1) Business Combination Arrangement: An Overview
With the increase in business activities and need for efficient operation and globalization, companies are dominating every part of the world. Some companies are arguably even stronger than strongest nations of the world. That is something to take in. It is thus very important to promote business combinations by the government to promote the domestic companies to enter into global market. With the current tax legislations prevalent in Nepal, Business Combinations: Mergers and Acquisitions, it is very difficult for us to see any significant mergers and acquisitions happening.
Business combinations contribute majorly to industrial and trade expansion of a country and is a key enhancer to competition among variety of businesses that lead to provision of quality services and products to consumers. Since Nepal is also committed to establishing a market powered economy, government authorities, especially revenue and tax authorities should thus be fully aware of the importance of M&A transactions as part of that process.
A combination of resources through a business combination arrangement; firms are able to increase efficiencies through reduced costs, strategic reorganization, adoption of new technologies and combined expertise. Also, investors find it viable to venture into mergers and acquisitions to establish their presence into Nepal and enhance their presence in the business environment. The facilitation of acquisition of local firms within our own country could be an important factor in attracting foreign direct investment as well as facilitating new market entries. It is definitely easy when foreign or local entities can easily merge with or acquire companies or firms which is already established, with a ready list of customers, employees and suppliers, infrastructure as well as perhaps benefiting from local licenses and domestically registered intellectual property rights.
2) Types of M&A Deals
Deals of mergers, acquisitions and amalgamations may be structured in a variety of ways for legal, economic, taxation or other reasons. It could be categorized from various aspects:
2.1) From the aspect of consideration: (A negotiator’s view)
- Consideration in form of creation of Equity interests
- Consideration in form of creation of Liability
- Consideration in form of Cash
- Any mix of above
Consideration is the payment made for the business combination arrangement. It could constitute creation of equity interests or liabilities against the deal or payment in cash or any combination of these. A deal may require one party acquiring the identifiable net assets of the other party or the shares that represent the ownership in those net assets.
2.2) From aspect of combination of business: (An economist/accountant’s view)
- Combination of business
- Not a combination of business
An accountant will typically view a deal to determine if it actually is a business combination or not, irrespective of the forms of consideration of the deal. This is also how Financial Reporting Standard (IFRS 3: Business Combination) is applied in the context of the a particular deal. It shall be first determined whether a transaction or other event is a business combination by identifying if or not the assets acquired and liabilities assumed constitute a business. If the assets acquired are not a business, the reporting entity shall account for the transaction as a business combination but rather as an asset acquisition. A deal is typically a combination of business if the acquired set of net assets could form the whole of the input, process and output as a functional business. According to financial reporting standards, business is an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing goods or services to customers, generating investment income (such as dividends or interest) or generating other income from ordinary activities.
Applying the accounting method for business combination requires: (a) identifying the acquirer; (b) determining the acquisition date; (c) recognizing and measuring the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree; and (d) recognizing and measuring goodwill or a gain from a bargain purchase. Under the reporting standard, the acquirer is required to measure the identifiable assets acquired and the liabilities assumed at their acquisition-date fair values.
2.3) From the aspect of control: (A taxman’s view)
- Control is transitory
- Control is not transitory
It is quite clear that the financial reporting standards on business combination doesn’t apply in the case of businesses already under a common control. A business combination involving entities or businesses under common control is a business combination in which all of the combining entities or businesses are ultimately controlled by the same party or parties both before and after the business combination, and that control is not transitory. So, they are not under the scope of application of IFRS 3: Business Combination.
A taxman is mainly concerned with how the merger and acquisition leads to the transition in control. This is because the transition of the ownership has consequences for taxation. Particularly, in the context of Nepal, the businesses going into combination process will have to go through the various stages of taxation:
- the taxation on the shareholders of the combining entities (Section 95Ka Taxes)
- the taxation on the company acquiring the asset and the company disposing the asset (Section 39 Taxes)
- the taxation that could be applicable on the acquiring entity by the action of change in control (Section 57 Taxes)
This we will discuss in detail below.
3) Part One: Common Control Transactions of Business Combination
Nepal’s tax law is modeled after the IMF’s model tax law: Income Tax Act of the Commonwealth of Symmetrica. Neither this particular Model Tax Law nor the Income Tax Act, 2058 prevailing in Nepal provides elaborated schemes for facilitating business combinations.
