Dividend Stripping: Is it possible in Nepal?

Meaning of “Dividend Stripping ”

Dividend Stripping could be interpreted as an investment strategy as well as a tax avoidance strategy, depending on how we look at this. Dividend Stripping arrangement may be done either by an investor as an investment strategy, or by a company’s owners or associates as a tax avoidance strategy.

As the term suggests “dividend stripping” is an arrangement by which we “strip / sell off” accrued dividends as shares instruments and split the “dividend income” into “capital income and/or dividend income” and thereby obtain benefit from the differential taxes in dividend incomes and/or capital incomes.

So Dividend Stripping can be simply understood as the practice of buying share units, just before the declaration of dividend and then selling it off right after the receipt of dividend, when the share prices fall below the purchase price. At face it may seem why one wants to sell shares at reduced prices, but there is a tax saving incentive behind this. We will discuss this in detail below.

Dividend Stripping as an Investment Strategy


In a perfect market, a rational investor can estimate the price of the share cum-dividend (before the announcement of dividend / book closure) and ex-dividend (after the distribution of dividend).

An example: Let’s say a price of a share is at Rs. 550 per share cum dividend on which a dividend of Rs. 100 will be announced. After the distribution of the dividend the price will likely fall to Rs. 450 per share (ex dividend). If Mr. A purchases the share today at Rs. 550 and sell it at Rs. 450 after distribution of dividend, his transaction can be summed up as follows:

  1. He will receive dividend of Rs. 100 after final withholding of taxes Net Income
  2. He will gain deductible losses of Rs. 100 (i.e Rs. 450 – Rs. 550)

If the tax rate applicable on his investment income (assuming there are other adjustable investment income) is greater than the rate of withholding – which typically is the case in most tax jurisdictions including in Nepal, he will stand to gain from this transaction as a result of planning the timing and amount of purchase and sell of the shares based on the dividend announcement rather than other sporadic trades.

Can this strategy be employed by all kinds of investors?

In Nepal, under Section 88(2)(a) of the Income Tax Act 2058, the rate of withholding taxes applicable on payment of dividend is 5%. There are few exceptions where limited to no withholding rate is applicable on dividend distribution but it doesn’t exceed 5% of the payment. See withholding rate on Dividend Payments in more detail here: Withholding Taxes Applicable in Nepal.

But is dividend payment always a final withholding payment? Yes in most of the cases. Dividends paid by resident companies, partnerships and mutual funds are final withholding payments under section Section 92(1)(Ka) and Section 92(1)(Wyan). Dividend payment by any entity to foreign person is also a final withholding payment under Section 92(1)(Cha). So in most cases, Dividend payment by a resident person from Nepal to any person is the final withholding payment. Once the payment is final withholding payment no additional tax liability is applicable on such income other than what was withheld by the payer and no credit is allowed against such taxes, i.e. they are final taxes. 

Similarly, what are withholding tax rates on capital transactions of sale/purchase of shares in Nepal? See the applicable Capital Gain Taxes in Nepal here: Capital Gains Tax in Nepal. There taxes are withheld by an entity conducting securities exchange market business (i.e. broker) in case of listed securities and in case of non-listed securities these are withheld by the entity whose interest is being disposed of. But an important question is: Are the withholding rates for capital transactions as stated above in sale/purchase of securities in Nepal a final withholding taxes? The answer is no. The basic rate of taxation would apply on the person transacting these securities. However, in the case of individual traders their basic rate will not apply but the rates under schedule 1(1)(4)(Kha)(3) are applicable. See in more detail here: Capital Gains Tax in Nepal. But this doesn’t mean that individual traders are not able to set off their investment losses with their investment income, it’s just that they are only required to pay tax at the reduced rates than their basic tax rates and obtain tax credit for the amount withheld as taxes earlier. In case of companies, they will be liable to pay their basic tax rate on the gain/loss of the investment transaction and obtain tax credit for the amount withheld as taxes earlier. 

So yes, in conclusion “dividend stripping” arrangement as a part of the investment strategy is very much legal and doable and the only limitation for this is (i) the perfect market knowledge, (ii) perfect reflection of prices in the market, and (iii) the existence of the taxable investment incomes to deduct with the investment losses. 

