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Amazon, Apple, Alphabet, Microsoft, and Meta are among the highest global spenders on research and development with each spending billions a year and employing scientists, engineers and other experts who command high salaries.JOSEPH PREZIOSO/AFP/Getty Images

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Stock buybacks have become a political target on both sides of the border as governments hold them up as greedy face of capitalism, rewarding shareholders at the expense of jobs and investment.

The Biden administration’s Inflation Reduction Act of 2022 in the U.S. includes a 1 per cent tax on stock buybacks. Canada’s Finance Minister Chrystia Freeland one-upped that with a 2 per cent tax on share buybacks in her fall economic statement. The Canadian tax takes effect on Jan. 1, 2024.

The question for investors is what to do? Should they steer clear of tech giants like Microsoft Corp. MSFT-Q, Apple Inc. AAPL-Q and Alphabet Inc. GOOG-Q, which spent billions on share buybacks in 2021, or view it as political theatre and ignore it.

“In the scheme of things, [the tax] is minor,” says Tom Bradley, chair and co-founder at Steadyhand Investment Funds Inc. in Vancouver. “It wouldn’t affect what companies we invest in.”

Dan Hallett, vice president of research and principal at Highview Financial Group in Oakville, Ont., also says the tax won’t make much difference and is political posturing that demonstrates a misunderstanding of corporate finance.

“In most cases, companies are already doing a combination of things – making capital investments, paying dividends, and buying back shares,” he says.

Mr. Hallett says companies reinvest profits if they believe they can do so profitably with the result being higher revenue and profits. In the absence of attractive investments, it makes sense to return cash to shareholders, either as dividends or by repurchasing shares. It’s a reward for the company doing well.

“The notion that buybacks are some kind of windfall is baseless,” he says.

The advantages of buybacks

Investors like buybacks because they offer several advantages over dividends. They raise a company’s earnings per share by reducing the number of shares outstanding. That tends to raise the price of the shares. There’s also a tax advantage. The gain is deferred until the shares are sold, unlike cash dividends that are taxed in the year in which they’re paid.

Companies with the highest levels of buybacks tend to be the most profitable. That’s precisely because they have made investments in their operations that have paid off.

Data from S&P Global this past spring showed S&P 500 companies bought back a record US$881.7-billion of their stocks in 2021. Five of the companies were nicknamed “buyback monsters” for the size of their buybacks. They were Apple, Google’s parent Alphabet, Facebook’s parent Meta Platforms Inc. META-Q, Microsoft and Bank of America Corp. BAC-N, which made up a quarter of the dollar value of the buybacks. The companies are also among the most widely held stocks by small investors and among the most profitable global entities.

Not coincidentally, Inc. AMZN-Q, Apple, Alphabet, Microsoft, and Meta are among the highest global spenders on research and development (R&D), with each spending billions a year and employing scientists, engineers and other experts who command high salaries. The work they do leads to new products, which over time create more jobs and more investment.

In 2021, Alphabet spent US$31.5-billion, or 15.1 per cent, of revenue to do things such as enhance its search engines, improve YouTube and experiment with driverless cars. Amazon spent US$42.74-billion in 2020 (11 per cent of sales) on “technology and content.” This year, Microsoft will spend 12 per cent of revenue or US$24.5-billion to enhance its cloud and artificial intelligence capabilities and explore concepts such as the metaverse and augmented reality.

In Canada, banks and energy companies are among those with the biggest buyback plans, but according to Research Infosource Inc., a data analytics company, car parts firm Magna International Inc. MG-T was top of the list in 2020 with R&D spending of $1.1-billion, or 2.5 per cent of sales. It was followed by Constellation Software Inc. CSU-T and Shopify Inc. SHOP-T

Tax ‘unlikely to encourage businesses to invest more’

Mr. Hallett notes that the money used to pay a cash dividend or buy back a share has already been taxed. That’s why Canadians get a dividend tax credit for investments in Canadian companies.

The dividends are grossed up for tax purposes to a number that approximates the pre-tax equivalent of the dividend. Shareholders then receive a credit to approximate the taxes already paid by the company.

“It avoids doubles taxation,” he says.

Mr. Hallett adds that the tax is unlikely to encourage businesses to invest more in their businesses than they already do.

Neither Mr. Bradley nor Mr. Hallett expects a surge in share buybacks in 2023 to beat the 2024 deadline, but companies may make more or fewer repurchases based on their conditions.

“I don’t expect an avalanche of buybacks specifically because of this proposed tax,” Mr. Hallett adds.

Adam Mayers is a contributing editor to the Internet Wealth Builder investment newsletter.

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