Internal restructuring and reorganizations not constituting substantial changes are allowed in limited circumstances under Section 45 of the act, by the way of transfer of the assets between the associated persons at their respective tax bases. When applied, section 45 leads to non-recognition of the deemed disposal of the assets at their market values, which enables the associated persons to transfer the assets between them at that their tax bases without recognizing any intermediary profits. This will enable companies under common control to better position their assets between the related companies without worrying about the tax consequences. This seems to be the only available remedy for the reorganization arrangement in Nepal. This is regarding the application of taxes under Section 39 and it is also a provision opposite in nature of the taxes in Section 57. But the non-recognition rule under Section 45 is applicable only upon fulfilling certain conditions. Elsewise, even the transfers between the associates will be deemed to have been made at their market values and it therefore will not be eligible to obtain the non-recognition benefit under Section 45. See more detailed discussion on that topic here: Transfer of tax base between associates
So, what about the taxes under Section 95Ka in the case of internal reorganization? Does Section 95Ka apply even in the case of internal reorganization? Should Section 95Ka be applied in the case of transfer of shares from one entity to other by the reason of reorganizations like internal restructuring, where there are no / substantial changes in the underlying ownerships? Many tax and legal practitioners in Nepal have adopted this view that Section 95Ka should only be applied in the case where company undergoes a change in underlying ownership. But, is that correct?
If Section 95Ka intends to look into the beneficial ownership test for applying the capital gains taxes, then why wasn’t Telia Sonera (a foreign entity) taxed for the shares it disposed, why was there even a need to tax Ncell (a resident entity) under Section 57? There are few more additional reasons on why I think Section 95Ka does apply even in the case of case of internal reorganization. See more detailed discussion on that topic here: Section 95Ka of ITA
4) Part Two: Other Business Combination Transactions
Unlike discussed in Part One above, which applies only in limited circumstances of the common control transactions, there are different tax consequences for the transactions listed below:
- business combinations other than common control transactions, and
- business combinations that do not qualify to be recognized as common control transaction under the provision of Section 45 of Income Tax Act of Nepal, as discussed in Part One above.
In such deals the main concern is with how the deal leads to the transition in control. This is because the transition of the ownership has consequences for taxation. Particularly, in the context of Nepal, the businesses into the combination process will have to go through the various stages of taxation:
- the taxation on the shareholders of the combining entities (Section 95Ka Taxes)
- the taxation on the company acquiring the asset and the company disposing the asset (Section 39 Taxes)
- the taxation that could be applicable on the acquiring entity by the action of change in control (Section 57 Taxes)
This we will discuss in detail below in separate three sections:
4.1) Section 95Ka Taxes
4.1.1) Introduction to Section 95Ka Taxes
Section 95Ka is yet another highly debated and discussed taxing provision in Nepal. Section 95Ka of the Income Tax Act, 2058 contains the taxing provision regarding the direct disposal of shares. Section 95Ka provides the taxing right in regard to the disposal of shares in an entity in Nepal. The present taxing right for share disposal under ITA was introduced through an amendment brought by Finance Act 2064 (2007). In most cases it applies together with the the taxes under Section 57. Reading the text of 95Ka(2) we can derive the followings regarding the capital gain tax under Section 95Ka(2):
- It applies to the person who disposes their interest in entity resident in Nepal, and
- It applies on the gains derived under Section 37, and
- The advance tax under Section 95Ka(2) is required to be withheld by (i) the resident unlisted entity whose interest is being disposed of, or (ii) the broker facilitating the transaction in case of listed entity
Under Section 37 the gain/loss of a person from the disposal of an asset / liability shall be calculated as the amount of difference between the incomings for the asset / liability and the outgoings for the asset or liability at the time of disposal. More on the Section 95Ka taxes here: Section 95Ka of ITA
The concept of the development of the taxes on direct disposal of shares though offshore transfers is quite interesting in the context of Nepal. View more detailed discussion on that here: Capital Gains Tax in Nepal
4.1.2) Source Principle to Section 95Ka Taxes
Section 95Ka is also debated in the context of whether it actually establishes the income source in Nepal before applying the taxing provision or not. Many tax and legal practitioners have observed that the provisions for withholding taxes under Section 95A doesn’t actually establish the source principle for the application of taxes. The examples cited below illustrates this issue:
Example 1: A non-resident person supplies wheat to Nepal. The mere activity of supplying into Nepal the person’s income from cannot be deemed to be Nepal sourced. But Section 95Ka requires a withholding of 2.5% tax at the point of customs by Customs Office, disregarding the source principle of taxation to non-residents.
