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Stocks

A Special Situation Opportunity Only For Those That Don’t Pay Tax

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In Capitalmind Premium, we run a bunch of “experimentals”. These are ideas that may not apply to everyone equally, or may have a very short term focus, or have a layer of risk that we don’t really want to expose ourselves for the long term. A recent experimental saw a near 50% return in three months where the risk-reward went in favour of a reward.

This article is about another experimental.


There’s a special situation in a company that is going to zero, and will pay out all the money it has over the next few months. That, however, is a wretched tax situation. The tax means only one thing: the use of this situation is only for institutions like mutual funds and insurers. (Who don’t pay any tax)

Majesco Ltd. has this interesting situation:

  • It trades at Rs. 935 per share
  • Majesco’s US subsidiary was listed on the Nasdaq.
  • The US subsidiary was bought over by a US PE fund- which leaves it with a post tax figure of roughly Rs. 3072 cr.
  • This is about Rs. 1028 per share which is distributable.
  • The company intends to distribute all of it.
  • There will be no software business left at the end. No business except a 120,000 sq. ft. commercial real estate (land and building) in Mahape, which they intend to sell after the lockdowns. That should generate about Rs. 150 cr. or so – which is about Rs. 50 per share.

What happens next?

They currently have a buyback on, at Rs. 845 per share. Why 845, when the market price is 935? We’ll explain in a bit.

After the buyback, with whatever cash is left, they will pay out a dividend. We should expect that Rs. 1020 per share or so will be declared. (They have said so in a conference call and presentation)

Distribution Plan

 

This part is interesting. Pay Rs. 935 to get a Rs. 1020 dividend and have a share with about Rs. 50 of value left?

But first, why is the buyback at Rs. 845?

If they have Rs. 1020 per share why is the buyback at Rs. 845? Buyback taxes.

The government charges 20%+12% surcharge + cess to the company on any buyback. So if the company pays Rs. 845 to a shareholder it will have to pay an additional 20%+ to the government which adds up to around Rs. 1040 which is nearabout what they own.

Promoters are considering that they might tender, because if they don’t, the oncoming dividend will be added to their income. This is now taxed at 42.7% (highest slab) so their tendering at 20% lower is fine.

(Remember, buyback proceeds are fully tax free – no capital gains for the shareholders whose shares are accepted)

Note that the buyback can only be for 25% of the company’s free reserves, which is why it’s also not a full buyback.

What if we wait for the dividend? Is there an opportunity?

If you buy now, you will get Rs. 1020 or so as dividend after the buyback, say in January. Now if you’re in any tax bracket more than 0% this makes no sense. Why?

Because dividends are now income. Even at the 10% tax bracket you will pay Rs. 100+ as tax. This cannot be offset with any other head of “loss”. So you lose a packet.

Even if you’re in the 0% tax bracket, you will see a 7.5% TDS on the dividend distributed. You will have to give a form 15G/H to ensure they don’t deduct tax – otherwise the money is stuck with the government for year.

Can you use the loss in the stock price? (Which will fall to Rs. 50 or so) Worse, there are dividend stripping laws that say you have to hold the stock for at least three months after the dividend, which crosses into April 2021. Effectively this means you can’t even take the losses to offset against any other capital gains you have this year.

Apparently, you can. The section for dividend stripping is only applicable if dividends are not taxed. So you can book losses immediately.

In effect: Mutual Funds and Insurers are the only beneficiaries

A mutual fund or insurer pays no tax. So it can get dividends, a tax-free 9% or so for itself, if it chooses to buy here.

These should in fact make deals with the promoters and buy it at market price or lower. The promoters get a better price than for tendering in the buyback. And then, the dividend is enough to give a decent return on the investment, but only for people that don’t pay tax.

Caveat: Maybe if you don’t pay taxes…

If there’s someone that doesn’t pay taxes – a major child, your spouse, or parents – they can use this to get a very decent yield. 10% for three months isn’t exactly bad, so the idea would be:

  • To buy now at 935
  • To get the dividend (expected Rs. 1020)
  • And then sell the remaining at leisure

If you don’t need to use the losses (at a zero tax bracket it may not be required) selling can be immediately after the dividend.

The upper limit of such a thing is obviously the income tax bracket of Rs. 5 lakh, so investing more than 5 lakh on this is a bad idea.

Please note: There are many risks here. The company may change their mind about the dividend, or the amount of dividend can be lesser. Plus in general, stocks have risks. So it’s not a “sure” thing. Consider it an “experimental” for zero tax accounts only. 


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