A common disagreement for this arrangement among traders is that a tax advantage available to everyone would be expected to show up in the ex-dividend price fall. But an advantage available only to a limited set of investors might not so it still may be recommendable. However, in any case, the amount of profit on such a transaction is usually small, meaning that it may not be worthwhile after brokerage fees, the risk of holding shares overnight, the market spread, or possible slippage if the market lacks liquidity. Theory doesn’t so much correlate with the market always, does it?

Dividend Stripping as a Tax Avoidance Strategy


Dividend stripping or cum-ex trading can be used as a tax avoidance strategy, enabling a company to distribute profits to its owners as a capital sum, instead of a dividend, which offers tax benefits if the effective tax rate on capital gains is lower than for dividends.

Provision of the Income Tax Act

English Text

Section 58: Provision restricting reduction of dividend tax:
58(1): An arrangement made by any entity upon maintaining all of the following arrangements shall be deemed to be an arrangement made for reducing dividend tax:
(a) Where profit of such entity is reserved, current or expected,
(b) Where any person who acquires an interest of the entity and the recipient of the interest or his or her associated person makes any payment to the present or previous beneficiary of the entity or his or her associated person irrespective of whether or not it is related to the acquisition of interest and whether or not it is made at the time of acquisition of interest,
(c) Where the payment is fully or partly reflected in the profits of the entity, and
(d) Where the entity distributes dividends to the recipient of interest and the profits cover the dividends fully or partly.
58(2): If dividends are distributed by any entity under an arrangement reducing dividend tax made pursuant to Section 58(1), the arrangement shall be deemed to be as follows:
(a) Payment made by the recipient of interest or his or her associated person shall not be deemed as payment made by that person but as distribution by that entity of dividends to the previous or present beneficiary referred to in clause (b).
(b) Dividends distributed by that entity to the recipient of interest shall be deemed as equal to a sum to be set by subtracting the amount of payment said to have been made from the dividends referred to in clause (a).

Nepali Text

दफा ५८: लाभांश कर घटाउन नदिने व्यवस्था
५८(१): कुनै निकायले देहायको १५० सबै अवस्था कायम राखी गरेको प्रबन्धलाई लाभांश कर घटाउन गरेको प्रबन्ध मानिने छ :
(क) त्यस्तो निकायको सञ्चित, चालु वा अपेक्षित मुनाफा भएमा,
(ख) हित प्राप्त गर्ने कुनै व्यक्तिले त्यस्तो निकायको कुनै हित प्राप्त गर्छ र त्यस्तो हित प्राप्तकर्ता वा निजको सम्बद्ध व्यक्तिले त्यस्तो निकायको हालको वा साविकको हिताधिकारीलाई वा निजको सम्बद्ध व्यक्तिलाई हित प्राप्तिसंग सम्बन्धित भए वा नभए पनि रहित प्राप्तिको समयमा भुक्तानी भए वा नभए पनि कुनै भुक्तानी गरेकोमा,
(ग) त्यस्तो भुक्ता पूर्ण वा आंशिक रूपमा निकायको मुनाफामा प्रतिविम्बित भएमा, र
(घ) त्यस्तो निकायले त्यस्तो हित प्राप्तकर्तालाई लाभांश वितरण गरेकोमा र त्यस्तो लाभांशले पूर्ण वा आंशिक रूपले सो मुनाफालाई समावेश गरेमा ।
५८(२): उपदफा (१) बमोजिम गरिएको लाभांश कर घटाउने प्रबन्ध अन्तर्गत कुनै निकायबाट लाभांश वितरण गरिएकोमा सो प्रबन्धलाई देहाय सरह भएको मानिनेछ :
(क) हित प्राप्तकर्ता वा निजको सम्बद्ध व्यक्तिले गरेको भुक्तानीलाई सो व्यक्तिले गरेको भुक्तानी नमानी सो निकायले खण्ड (ख) मा उल्लिखित साबिक वा हालको हिताधिकारीलाई लाभांश वितरण गरे सरह मानिनेछ ।
(ख) सो निकायबाट हित प्राप्तकर्तालाई वितरण गरिएको लाभांश खण्ड (क) मा उल्लिखित लाभांशबाट सो भुक्तानी भनिएको रकम घटाई हुन आउने रकम बराबर भएको मानिनेछ ।

