New plan to tax share buybacks

Canada plans to tax share buybacks by two per cent starting January 1, 2024. U.S. already taxes buybacks by one per cent. This could persuade companies to raise their dividends faster. We prefer dividends to share buybacks.


How to protect your portfolio from Canada’s new tax on share buybacks

In its fiscal update on November 4, the federal government announced plans to impose a two per cent tax when companies buy back their common shares. This tax is expected to take effect on New Year’s Day in 2024. Finance Minister Chrystia Freeland called it a “smart tax”. The idea is to create financial incentives for companies to reinvest in their businesses and workers.

We think that share buybacks have grown excessively. According to S&P Global Market Intelligence, “The TSX 60 companies spent $67.1 billion in the past 12 months repurchasing their common shares.” That’s up by 157 per cent from $26.1 billion five years ago. By contrast, these companies paid dividends of $59.4 billion in the past 12 months. This was up by less than 30 per cent, or $45.8 billion, five years ago. We think that dividends should take preference over share buybacks.”

We prefer dividends to share buybacks

Our view is that share repurchases help management more than individual investors. Let’s say that management wants to cash in stock-based compensation, such as stock options. They may announce a share buyback to send the share price up, at least temporarily. This gives them an even more generous payday on the shareholders’ dime. Management rarely needs more cash. But individual investors, particularly retirees, often do, Growing dividends let them offset the rising cost of living.

There’s one case where share buybacks are preferable to dividends. That’s when a company’s outlook is uncertain. For instance, some economists predict that we’ll enter a recession in 2023. Especially if central banks raise interest rates too far, too fast. In such cases, a company can quietly let its buyback plan lapse and conserve cash. When a company trims or eliminates its dividend, it sends a negative signal to the market that can knock down the shares.

Our hope is that this two per cent tax on buybacks will lead more companies to focus on raising their dividends. The one per cent tax on purchases south of the border should do the same for American stocks. But we could see Canadian companies implement share buybacks before the start of 2024.

This is an edited version of an article that was originally published for subscribers in the November 18, 2022 issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
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