circular transactions that artificially inflate demand.
When buyback is financed out of free reserves or securities premium, the company must transfer an amount equal to the nominal value of shares bought back to a separate Capital Redemption Reserve account. This transfer preserves the capital base and ensures that the reduction in share capital does not adversely affect creditors. The Capital Redemption Reserve can only be used for issuing fully paid bonus shares, thereby locking it for shareholder benefit and preventing misuse.
Meaning of Reserves and Free Reserves
The Companies Act, 2013 does not provide a comprehensive definition of the term reserve. However, as per accepted accounting principles and references in Table F of Schedule I, reserves are funds set aside from profits for specific or general purposes.
Free reserves refer to reserves available for distribution as dividends and for buyback. Certain reserves are excluded from this definition, including:
- Capital redemption reserve
- Debenture redemption reserve
- Share forfeiture account
- Revaluation reserve
- Pre-incorporation profits
- Statutory reserves created under tax laws or other statutes
These exclusions are important because such reserves represent funds that are either earmarked for specific obligations or not considered as freely distributable profits.
Meaning of Specified Securities
The law also uses the expression specified securities in the context of buyback. Section 68 clarifies that specified securities include employee stock options and any other securities as may be notified by the central government.
As of now, no additional securities have been notified. This definition ensures that the buyback framework extends beyond ordinary equity shares to cover other instruments issued to employees and stakeholders.
Meaning of Proceeds of Shares or Securities
The term proceeds refers to the par value of shares issued. Premium received on issue is treated separately under Section 52 of the Companies Act and can only be applied for specific purposes such as issuing bonus shares, writing off preliminary expenses, or premium payable on redemption of debentures. It cannot be freely used for buyback unless explicitly permitted under the law.
Conditions for Buyback
A company must satisfy several conditions before undertaking a buyback. These conditions are designed to balance the interests of shareholders, creditors, and the financial system.
- Only fully paid shares or securities can be bought back. This ensures that there are no complications relating to unpaid liabilities.
- The company’s Articles of Association must authorize the buyback. If such authorization does not exist, the articles must first be amended through shareholder approval.
- Buyback must be approved by a special resolution in a general meeting of shareholders. However, if the buyback is up to 10 percent of the total paid-up equity capital and free reserves, it can be approved by a board resolution. For amounts above this threshold, shareholder approval is mandatory.
- The buyback should not exceed 25 percent of the aggregate of paid-up capital and free reserves of the company. In the case of equity shares, the limit of 25 percent applies specifically to the total paid-up equity capital.
- The ratio of the aggregate of secured and unsecured debts owed by the company after buyback must not exceed twice the paid-up capital and free reserves, unless a higher ratio is prescribed for certain classes of companies.
- All shares and securities to be bought back must be extinguished and physically destroyed within seven days of completion.
- The entire process must be completed within 12 months from the date of passing the special resolution or board resolution.
- The company must not make any fresh issue of the same kind of shares within six months of buyback, except in cases such as bonus issues or conversion of existing warrants or stock options.
Notice of Meeting
When shareholder approval is required for buyback, the notice of the meeting must provide clear and transparent disclosures. These include:
- A full and true explanation of the material facts relating to the buyback
- The necessity of buyback and the benefits it is expected to provide
- The class of security intended to be repurchased
- The total amount earmarked for buyback
- The timeframe within which the company expects to complete the process
This disclosure requirement ensures that shareholders can make informed decisions and prevents management from initiating buybacks without adequate justification.
Declaration of Solvency
Before proceeding with a buyback, the company is required to file a declaration of solvency with the Registrar of Companies. In the case of listed companies, this declaration must also be filed with SEBI. The declaration must be signed by at least two directors, including the Managing Director, if any.
The declaration affirms that the company is solvent, will not be rendered insolvent within one year of completing the buyback, and will be able to meet its obligations to creditors. This safeguard is crucial to ensure that companies do not use buybacks to strip themselves of liquidity and compromise their ability to meet financial commitments.
Extinguishment of Shares
The law requires that all shares bought back must be extinguished and destroyed within seven days of completion. This rule prevents companies from holding treasury stock and reissuing it later, which could lead to market manipulation. Once extinguished, the shares cease to exist, and the company’s issued capital is reduced accordingly.
Restriction on Further Issue
After completing a buyback, a company cannot issue the same kind of shares for a period of six months. The only exceptions are issuance by way of bonus shares or conversion of stock options, sweat equity, or other existing instruments. This restriction ensures that companies do not misuse buybacks to artificially inflate demand and then reissue shares quickly.
Register of Bought-Back Securities
The company is required to maintain a register of bought-back securities. This register must contain details such as the consideration paid, the date of cancellation, the number of securities extinguished, and the date of extinguishment. Maintaining such a register ensures accountability and provides an official record for regulatory and audit purposes.
Filing of Return
Within 30 days of completing a buyback, the company must file a return with the Registrar of Companies and, in the case of listed entities, with SEBI as well. This return confirms compliance with legal provisions and serves as evidence that the buyback was conducted within the prescribed framework.
