Question

Given the same personal tax rate on dividends and capital gains, a stock repurchase:

• creates a personal tax liability for the investor equivalent to that of a dividend.

• creates a personal tax liability for the investor that is lower than that of a dividend.

• Creates a personal tax liability for the investor that is higher than that of a dividend.

• is more highly taxed than a cash dividend.

• creates a tax liability even if the investor does not sell any of the shares he owns.

Answer 1

A stock repurchase will result in a Capital Gain to shareholder

Gain will be calculated using the formulae = (Repurchase price - Purchase Price) * Number of Shares Repurchased

Now let us consider the following example where tax rate is 20 % on both dividend and Capital Gain

100 Shares of Stock A bought at 500 per share

Scenerio 1 = Stock A pays Dividend of 50/share = 50*100 = 5000  

Tax = 5000 * 0.20 = 1000

Scenerio 2 = Company repurchases 8% of shares held by shareholders at a repurchase price of 625

Shareholder will recieve = (8% of 100) * 625 = 5000  (this amount of 5000 has been intentionally kept same in the example)

Calculation of tax on Repurchase

Capital Gain = (625-500)*8 = 1000

Tax on Capital Gain = 1000*20% = 200

Therefore Share repurchase will result in less tax because what investor recieves in a share repurchase is his investment amount and Capital Gain and tax is calculated only on capital gain