Example 2: A non-resident has an interest in equity shares of an entity in Nepal. He disposes of that share. But since the disposal of that share doesn’t fall under the definition of disposal of domestic assets, it doesn’t constitute Nepal sourced income under Section 67 of the ITA. However, it still is taxable under the provision of Section 95A and the tax applicable is withheld by the entity whose interest is being disposed of in case of unlisted shares and by the entity involved in securities market business in case of listed shares.
These issues of contradiction between the source principle and taxing principle have been acknowledged and discussed in commentaries from OECD and other Tax Law Commentaries around the world.
4.1.3) Capital Gains taxing rights under model DTAAs
Another notable observation to be made in the context of the taxing right of the disposal of the interest in an entity in Nepal though offshore transfer is based on how the Double Tax Avoidance Agreement (DTAA) between Nepal and other countries around the world has been negotiated. Nepal has entered into DTAA agreement with 11 countries: India, Austria, China, South Korea, Mauritius, Norway, Pakistan, Qatar, Thailand, Sri Lanka and Bangladesh.
1. In case of DTAA with Austria, Mauritius, Bangladesh and Norway, the state where the entity whose interest is being disposed of, doesn’t hold any taxing right. In case an entity resident in Nepal has investors based in Austria, Mauritius, Bangladesh or Norway, Nepal doesn’t have taxing rights in case of the capital gains derived from transfers. The taxing provision under Section 95Ka will not apply in such offshore transfers.
2. Similarly, in case of DTAA with India, Qatar, Thailand and South Korea, the state where the entity whose interest is being disposed of also holds taxing rights. In this case, where the entity resident in Nepal has investors based in India, Qatar, Thailand or South Korea, Nepal has taxing rights. The taxing provision of ITA under Section 95Ka applies in such cases.
3. However, in case of DTAA with China, Pakistan and Srilanka, the state where the entity whose interest is being disposed of also holds taxing rights but only if the alienator has at least 25% interest in such an entity. This allows the resident country to tax the investors of the resident entity only if the investor has at least 25% interest in the resident entity.
Regarding the the taxing right on the offshore transfers, DTAAs has been negotiated by Nepal in three different ways: (a) Austria, Mauritius, Bangladesh, Norway: Nepal has no taxing right, (b) China, Pakistan, Srilanka: Nepal has limited taxing right, and (c) India, Qatar, Thailand, South Korea: Nepal has full taxing rights
Section 73(1) of the ITA provides that if Nepal has entered into a Double Tax Avoidance Treaty (DTA) with another country, and a person’s same income is taxable in both countries, the beneficial tax provisions (exemption or lower rate of tax) under the DTAA would be applicable. Section 73(5), of ITA provides limitation on benefit under the DTAA to the entity claiming the benefit is an entity whose 50% or more of the vested ownership of the entity is owned by natural persons or entities (in which no natural person has an interest), which are not residents of Nepal and/or the country with the DTAA. This issue was highly debated in the Ncell Case. As majority of the DTAs were signed by Nepal prior to introduction of the Income Tax Act, the provisions of Section 73(5) should not apply to those DTAs. Further, even in cases where the DTAs signed after commencement of the Income Tax Act and which do not specifically provide for limitation of benefit provision, operation of limitation of benefit as provided in Section 73(5) needs to be considered from the perspective of Nepal Treaty Act 1990 which provides that provisions of the domestic law which are inconsistent with the treaty provision shall be void to the extent of inconsistency. Nepal had entered into DTAA with India, Norway, Thailand, Sri Lanka, Mauritius, Austria, China and Pakistan before Income Tax Act, 2058 came into effect. DTAA with South Korea, Qatar and Bangladesh were entered into after the Income Tax Act, 2058 came into effect.
4.1.4) Section 95Ka applies irrespective of the change in underlying ownership
Another important question regarding the application of Section 95Ka is: Should Section 95Ka be applied in the case of transfer of shares from one entity to another by the reason of reorganizations like internal restructuring, where there are no / substantial changes in the underlying ownerships? Income Tax Act, 2058 under Section 45 and Section 46 allows non recognition provisions for internal restructuring, so it is fair to conclude that Section 95Ka is intended to apply on direct disposal of the shares irrespective of any changes or lack thereof in the underlying ownership. Section 45 of the Income Tax Act in Nepal already allows (albeit in limited circumstances) where the assets can be transferred between associates as a part of the transaction without recognizing the transactions at their market values. Section 46 of the Income Tax Act in Nepal (read with Rule 16 of the Act) already provides IRD with the right to approve the transactions as non-recognizable at market values or tax neutral in situations like internal restructuring and mergers. Further to this, the Supreme Court, in the Interpretation provided in Ncell Case, has also decided that the taxes to be levied in the Ncell Case is to be applied and recovered from Ncell (a resident entity) by the application of Section 57 rather than Section 95Ka. More detailed discussion on that part here: Section 95Ka of ITA
4.1.5) What is the exception to Section 95Ka taxes in context of business combination in Nepal?