Prohibition of Buyback
Section 70 of the Companies Act, 2013 prohibits buyback in certain circumstances to prevent misuse and safeguard creditors. A company cannot buy back its shares:
- Through any of its subsidiaries, including step-down subsidiaries
- Through any investment company or group of investment companies
- If it has defaulted in repayment of deposits, interest thereon, redemption of debentures or preference shares, or repayment of any term loan or interest thereon to a financial institution or bank
- If it has defaulted in payment of dividend to shareholders
- If it has not complied with statutory filing requirements or preparation of financial statements
These prohibitions are intended to prevent financially distressed or non-compliant companies from diverting funds toward buybacks at the expense of creditors and shareholders.
SEBI Regulations for Listed Companies
For listed companies, buybacks are subject not only to the Companies Act but also to SEBI regulations. The SEBI (Buy Back of Securities) Regulations, 1999 provide detailed rules to ensure fairness, transparency, and protection of minority shareholders.
Key requirements include:
- Detailed disclosure of material facts and reasons for the buyback
- Disclosure of the class of security to be bought, the amount earmarked, and the buyback price or range
- Timelines for completion of the process
- Disclosure of promoter participation and details of transactions carried out by them in the preceding six months
- Public announcement of buyback to ensure transparency and equal opportunity for investors
SEBI regulations also prohibit certain methods of buyback such as negotiated deals, private arrangements, or spot transactions. The only permitted methods are through tender offers, open market purchases, and repurchase of employee stock options or sweat equity shares.
Methods of Buyback
Tender Offer
Under the tender offer method, the company offers to repurchase a specified number of shares at a fixed price. The buyback price is usually set at a premium to the prevailing market price, providing shareholders with an incentive to tender their shares.
If the buyback receives applications exceeding the intended number of shares, the acceptance is done proportionately. This ensures equitable treatment of all shareholders and prevents disproportionate participation by any single shareholder group.
Tender offers are particularly useful when the company wants to repurchase a significant percentage of its outstanding equity within a short period. Since promoters are also allowed to participate in this method, their shareholding percentage may increase if other shareholders tender more shares than they do.
Open Market Purchases
Companies can also repurchase shares directly from the open market. Under this method, the company buys shares on the stock exchange at prevailing prices, subject to regulatory limits. This method gives the company flexibility to spread purchases over time and respond to market conditions.
Open market purchases are carried out in two primary forms:
- Through stock exchange purchases, where shares are bought at market prices, and
- Through the book-building process, where shareholders bid within a price range, and the company determines the final buyback price based on demand and offers.
In stock exchange-based buybacks, promoters are not permitted to participate. This ensures that buybacks benefit public shareholders and do not disproportionately increase promoter holdings.
Book-Building Process
The book-building process is a more dynamic form of open market buyback. The company specifies a price band within which shareholders can submit bids for tendering their shares. Based on the bids received, the company determines the final buyback price, ensuring fair price discovery.
This process encourages active participation from shareholders and aligns buyback pricing with market demand. However, it also requires greater administrative efforts and adherence to strict disclosure norms.
Buyback of Employee Securities
Apart from shares held by general shareholders, companies can also buy back securities issued to employees, such as stock options or sweat equity shares. This method provides an exit option to employees and helps the company manage its equity structure. It is particularly useful when employee stock options are no longer in alignment with company strategy or when the company wishes to consolidate ownership.
Prohibition of Private Deals
The regulatory framework prohibits buybacks through negotiated deals, spot transactions, or private placements. These restrictions prevent manipulation of market prices and ensure that all shareholders receive an equal and transparent opportunity to participate.
Accounting Treatment of Buyback
Accounting for buybacks is governed by the Companies Act, 2013, as well as applicable accounting standards. Since buybacks reduce the share capital of a company, special treatment is required to ensure that the capital base remains safeguarded and creditors’ rights are not adversely affected.
Sources of Funds
Buybacks can be financed from:
- Free reserves
- Securities premium account
- Proceeds of an earlier issue of different securities
When free reserves or securities premiums are used, an amount equal to the nominal value of the shares bought back must be transferred to the Capital Redemption Reserve (CRR). This requirement ensures that the company’s capital base is not unduly eroded.
Entries for Buyback at Par
When shares are bought back at par value, the accounting entry is:
- Debit Share Capital Account
- Credit Bank Account (for the payment made to shareholders)
If free reserves are used, a corresponding debit is made to the reserves, and a transfer of equal nominal value is made to the CRR.
Entries for Buyback at Premium
When shares are bought back at a price higher than par value, the excess (premium) is debited either to the securities premium account or to free reserves if the premium account is insufficient. The journal entries record the payment to shareholders and adjustments to reserves accordingly.
Treatment of Capital Redemption Reserve
The Capital Redemption Reserve is a statutory safeguard. It can only be used for issuing fully paid bonus shares to shareholders. It cannot be distributed as dividend or used for general business purposes. This preserves the long-term interests of creditors and ensures that the company does not weaken its financial base through buybacks.