Conditions for “Dividend Stripping” and its Consequence

For the purposes of Section 58, for an arrangement to be treated as “dividend stripping arrangement” the following are the essential conditions:
(a) The entity whose “distributable profit” is being intended to be stripped should have some accumulated, current or expected profit.
(b) The new shareholders or their associates provides “payment” (in any form or timing) to the old shareholders or their associates for acquiring the interest in the entity
(c) The “payment” reflects, in whole or in part, the “distributable profit”
(d) After the new shareholder acquires the interest in the entity, the entity makes distribution to the new shareholder that reflects, in whole or in part, the “distributable profit”

Let’s say an entity has distributable profit of D0 at the date when the existing shareholders sell their shares to new shareholders at a price which includes the existing distributable profit. After the share purchase transaction and some time, the entity distributes dividend D1 to the new shareholders thereafter in single or multiple instances. Under the provision of Section 58, the dividend to the extent of amount D0 is treated as dividend distributed to the original shareholders and only the amount exceeding D0 (i.e D1 – D0) is the amount distributed to the new shareholders. Considering the existing taxation provision on dividend distribution and capital gain taxes under Income Tax Act – why bother making this distinction? How is abuse of the distribution and capital gain taxes prevented by this provision? Answer is: None, as this is no longer relevant in the context of the prevalent tax laws of Nepal.

In conclusion, since the withholding tax rates for dividend is uniform for all recipients of the dividend, there effectively is no consequence even if an arrangement is deemed as “dividend stripping arrangement”.

Purpose of Section 58

On the one hand the provision of Section 58  is quite counter-intuitive and secondly it’s not very relevant as of now – considering the other prevalent tax laws in Nepal. Although the provision under Section 58 is an anti-abuse provision – the abuse of tax provisions to diminish tax liabilities through this stripping arrangement. 

If we look at the history of the rate of taxation of dividend payment in Nepal we will observe the following. The withholding tax rate applicable in the payment of dividend has seen certain changes since the introduction of the Income Tax Act, 2058. For the period 2058.12.19 to 2060.03.32 the withholding tax rate on dividend was 10%. For the period 2060.04.01 to 2064.03.32 the withholding tax rate on dividend was reduced to 5%. For the period 2064.04.01 to 2066.03.31 the withholding tax rate on dividends distributed to resident persons remained the same at 5% but the dividend distributed to non-resident was increased back to 10%. Finally, from 2066.04.01 the rate got revised to 5% for both residents and non-resident recipients of the dividend. See in more detail here: Dividends: Tax Perspective. 

Similarly, if we look at the history of rate of capital gain taxes in Nepal, until Section 89A was introduced by Finance Act 2064 (2007) which was effective since 2064.04.01, there weren’t any provisions in Income Tax Act 2058 which charged taxes to non-residents in income that were not sourced in Nepal. So the gains on disposal of interest by non-residents were not taxable in Nepal for the period 2058.12.19 to 2064.03.32. See in more detail here: Capital Gains Tax in Nepal. 

So the anti-abuse provision under Section 58 actually made sense during the period where there was a difference in withholding taxes in dividend payments for residents and non-residents. Also this anti-abuse relevant provision was relevant when there weren’t any taxing mechanisms for gain on disposal of shares by non-residents. 

Section 58 is a provision of an anti-abuse nature. It is primarily targeted at the indirect removal of profits from an entity in a manner that avoids taxation that would occur if the profits were distributed, e.g. the final withholding tax on dividends. This might occur, e.g. where a foreign parent sells shares in a domestic subsidiary to another resident company. The seller may try to remove the profits of the company by taking advantage of the differential dividend tax rates between resident or non-residents or by taking the advantage of the non-taxation of the gains of disposal of shares. 