Under Section 40(1) of the Income Tax Act 2058, a person disposes of an asset when the person parts with ownership of the asset including when the asset is distributed by the owner of the asset, merged with another asset or a liability, installment sale, leased to another person under a finance lease, cancelled, redeemed, destroyed (extinguishment), lost, expired, or surrendered.
This clearly means that when a shareholder from one company parts with those shares and acquires shares from other company instead, as a part of merger or acquisition arrangement, it will be treated as disposal of shares for the purpose of Income Tax Act. So a common confusion to be addressed in case of merger arrangement is whether the deemed consideration under merger arrangement will be assumed as transaction price of the merger. This is mostly significant because the assumption of deemed consideration for this disposal will lead to taxation in unrealized gains to the Shareholders. This leads to situations where the transaction will have to bear the capital gains taxes leading to tax frictions in a merger transaction, even when it is purely done for business synergies or regulatory order.
One view may be that merger arrangement qualifies to be a “Involuntary Disposal of Asset or Liability with Replacement within 1 year” under Section 46 of the Income Tax Act, 2058. However, this will not be true. We can refer to the following commentary from the “Income Tax Act of Commonwealth of Symmetrica”:
Para 195: Section 46 provides non-recognition treatment for involuntary realizations by way of parting with ownership of assets or obligations of liabilities. Non recognition is available where a replacement asset or liability is acquired or incurred within one year of the realization. The rule is complicated somewhat by covering situations in which the replacement asset or liability is of a greater or lesser value than the asset or liability realized. These situations may result in part recognition of any gain. Non-recognition only applies where the person makes an election. The section does not define “involuntary”, which will take its ordinary meaning. The application of the term to particular circumstances may be an appropriate subject for practice notes. However, “involuntary” would not cover, e.g. the exchange of securities in a merger. This is a situation in which relief is often provided in order to prevent lock-in. This lock-in is similar to that which may occur through the taxation of transfers between associates and which is addressed by section 45. The regulations may however prescribe the circumstances in which the replacement of one security in an entity with another security in an entity as a result of conversion of the security or reconstruction of the entity constitutes an involuntary realization.
Has Income Tax Act, 2058 provided any criteria for considering the replace of shares by the reason of merger as “involuntary disposal with replacement”?
Answer: Interestingly, yes. Rule 16 of Income Tax Rule, 2059 states that where a person’s security in one entity is replaced by another security in the same entity or with a security in another entity as a result of merger or reconstruction of the entity, the same shall be treated as an event of an involutory disposal with replacement. However, IRD reserves a right to approve such transaction to qualify for “involuntary disposal with replacement”. IRD will look into the matter and may give an approval to that effect.
Does IRD looks into approving business combination deal to be able to be approved or the purpose of non-recognition under Rule 16?
Answer: Yes, Under the present tax laws in Nepal, entities under Banking and Insurance industry are allowed a breathing space regarding the business combination taxes, more specifically, the relief for taxes under Section 57 and Section 39. This specific relief for banking and insurance industries were bought under Section 47Ka of the Income Tax Act. However, the reliefs under Section 47Ka still doesn’t extend to the taxes that applies to the shareholder of the merging entity under Section 95Ka. To make the business combination arrangement tax neutral even to the shareholders the merging entities in banking and insurance industry further applies to Inland Revenue Department for the relief of these taxes under 95Ka. Under Rule 16, Inland Revenue Department reserves the right to provide the consent to agree if in fact such business combination arrangement will be or not be treated as the “involuntary disposal with replacement” under Section 46 of the Act.
So, what qualifications / characteristics should a business combination arrangement have for IRD to approve it for non-recognition under Section 46 and Rule 16?
