In spite of tax changes, the buyback is not yet dead.
Typically, companies wanting to reduce their capital can do so by either paying a special dividend, or buying their own shares on the Stock Exchange. Following tax changes last October, tax-exempt investors no longer receive advance corporation tax (ACT) rebates on buybacks. It appeared that companies would prefer the special dividend which minimises the government's tax take because (for example) pension funds can get the ACT back. However, the buyback hasn't died. RJB Mining recently elected for a buyback over a special dividend and in May, Royal & Sun Alliance said it was considering one. So what are the appropriate circumstances for a buyback of shares?
Barclays was short of takers for its £300 million buyback in February. Martin Taylor defended the attempt as 'an investment on behalf of the shareholders who do not sell ... It is in this class of shareholder that managements should be interested.' In other words, the buyback was pursued to shake out 'loose' shareholders.
Reuters' tax manager Mike Canty says: 'You have to deliver optimum shareholder value, which means not paying ACT if you can avoid it, but we dislike the "lack of choice" aspect of a special dividend.' This lack of choice comes about because whereas the dividend route means that all shareholders get the money, it still forces all small shareholders to pay ACT. The share buyback, by contrast, means that those who don't want an undesirable tax bill don't participate.
Christian Salvesen recently paid out a significant special dividend but since this was based on foreign income, it was allowed by the tax rules to include the amount which would otherwise have been deducted as ACT. Salvesen finance director Ian Adam says, 'The foreign income aspect made ours a special case, otherwise I would have preferred the buyback route. Although small shareholders don't get the ACT back, nevertheless it gives them cash and it will reduce the company's cost of capital in overall terms. A special dividend is a sort of, "We've got some spare money" gesture, a buyback signals a commitment to improve equity returns.'
David Gould, Manager of Investment Services at the National Association of Pension Funds is indifferent: 'We don't really see advantages one way or the other any longer, but companies seem to prefer buybacks.'
There are usually specific factors, such as the company's ACT capacity, which point it in the direction of either a special dividend or a buyback. Despite the lack of choice aspect of special dividends, shareholders have perhaps not been vocal enough in indicating their preference.