For the period between 2058.12.19 to 2064.03.32 the foreign parent company was not subject to tax on a transactional basis with respect to any gain on the shares realized. The gain of disposal of shares owned by foreign investors are still not treated as “domestic assets” under Section 67 but now a Capital Gain Tax in the nature of the withholding tax has been introduced under Section 95Ka. Section 95Ka has its own problems which we will discuss here: Capital Gains Tax in Nepal. 

But for that brief period between 2058.12.19 to 2064.03.32 the capital gains made by foreign investors through their interests in Nepal did not have a domestic source by reason of section 67, and, therefore, the gain was not included in their assessable income. Such a “dividend stripping” scheme would work in that time to defer the dividend tax or altogether avoid it by realizing the distributable profits in form of disposal of shares. So, axiomatically, in those times, the withholding tax rate of dividend for non-resident persons would likely be equal to a sum of (i) dividend tax rate for domestic dividend recipients and (ii) average capital gain tax rate in the country. Where such differential withholding tax rates on dividends were applicable, the opportunity for abusing these differential tax rates situations were addressed by treating the payment by the acquirer to the foreign parent for the shares in the subsidiary as a distribution of dividends by the subsidiary to the parent. Such a payment would, therefore, give rise to a final withholding tax liability. This treatment will also reduce the tax base of the acquirer for the shares acquired, removing the potential for any benefits by the reason of deductible losses.

This particular example in the Income Tax Directive, 2066 proves our explanation above: 
उदाहरण १३.११.१: मानौ, डाँफे कम्पनी प्रा. लि. नेपालको बासिन्दा व्यक्ति रहेछ । उक्त कम्पनीको शतप्रतिशत शेयर Donald Inc. भन्ने एक गैर वासिन्दा कम्पनीले खरिद गरेको रहेछ । डाँफे कम्पनी प्रा.लि.ले हरेक वर्ष मुनाफा आर्जन गर्दै आएको छ । यसरी आर्जित मुनाफालाई उक्त कम्पनीले आफ्ना हिताधिकारी Donald Inc. लाई वितरण नगरी सञ्चित गरिरहेको रहेछ । मानौं, उक्त सञ्चित मुनाफा रकम रु.१ लाख पुगेको रहेछ । स्काई कम्पनी प्रा. लि. नेपालमा स्थापना भएको अर्को कम्पनी रहेछ । उक्त कम्पनीले Donald Inc. बाट डाँफे कम्पनी प्रा.लि.को सम्पूर्ण शेयर रु.१ लाख ६० हजारमा खरिद गरेको रहेछ । स्काई कम्पनी प्रा.लि.ले डाँफे कम्पनी प्रा. लि. को शेयर खरिद गरिसके पश्चात डाँफे कम्पनी प्रा.लि.ले रु. ७० हजारको लाभांश वितरण गर्ने घोषणा गरेको रहेछ । यस अवस्थामा स्काई कम्पनी प्रा.लि.ले Donald Inc. लाई शेयर विक्रीबापत भुक्तानी मध्येको रु.१ लाखसम्मको वितरणमध्येको हाल वितरित रु.७० हजारलाई स्काई कम्पनी प्रा.लि.ले पाएको लाभांश नमानी डाँफे कम्पनी प्रा.लि.बाट Donald Inc. लाई भुक्तानी गरेको वितरण मानिन्छ । मानौ वितरण गरेको वर्ष बासिन्दा शेयरधनीलाई लाभांशमा ५ प्रतिशत र शेयर विक्री गरेको Donald Inc. लाई सो शेयर हस्तान्तरण गरेको वर्षको दरले गणना गर्दा सो वर्ष गैर बासिन्दालाई १० प्रतिशत कर लाग्ने व्यवस्था रहेछ भने त्यस्तो अवस्थामा सो लाभांश स्काई कम्पनीले प्राप्त गर्दा डोनाल्ड इन्कको दरले १० प्रतिशत कट्टा गर्नु पर्दथ्यो । Donald Inc. लाई वितरण मानिएकाले सो वास्तवमा वितरण भएको वर्षमा कर भुक्तानी गर्दा दफा ११९ बमोजिम व्याज समेत लाग्दछ । माथि उल्लेख गरिएको उदाहरणमा स्काई कम्पनीले व्यवसाय गरी कमाएको मुनाफासहित कुनै वर्षमा गएर रु.१ लाख १० हजार लाभांश भुक्तानी गरेको भएमा लाभांश फरक रु.१ लाखसम्ममा Donald Inc. ले डाफे कम्पनी प्रा.लि. बाट लाभांश वापत प्राप्त गरेको र बाँकी रु.१० हजारमात्र स्काई कम्पनीले लाभांश पाएको मानिन्थ्यो जबकी सबै लाभांश स्काई कम्पनीले नै गर्दछ ।