Answer: This is not very clear. But we can infer to the actual mergers of the entities in banking and insurance sector that took place and theoretically derive that if the business combination arrangement has at least fulfilled all the following characteristics, then it could potentially be approved for said relief from Section 95Ka taxes:
- Business combination arrangement is made between two public entities, and
- Entities are listed and there are general public shareholders, and
- It is only a change of wealth from one form to another but not a creation of wealth, and
- It is approved structure with appropriate consent, go ahead or instruction from relevant regulatory, and
- It should stem from a natural, legal or commercial need
The above list is only my theoretical conclusion looking into the mergers and acquisitions that took place in Nepal in past. The actual qualifying parameters of IRD could be more relaxing than these too. But IRD has not till this date published any directive or circular in this regard, which clearly needs to be done, considering its need for clarity in the market and to facilitate tax efficient mergers and acquisitions between entities in other industries or entities in cross-industries, as the need may be. View more detailed discussion on this topic here: Involuntary Disposal with Replacement: Definitive Analysis
4.2) Section 39 Taxes
Section 39 is not actually a taxing provision, but rather discusses how to calculate the gain/loss from the disposal of the asset/liability under a transaction. But for our ease of reading and understanding, we will take this Section as taxing provision, but needs to be read in total understanding of entire Chapter 8 of the Income Tax Act, 2058.
4.2.1) The common confusion we all fall for: Section 47
Some practitioners have gone into interpreting that any form of mergers and acquisitions are exempt from the “deemed disposal at market value” by the reason of non-recognition under Section 47 of the Act. I believe that it is not true, and I present the following reasons for why not:
- Income Tax Act, 2058 is modeled from IMF’s Income Tax Act, The Commonwealth of Symmetrica, where from the commentary of the model act, we can infer that the Act was not made with an intention to relieve any mergers and acquisitions from tax frictions, except when it is a reorganization within associated person.
- Income Tax Act, under Section 45 allows in a limited circumstance and fulfilling certain conditions where asset reorganization between associated person can be made without recognizing at market value. The Income Tax Act of Nepal already limits the asset reorganization arrangement even within associated parties; thus, it is very unsafe to infer that Section 47’s non recognition extends to the mergers and acquisition between any entities.
- Section 57 of the Act recognizes the change in ownership exceeding 50% as a triggering event for deemed disposal. This in itself is an example of limitation in the restructuring, acquisition and reorganization schemes between unrelated parties. Since such restrictive provision are already in force, why would any merger or acquisition arrangement be exempt from the taxes through Section 47?
- The indicative examples provided in the commentary on the Income Tax Act of the Commonwealth of Symmetrica and Income Tax Directive of Nepal, clearly indicates that Section 47 applies in limited circumstances within the asset and liabilities already owned by the entity. This provision seeks to provide the relief to the taxpayer from having to recognize deemed disposal of assets due to the intermediary activities of the entity. This is also appropriate for the reason that that income tax being primarily targeted at creations of wealth rather than transfer of wealth, which is the true principle of the Income Tax Act on Nepal.
- Mergers and acquisitions are mostly motivated by commercial reasons. They are commercial transactions and also as discussed in the IFRS 3: a true merger is very rare. There is always a commercially motivated acquirer. So, it is not wise to conclude that Section 47’s non-recognition rule extends to any mergers and acquisitions.
- Income Tax Act already has the provision under Rule 16 to tax neutralize or non-recognize the mergers, acquisitions and restructuring arrangements, given the approval from the Inland Revenue Department. So, if it was the intention of the Act to tax neutralize even the companies entering into mergers and acquisitions, would not there be such provision specific to that extent? This we will discuss in detail comparing the tax relief provided to merger and acquisition arrangements in India, below.
See more discussions on this topic in my other article: Section 47 of ITA: when does this really apply? Also see this link Section 45 and 46 of ITA: the balance discussing the restructuring arrangements that is allowed in non-recognition basis under Income Tax Act, 2058.
4.2.2) So how should the tax consequences under Section 39 work?
Let’s take an example for this purpose: Co.A will acquire the net assets of Co.B and shareholders of Co.B will be allocated equity interests in Co.A as a consideration for that transaction.
This business combination arrangement theoretically should work as follows, disregarding the merger agreement.:
1. A acquires net assets from Co.B by providing consideration in form of shares in Co.A to Co.B
This would require a net asset acquisition agreement between Co.A and Co.B
2. B’s shareholders will realize the shares of Co.A in Co.B by liquidating Co.B.
Co.B’s shareholder certificate will be updated as Co.B’s shareholder certificate by the action of Companies Law
So, let’s think about it: Assuming the transaction 1 and transaction 2 are both stand-alone transactions, should not this transaction be made at market values? Just because the transaction 1 and transaction 2 combinedly could be performed through a merger agreement, why should the tax consequences be different? In a merger arrangement, Co.A acquires net assets from Co.B directly by providing consideration in form of shares in Co.A to the shareholders of Co.B. (This requires a separate merger agreement between Co.A, Co.B and Co.B’s shareholders). Later Co.B shareholders will liquidate the Co.B.
