Infosys buyback: A great opportunity

Are you an Infosys shareholder? Then you must be aware that their buyback offer is on. Although technically it is not strictly a buyback, the process and taxation work similarly.

However, actually what Infosys is doing is sponsoring an additional ADR/GDR offering against equity shares offered by its existing shareholders. In other words, Infosys is inviting you as a selling shareholder to participate in a public offering of American Depository Shares (ADS) on the Nasdaq.

Now for the main question. Should you go for it or not? This will depend upon the following two factors:

• The price at which the shares are bought back from you; and
• The tax impact of this transaction on you.

Unfortunately, the first point cannot be answered, even by Infosys. The price at which the shares will be bought back from you depends upon how much the underwriters can get for the ADSs being sold -- which in turn depends upon the prevailing market conditions at the time of sale.

The proceeds of the ADS sale after deduction of registration and other expenses will be distributed between the selling shareholders in proportion of the shares accepted from them.

However, at this point it is pertinent to note that historically Infosys ADSs have largely been trading at a premium to the domestic share price. The historical data in this regard can give a selling shareholder a fair idea about the price appetite that the foreign market has for the offered shares.

The offer document contains data in this regard since September 2005 till October 2006 and one finds that the premium is in the range of a high of 28 per cent to a low of 14 per cent with the mean being somewhere close to 20 per cent.

This information is important as it can serve as a benchmark for your tax calculations upon accepting the offer. However, apart from the price realization, shareholders need to understand the tax impact, if any, of the above transaction since taxes will directly cut into your profits.

Readers would know that long-term capital gains (on shares held for over one year) are tax-free while short-term capital gains (on shares held for less than one year) are taxed at 10 per cent.

Now, first and foremost note that these rates will NOT be applicable to this Infosys offer. The reason for this is that the abovementioned rates of capital gains taxes are only applicable for shares sold on a recognized stock exchange where the seller pays STT (Securities Transaction Tax).

The offer doesn't meet these conditions, i.e. it does not constitute a sale on a recognised stock exchange and the seller will not be paying STT thereon. Instead, it would be construed as an off-market transaction.

Here the tax rates on long-term capital gains will be 20 per cent with indexation benefits or 10 per cent without indexation, whichever is lower.

Any short-term gains will be added to your other general income and be taxed at the slab rates applicable to you. As generally most investors would be in the 30 per cent bracket, it would be safe to say that such short-term gains would be taxed at 30 per cent.

There is yet another twist in the tale. Remember, Infosys declared a bonus in July. Since you will be offering the shares from your demat account, the FIFO (First In First Out) method will apply. In a bonus issue, the original shares are carried at the same cost (the price you paid for them) whereas the bonus shares are taken at nil value.

Therefore, in all probability, by selling your shares in this offer, you would book a notional capital loss. I cannot emphasise the word 'notional' enough. In other words, on your investment as a whole, there would (or more appropriately) should be a profit. It is only on account of the taxation system that a notional loss comes about.

Now, this loss (though notional) can be used for tax planning. The rule is that long-term loss can only be set-off against taxable long-term gains whereas short-term loss can be set-off against short-term gains or taxable long-term gains.

Ergo, this Infosys offer has the potential of being a win-win. On the one hand you can make some money over and above what you would have, had you sold the shares in the market and at the same time, you can save some tax on your other profits.

The following table sets out the above discussion in terms of numbers:

* Number and price of shares accepted is assumed

In the above example, since only 5 shares have been accepted and 15 shares returned back, the tax impact will only be on the 5 shares. 15 shares go back in your demat account and there is no tax impact thereon.

On the accepted 5 shares, FIFO will apply and your cost per share would be Rs 2,700. You have sold these at Rs 2,600 thereby making a notional loss of Rs 100 per share. Why notional? Because your actual average cost per share is Rs 1,350 (Rs 54,000/40). So ipso facto, though you are earning a profit of Rs 1,250 per share, tax wise you are actually booking a loss.

Depending upon your period of holding, the loss is either long-term or short-term as the case maybe and the tax treatment would be as explained before in the article.

In conclusion, the offer offers the Indian shareholder to earn some arbitrage profits on account of the differential price of Infosys on the Nasdaq. You can always buy back the accepted shares in the domestic market thereby making some relatively risk-free profit.

The tax benefit is just icing on the cake. Note that the offer closes on November 17.

The writer is Director, A N Shanbhag NR Group. He may be contacted at sandeep.shanbhag@gmail.com