But is the anti-abuse provision of Section 58 an holistic solution?

Let’s consider a company called ProfCo wishing to distribute a dividend amount Rs. D, with the help of a stripper company called StripperCo.

  1. StripperCo buys ProfCo shares from their present owners for Rs. X+D. The cost to the present owners being Rs. C
  2. ProfCo, now owned by StripperCo, declares a dividend of Rs. D, which is paid to StripperCo.
  3. StripperCo sells its shares back to the owners for Rs. X.

The net tax effect of the above can be summarized as follows and how the anti-abuse provision of Section 58 doesn’t prevent anything in this stripping arrangement:

  1. Present Shareholders of ProfCo pays Capital Gain Tax on Rs. X+D-C
  2. StripperCo pays Dividend Tax on Rs. D
  3. StripperCo pays Capital Gain Tax Rs. X-(X+D)

Since the present shareholders are ultimately individual beneficiaries (with lower capital gain tax rates) and the StripperCo is intermediary investment company (with high business tax rate) the net cost the taxes of the above arrangement will be beneficial if:

  1. the StripperCo is in the business of investment or trading securities, and
  2. there is perfect market knowledge and perfect reflection of prices in the market, and
  3. the StripperCo has taxable investment incomes to deduct with the investment losses due to the stripping arrangement

Many other variations of the stripping arrangement may be possible:

  1. StripperCo might buy different “class B” shares in ProfCo for just the D amount, not the whole of ProfCo.
  2. Such class B shares could have their rights changed by ProfCo, rendering them worthless, instead of StripperCo selling them back.
  3. ProfCo might lend money to StripperCo for the transaction, instead of the latter needing bridging finance.

As we can note that the anti-abuse provision of the Section 58 doesn’t impact this arrangement even if the dividend distributions are characterized as being distributed to present or the new owners of the company – as the withholding rate would remain the same either way. This example is both the explanation and the testament to the fact that the present “anti dividend stripping” provision in the Income Tax Act is quite redundant.

Unintentional Safeguards against “Dividend Stripping” strategy in Income Tax Act

But if you want to enter into a dividend stripping arrangement right away- it might not be that easy. There are some safeguards against income stripping arrangements, albeit unintentionally, in the Income Tax Act, that could very much change your tax planning strategy into a nightmare. One should be careful of the followings: 

  1. There needs to be perfect market knowledge and perfect price reflection if we are dealing with listed securities. 
  2. The StripperCo better be a related party investment company with taxable investment incomes otherwise we might lose our deductible investment losses – as investment losses cannot be set off with business incomes. 
  3. In a dividend stripping arrangement there is a requirement to actually sell or purchase the shares. This might trigger the application of Section 57 which would require to pay taxes on unrealized gains making the arrangement altogether superfluous and useless. See more on Section 57 here: What the bug is Section 57?
  4. The General Anti Avoidance Provision though unpopular in application is still a risk for adverse assessments from Tax Authorities if there is an absence of commercial objective and rationale behind the transaction which in itself is hard task to prove in case of by-the-books “dividend stripping arrangement”. But it might help to view this as an “investment strategy” rather than an “avoidance strategy”. 
  5. The “transaction between associates” in the case of the “stripping arrangement” may create subsequent gains to present shareholders by way of favorable transactions between the associated persons. This may lead to value shifting between the associated persons which may have tax consequences. Tax authorities under Section 29 of the Income Tax Act reserve a right to recharacterize such transactions.  

So unless you think all your planets have aligned, dividend stripping arrangement is still a risky bet but not entirely impossible – just be sure to have your explanations.