So, it is fair to conclude that unless there are specific provisions for relieving the taxes under Section 39 in the case of business combination arrangement, the taxes will apply. Just like the discussion in above paragraph, we will look into two separate circumstances:
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Where two transactions above take place separately (via asset acquisition agreement and action of companies law) |
Where two transactions above take place together (via merger agreement) |
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In books of Co.A Net Asset 100 |
In books of Co.A Net Asset 100 |
|
In books of Co.B Investment 100 Equity 70 |
In books of Co.B Net Asset 20 Equity 70 |
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Books of Co.B’s shareholder Equity 100 |
Books of Co.B’s shareholder Equity 100 |
In conclusion,
- Company A is not subject to taxation but derives the net assets at their market values
- Company B is subject to taxation on Rs. 20 (which is the difference between transaction price and tax base of the net assets)
- Shareholder of Company B is subject to taxation on the gain of Rs. 30 (which is the difference between the transaction price and the cost of the initial investment)
Had these been entities under the banking and insurance industry:
- Company B will not have been subject to any taxes because of the provision of the Section 47Ka which allows the assets to be transferred at their tax bases, which leads to no recognition of the gains
- Shareholders of the Company B will not have been subject to any taxes because of the relief that the entity could obtain under Rule 16 with the approval of the Inland Revenue Department
The example above is hypothetical, simple and doesn’t cover all the intricacies of the complex business combination arrangement that takes place. For additional examples and discussion on this topic view my other posts:
1. M&A FAQs from Tax Perspective: M&A Ep01
2. Common Control Transactions: M&A Ep02
3. Rollup Transactions: M&A Ep03
4.2.3) The recent OAG’s Report 2078
Paragraph 6.1 (Page 79) of the Annual Report 2078 from Office of Auditor General had listed an issue regarding the taxation of bargain/gain or losses arising from the mergers of the entities in banking and insurance industry. It goes:
मर्जर/एक्विजिसनमा कर- आयकर ऐन, २०५८ को दफा २२ को उपदफा (१) मा कुनै व्यक्तिले कहिले कुनै आय प्राप्त गर्छ वा कुनै खर्च गर्छ भन्ने कुराको निर्धारण यस ऐनको अधीनमा रही लेखाको सर्वमान्य सिद्धान्तअनुरूप हुने र उपदफा ३ मा कम्पनीले कर प्रयोजनको लागि एक्रुअल आधारमा लेखाङ्कन गर्नुपर्ने उल्लेख छ । सोही ऐनको दफा ७ मा व्यवसायबाट भएको सबै लाभ तथा मुनाफा व्यवसायको आयमा समावेश हुने व्यवस्था छ । त्यसैगरी नेपालका बैङ्क एवं वित्तीय संस्थाहरूले कम्पनी ऐन, २०६३ को दफा १०८ बमोजिम दोहोरो लेखा प्रणालीअनुसार कम्पनीको कारोबारको यर्थाथ स्थिति स्पष्ट रूपमा प्रतिविम्वित हुने गरी प्रचलित कानुनबमोजिम अधिकार प्राप्त निकायले लागू गरेको लेखामानअनुरूप लेखा राख्नुपर्ने व्यवस्था छ । नेपाल चार्टर्ड एकाउन्टेन्ट्स संस्थाले जारी गरेको नेपाल वित्तीय प्रतिवेदनमान ३ ले विजनेश कम्बिनेशन अनुसार कुनै पब्लिक कम्पनीले प्राप्ति गर्ने वा अर्को कम्पनीमा गाभिने सम्बन्धमा विभिन्न व्यवस्था गरेको छ । वित्तीय प्रतिवेदनमानमा प्राप्ति गर्ने कम्पनीले प्राप्ति हुने कम्पनीको पहिचान भएको सम्पत्तिहरू प्राप्ति गर्दा र उक्त कम्पनीको पहिचान भएको दायित्व स्वीकार गर्दा बजार मूल्यमा गर्नुपर्ने र पहिचान भएको सम्पत्तिमा स्वीकार गरेको दायित्व घटाई बाँकी खुद सम्पत्ति वापत दिएको साधारण शेयरको बजार मूल्यको आधारमा आउने फरक रकमलाई अवस्थाअनुसार सौदाबाजी गर्दाको लाभको रूपमा (Gain from Bargain Purchase) वा साख (Good Will) को रूपमा लेखाङ्कन गर्नुपर्ने व्यवस्था छ। लेखामानको सो प्रावधानहरू विपरीत मर्जर/एक्वीजिसन गर्दा भएको लाभ लाई प्राप्ति गर्ने कम्पनीले सोझै आफ्नो इक्विटीमा भएको परिवर्तन विवरणमा एक्वीजिसन रिजर्भ, जेनेरल रिजर्भ, क्यापिटल रिजर्भ लगायतका शीर्षकमा देखाएको छ । नेपाल लेखामानमा भएको आयकरसम्बन्धी व्यवस्थाअनुसार सौदाबाजी गर्दा भएको लाभलाई नाफा नोक्सान विवरणमा उल्लेख गरी लेखाङ्कन गर्नुपर्नेमा सो नगरेकोले प्रचलित लेखामान र आयकर ऐन, २०५८ को दफा २२ विपरीत हुन गएको देखिन्छ। कतिपय बैङ्कले नाफा नोक्सान खातामा नै देखाएको अवस्था छ । बिजनेस कम्बिनेसनबाट प्राप्त भएको लाभलाई २१ बैङ्क तथा वित्तीय संस्थाले उपर्युक्त बमोजिम लाभ देखाई आयकर तिर्नुपर्नेमा सो नगरेकोले ती वाणिज्य बैङ्कहरूको लाभ रू.१४ अर्ब ९३ करोड ३ लाखमा आयकर ऐन २०५८, अनुसूची १ को दफा २ को उपदफा (२) बमोजिम ३० प्रतिशतले हुने कर रू.४ अर्ब ४७ करोड ९१ लाखमा शुल्क एवं ब्याज समेत छानबिन गरी कर निर्धारण हुनुपर्दछ ।
