The New 1% Excise Tax On Stock Repurchases Could Impact Companies Such As Colgate- Palmolive

Aug. 07, 2022 5:07 AM ETColgate-Palmolive Company (CL)39 Comments
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Summary

  • The new Inflation Reduction Act of 2022 would impose a 1% excise tax on stock repurchases.
  • In 2021, Colgate spent $1.32 billion to repurchase shares.
  • Colgate's board authorized a new $5 billion stock repurchase program, which would result in a $50 million tax, before adjustments.
  • Oddly, this new excise tax is an indirect tax on pension plans and other non-taxpaying shareholders.
New Tax Laws For 2022

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What is the potential impact on investors on companies such as Colgate- Palmolive (NYSE:CL) that have a long history of share repurchases by the new tax law that would impose a 1% excise tax on share repurchases? It could result in Colgate increasing their cash dividend to higher amounts than would otherwise be expected, if they reduce/eliminate their stock repurchases. As I write this article, it appears that the U.S. Senate may pass the Inflation Reduction Act of 2022. The information contained in this article may change when and if, the Act is eventually signed into law because they often rewrite the fine print.

Background on Share Repurchases

Currently many corporations, including Colgate-Palmolive, consider the amount of money spent on repurchasing their stock to be part of their return to shareholders that includes traditional cash dividends. That was not always the case. Years ago, many companies repurchased their shares solely because they used those shares as part of their employee stock incentive plans. Those companies did not want to cause dilution for existing shareholders by issuing new shares used for the incentive plans, so they repurchased shares in the market. Buying shares in the market is a way, in theory, to increase the stock price giving shareholders "paper" returns on the value of their stock. The dividends paid to shareholders is a taxable return to those investors who pay income taxes. The increased stock price is not taxed until the shareholder sells their shares and even then, the tax rate might be at a lower rate than the tax rate on dividends. This has been a major reason why companies use stock repurchases to increase returns for their shareholders, instead of increasing their dividends.

Proposed New Tax Law Changes

The Inflation Reduction Act of 2022 is actually just a rename for the Build Back Better Act (text of H.R. 5376). There are a number of changes to income taxes on corporations in this Act, but this article is very narrowly focused just on the excise tax on stock repurchases.

The new law would impose a 1% excise tax on the dollar amount of stock repurchased. This would apply to shares repurchased by Colgate Palmolive. It would not apply to investment management companies or REITs. It would also not apply to amounts of annual purchases totally less than $1 million in one year or those shares used for employee stock payment plans. The tax would only be imposed on the net amount of shares repurchased. So, if a company also issues shares during the year and also purchases some shares, only the net dollar amount would be taxed. It also seems that this tax is not a deductible expense.

Is this 1% tax enough of an incentive for companies not to repurchase shares? Or not to repurchase as much as was previously expected? Remember, non-tax paying investors, such as state pension investment accounts, do not pay taxes so they are not taxed on dividends they receive from Colgate. In the past, in theory, they were indifferent from a tax standpoint about getting dividends or stock repurchases as a part of their return from Colgate. If stock repurchases are taxed at 1%, these non-taxable shareholders may assert that they now want higher cash dividends instead of stock repurchases.

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Impact on Colgate-Palmolive

In 2021, Colgate spent $1.320 billion to repurchase shares. Based on my reading of the new excise tax proposal, the company would have to pay a 1% on $0.997 billion after adjusting for shares repurchased for stock-based compensation and shares issued for stock options. (Any final law may have changes that impact how I understand the current wording.) This would mean a tax of about $10 million would have been paid if the Act was in place in 2021.

Just for the sake of discussion, assuming Colgate instead used the $0.997 billion to pay higher dividends in 2021 than the $1.679 billion they paid that year, the total dividends paid in 2021 would be 59% higher to $2.85 per share instead of the amount they actually paid of $1.79. Further assume that they paid a quarterly dividend 59% higher than their current quarterly dividend of $0.47, the current quarterly dividend would be $0.75 per share. A $3.00 annual dividend would imply a current dividend yield of 3.72% based on latest CL stock price of $80.43, compared to a yield of 2.34% using the current annual dividend of $1.88. This could make the CL shares much more attractive to those investors seeking higher current income.

Of course, Colgate and other companies with large repurchase programs could just consider this new law just a "nuisance tax" and continue the status quo. Colgate could also use the cash to reduce their $7.957 billion long-term debt or even increase their annual CAPEX. The problem is that once started with a 1% amount, it could be easily raised in the future. There is actually a different excise tax bill (text of S.2758) that would impose a 2% excise tax also pending.

In March, Colgate's board approved a new $5 billion stock repurchase program. This would imply a $50 million in taxes would have to be paid, before various adjustments. You have to wonder if non-taxpayer shareholders who, as I noted above are in theory indifferent solely because of taxes to getting dividends or repurchases, would now oppose stock repurchases because the total value of Colgate would be reduced by the taxes paid. CALPERS, that owns about 6 million shares of Colgate, and other pension plans that are often active in asserting their agendas may oppose future repurchases. If Colgate and other companies do continue their stock repurchases it would have a negative impact on pension plans because the taxes paid would reduce the value of companies that they invested in. Oddly, this new excise tax would be an indirect tax on pension plans.

Note: I will post an article edit for the actual text of any bill passed.

Conclusion

I have always been against Colgate's massive stock repurchase programs. I thought they should instead increase their cash dividends and/or pay down their debt. This 1% excise tax could be indirect incentive to greatly reduce these purchase programs and to instead increase dividends. Since Colgate is a very mature company and no longer a growth company, it is likely that future repurchases will be at prices that will no longer be at "bargain" prices when looking back at the repurchase prices in the future.

If, again if, Colgate elects to increase dividends more than expected instead of repurchasing shares, the dividend yield would increase, based on the current stock price. At this point, however, we do not know how much impact, if any, this new excise tax will have on the board's decisions. The 1% tax might be too small to have an impact, but once this tax is established, there is the potential for the 1% to be increased in the future to a level that would have a more significant impact on Colgate's board to elect to increase dividends more and reduce or even eliminate stock repurchases. Because of the potential for a higher dividend yield, I am changing my CL recommendation to neutral/hold from sell.

This article was written by

WYCO Researcher profile picture
6.44K Followers
B.A. in Economics; M.S. in Finance. I usually write about distressed companies and companies in Ch.11 bankruptcy. I am semi-retired after spending decades in investments.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I owned CL shares for many decades, but I sold my shares a few years ago.

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