Separate Bank Account
For transparency, companies must open a separate bank account into which the buyback consideration is transferred. Payments to shareholders are made out of this account, ensuring that buyback funds are clearly distinguished from other company funds.
Tax Implications of Buyback
Taxation of buybacks has undergone significant reforms in India. Under Section 115QA of the Income-tax Act, 1961, domestic companies undertaking buyback of unlisted shares are required to pay buyback tax at the rate of 20 percent on the distributed income, along with surcharge and cess. The effective rate is slightly higher due to these additional levies.
Distributed income is calculated as the difference between the buyback price and the issue price of shares. Importantly, shareholders receiving buyback proceeds are exempt from tax, as the liability falls on the company. For listed companies, buyback tax rules apply selectively, and capital gains taxation rules may also apply depending on the structure of the transaction and the nature of securities.
Practical Illustrations
Illustration 1: Buyback from Free Reserves at Premium
A company has free reserves of 20 million and decides to buy back 100,000 shares of face value 10 each at a price of 50 per share.
- The nominal value of shares bought back = 1,000,000
- Premium on buyback = 4,000,000
- Total consideration = 5,000,000
Accounting treatment:
- Debit Share Capital Account = 1,000,000
- Debit Free Reserves = 4,000,000
- Credit Bank Account = 5,000,000
Additionally, transfer 1,000,000 from free reserves to Capital Redemption Reserve.
Illustration 2: Buyback Out of Securities Premium
Suppose a company has a securities premium balance of 15 million and decides to buy back 200,000 shares of face value 10 each at 40 per share.
- Nominal value = 2,000,000
- Premium = 6,000,000
- Total consideration = 8,000,000
Entries:
- Debit Share Capital Account = 2,000,000
- Debit Securities Premium Account = 6,000,000
- Credit Bank Account = 8,000,000
Transfer 2,000,000 from free reserves to CRR.
Illustration 3: Buyback Using Fresh Issue of Different Securities
A company issues debentures worth 10 million and uses the proceeds to buy back equity shares worth 8 million. Since buybacks cannot be funded by proceeds of the same kind of securities, the use of debenture proceeds is permissible.
Entries:
- Debit Share Capital and Reserves (as required)
- Credit Bank Account for buyback consideration
- Ensure creation of CRR for the nominal value of shares repurchased
Regulatory Timelines
The buyback process must be completed within 12 months of approval. Shares must be extinguished within seven days of completion. A return of buyback must be filed with the Registrar and SEBI (for listed companies) within 30 days. Non-compliance with these timelines attracts penalties and regulatory action.
Role of SEBI in Regulating Methods
SEBI regulations ensure that buybacks are conducted transparently, with detailed disclosures to the public. The choice of method is subject to restrictions to prevent misuse. For example, promoters are barred from participating in open market purchases through stock exchanges, ensuring that the benefit goes to public shareholders.
By mandating disclosures, proportional acceptance in tender offers, and prohibiting negotiated deals, SEBI ensures that all shareholders are treated fairly and market prices are not manipulated.
Conclusion
The concept of share buyback has evolved significantly in Indian corporate law and practice. Initially absent from the Companies Act, it was formally introduced through amendments in the late 1990s and has since become an important tool for corporate financial management. With the provisions of Section 68 of the Companies Act, 2013, and accompanying SEBI regulations, buybacks have been given a clear statutory and regulatory framework that balances the interests of companies, shareholders, and creditors.
A buyback essentially enables a company to repurchase its own shares and extinguish them, thereby reducing the outstanding share capital. This serves multiple objectives such as increasing promoters’ holding, enhancing earnings per share, supporting the stock price, preventing hostile takeovers, and providing efficient use of surplus funds. At the same time, it is subject to limitations and potential risks, such as the possibility of misuse for insider trading or reduction of public shareholding beyond permissible limits.
The law prescribes detailed conditions for conducting buybacks, including permissible sources of funds, declaration of solvency, timelines for completion, extinguishment of shares, and restrictions on subsequent issues. Buybacks can be carried out through several methods such as tender offers, open market purchases, the book-building process, or repurchase of employee securities. Each method carries its own procedures, disclosures, and regulatory safeguards to ensure transparency and fairness.
Accounting treatment plays a critical role in buybacks, with specific entries required for shares repurchased at par or at premium, creation of a Capital Redemption Reserve, and separate bank accounts for buyback consideration. This ensures that the company’s financial stability is not compromised and that creditor interests remain protected. In addition, taxation provisions, particularly the buyback tax under Section 115QA of the Income-tax Act, further define the financial impact of such transactions.
Practical illustrations highlight how companies can structure buybacks depending on the source of funds and the method chosen, while compliance with disclosure and filing requirements ensures regulatory oversight. The prohibition of private deals and negotiated transactions underscores the importance of maintaining market integrity and protecting minority shareholders.
Overall, share buyback has emerged as a strategic corporate action that, when used responsibly, benefits both companies and investors. It helps companies optimize their capital structure, return value to shareholders, and strengthen long-term market confidence. However, buybacks must be conducted strictly within the legal framework to prevent abuse and ensure that the broader interests of the financial system are upheld.