The whole point of non-recognition rule under Section 47Ka of the Act is to enable the entities in that industry to carry assets from acquiree entity at their tax bases and not create any intermediary taxable income in doing so. This has been made to omit the tax friction in the merger deals and carry a smooth unburdened transaction at least from tax perspective. The view from Office of Auditor General has completely failed to appreciate the fact that it is taxable profit that is subject to taxation, not the accounting profit. Despite the tax relief from Section 47Ka, the gain from bargain purchase or goodwill is still to be recognized under the requirement of the Financial Reporting Standard, particularly, IRFS 3: Business Combination and such recognized gains/losses are only a construct for accounting purposes but not for tax purposes. So the view of OAG to tax accounting gains is not correct.
4.2.4) The issue regarding the transfer of the losses in the books of acquiree
When an entity is not specifically provided an exemption under for the taxation under Section 39 (example by way of Section 47Ka for banking and insurance industry), then the companies have no alternative but to recognize the transfers of net assets into their respective market values (which is the transaction value of the deal). In such case the acquiree entity will obtain the identifiable assets allocated to their respective values based on the proportion of their market values. When transaction takes place in market values, the acquiree company has the last opportunity to actually settle their losses and tax bases with reference to the market values for the final taxation.
So, the issue of actually being able to carry forward the losses, economically arises only when the actual “market value recognition rule” is exempted for non-recognition rules like that in Section 47Ka. So, with the introduction of the Section 47Ka it was relevant to enable the acquirer company to settle the tax losses from the acquiree company, as the acquiree company did not have the opportunity to do it, due to the non-recognition rule.
In conclusion, the entities in industries who are not covered by specific non-recognition rules like Section 47Ka for banking and insurance industry, cannot carry the losses from the acquiree company. The acquiree company will themselves settle for any unrelieved losses in their books. This really is so very methodic and satisfying too.
4.2.5) Practice in India (something that Nepal can adopt)
The Indian Income Tax Act, 1961 contains several provisions that deal with the taxation of different categories of mergers and acquisitions. In the Indian context, M&As can be structured in different ways and the tax implications vary based on the structure that has been adopted for a particular acquisition. The Indian Income Tax Act first goes to distinguish the various nature of the merger and acquisition arrangement that exists. Namely:
- Merger: This entails a court approved process whereby one or more companies merge with another company or two or more companies merge together to form one company;
- Demerger: This entails a court approved process whereby the business / undertaking of one company is demerged into a resulting company;
- Share Purchase: This envisages the purchase of the shares of the target company by an acquirer;
- Slump Sale: A slump sale is a sale of a business / undertaking by a seller as a going concern to an acquirer, without specific values being assigned to individual assets;
- Asset Sale: An asset sale is another method of transfer of business, whereby individual assets / liabilities are cherry picked by an acquirer.
Then it goes to define the qualifying criteria that the business combination arrangement should be able to fulfill to be relieved from the tax consequences that may arise.
For example, only when a merger satisfies the following criteria, the merger will be regarded as tax neutral and exempt from gains tax in the hands of the amalgamating company and also in the hands of the shareholders of the amalgamating company:
1. All the properties and liabilities of the amalgamating company must become the properties and liabilities of the amalgamated company by virtue of the Amalgamation; and
2. Shareholders holding at least 3/4th in value of the shares in the amalgamating company (not including shares held by a nominee or a subsidiary of the amalgamated company) become shareholders of the amalgamated company by virtue of the Amalgamation.
4.3) Section 57 Taxes
Too much can be discussed on the principle, provision, application and problems surrounding Section 57 of the Income Tax Act of Nepal. As discussed in my many other posts, Section 57 is primarily an anti-abuse provision rather than a taxing provision. Section 57 was however applied in the Ncell Case to actually tax the offshore indirect transaction. The transaction gains of the Ncell deal between Telia and Axiata was considered for the purpose of taxation. The existing tax law of Nepal doesn’t have adequate basis for the taxation of the transaction that took place offshore even when the underlying asset is situated in Nepal. The correct approach to tax such transactions would be to amend the source principle under Section 67 and introduce a taxing right to that effect under Section 95Ka.
However, this creates additional philosophical issues for discussion. Countries around the world do not typically practice these forms of taxing rights. Generally, the offshore disposal of the beneficial interest in a resident entity is not subjected to source principle taxation. The equitable implementation of these forms of taxing mechanism brings additional challenges like:
- How to administer such taxation equally and cautiously among all scale of the entities, both huge and small enterprises?
- What might be the appropriate threshold to start defining (e.g say, 50%) the taxing rights and what gives the basis for such thresholds?
- How to equitably provide benefits to the onerous offshore transactions and recording of the losses incurred in such transactions to be allowed for setoff in the future?
- Will the introduction create unnecessary frictions in the business combination transactions? Will such taxing provisions discourage the foreign investments in Nepal?
These are some important aspects that should be considered before introducing such taxing rights. The Ncell Case is still unfolding in The International Centre for Settlement of Investment Dispute, an international tribunal, and could potentially have negative implications in the tax recovery strategy of the Tax Authorities in Nepal, leading to huge financial losses, just from the Ncell Case.
Its best not to discuss the nuances and problems of Section 57 here, which I have already done in many of my previous posts. For now, let’s agree unanimously that Section 57 applies when there is 50% or more change in the underlying ownership of an entity during the past three years, the entity shall be treated to dispose all its assets and liabilities at their market values. This is yet another problem that the entities involved in the business combination arrangement have to face.
It is not very uncommon that the introduction of the new shareholders in the company as a result of the business combination arrangement could lead to changing more than 50% of the underlying ownership of the company. Section 57(1) prevents the carry forward of tax attributes under the transactional basis income tax and it prevents the utilization of other tax attributes as well. It treats an entity as realizing all its assets and liabilities where there is a change of 50 percent or more in the underlying ownership of the entity within a 3-year period. The result is that the entity will realize any previously unrealized gains and losses just before the change. This, combined with section 57(2), prevents the purchaser of an entity indirectly obtaining access to these tax attributes. But it also leads to the acquirer company being subject to taxation on notional gains. The assets of the acquiree company have adequately been valued at market values under Section 39 taxes already before triggering Section 57, so the taxes on such acquired net assets could be inconsequential. However, the restatement of the acquirer company’s net assets into market values by the application of Section 57 will definitely require the acquirer company to pay taxes on the deemed gains.
Any discussion on Section 57 is not enough. Do visit my other posts where I have outlined the Section 57 problems and provisions in detail:
5) Conclusion
Conclusions are clichés. Instead, let’s list some solutions to help solve the present state of disastrous tax issues that entities undergoing business combination have to go face:
- Regarding Section 95Ka Taxes
Defining the qualifying criteria to be able to obtain the relief for Section 95Ka taxes under Section 46 & Rule 16 and enable entities across industries to actually understand the meaning of “business combination” for tax purpose. Such directives from IRD will help entities across industries to arrange their M&A arrangement to be tax neutral.
- Regarding Section 39 Taxes
Introduce solutions comparable to India (discussed above) to recognize what criteria does a business have to economically, legally, financially fulfill to obtain non-recognition benefit that presently has only been provided to banking and insurance industry.
- Regarding Section 57 Taxes
Much to be discussed in Section 57. So, a separate post instead: Section 57: Taxing Rule or Anti-Abuse Rule?