The Meaning of Dividend
A dividend is the distribution of a company’s earnings to its shareholders and is typically determined by the company’s board of directors and approved by the general meeting of the company. Dividends are often distributed annually and may be paid out as cash or in the form of bonus shares / reinvestment. A dividend is generally understood as a reward paid to the shareholders for their investment in a company’s equity, and it originates from the company’s net profits or retained profits.
Company Law v/s Tax Law
Company and Entity
Before going into the topic about the dividend – which we will discuss from both Company Law and Tax Law perspective – first let’s understand the meaning of “Company” under Companies Law and meaning of “Company” and “Entity” under the Tax Law.
Under Section 2(Ka) of the Companies Act, 2063 “company” means a company incorporated under this Act. Typically four forms of companies are established under Companies Act – Private Limited Companies, Public Limited Companies, Company Not Distributing Profits and Branch Offices of Foreign Companies. Since Company Not Distributing Profits do not distribute dividends – the discussions on dividend are not relevant to those companies.
Under the Tax Laws however, the meaning of the “Company” is quite wide and even wider meaning for “Entity”.
Under Section 2(Da) of the Income Tax Act, 2058 “company” means:
a. A company established under the Company Laws
b. Corporate body established under the laws for the time being in force (Institutions, Associations, NGOs, INGOs)
c. Any unincorporated association, committee, institution, society, or group of persons whether registered or not (other than a partnership or a proprietorship firm or a trust)
d. A partnership firm; (that has 20 or more partners, whether registered or not)
e. A retirement fund, a co-operative, a unit trust, or a joint venture (JV)
f. Foreign company
g. Any foreign institution as prescribed by the DG
Under Section 2(Bha) of the Income Tax Act, 2058 “entity” means the following organization or body:
(1) A partnership, trust or company,
(2) Rural Municipality, Municipality or District Coordination committee,
(3) Government of Nepal, Provincial Government or Local Level,
(4) Any foreign government or provincial or local government under that government or a public international organization established by any treaty, or
(5) A permanent establishment of the organization or body referred to in clauses (1), (2), (3) and (4), which is not situated in a country of which it is a resident.
So we can observe that when we talk about the meaning of “entity” and “distributions” of an entity under the Tax Laws, we are not just talking about the distribution of dividend by a company but the distributions made by any entity that fits the definition of an entity. Example: Partnership, Trust, Government Units etc.
Meaning of Dividend
Under Company Law
Companies Law has not defined the term “dividend” but under Section 179(1) it has provided that the amount available for distribution as dividend can be distributed as bonus shares.
As per the definition of the Bank and Financial Institutions Act, 2073 under Section 2(KaGna) “dividend” means the cash dividend, interim dividend and bonus share given pursuant to this Act and other prevailing laws.
In short, anything distributed out of the distributable profit in form of cash or shares are dividend.
Under Tax Law
But the definition of dividend provided by Income Tax Law is quite technical. Under Section 2(Ka.Gha) of the Income Tax Act, “dividend” means dividend of an entity as mentioned in section 53.
Following that definition, under Section 53(1) of the Income Tax Act – the term distribution includes both payments made to beneficiaries (e.g. dividend in cash or kind) and the capitalization of profits (e.g. bonus shares).
But not all payments made to the beneficiaries by an entity can be termed as distribution. Section 53(2) of the Act clarifies this. Under Section 53(2) for an amount to be termed as distribution: (i) the value of distribution made by entity should exceed the value paid to the entity by the beneficiary, and (ii) the value of distribution is included in computing the income of the beneficiary or the amount of distribution is taxed finally except by the reason of distribution. This clarification eliminates the confusion that may arise on the transactional payments made by the entity to its beneficiaries (e.g. purchase of goods or services from the beneficiary). Another provision for non-recognition of the distribution is provided in Section 53(3) of the Act. If the distribution made by the entity actually does not reduce the value of net assets of the entity – it will not be termed as distribution. For example: some assets of the company may be exchanged for value of some other assets with the beneficiary of any other similar arrangement – that does not reduce the value of the net assets of the company, they cannot be termed as distribution by the entity.
Distribution of Profit or Distribution Capital
Another important concept regarding the “distributions” in the context of tax law is the distinction between the “distribution of profit” and “distribution of capital”. When the market value of the entity’s net assets exceeds the amount of capital contribution – any distribution to the extent of that excess amount is termed as “distribution of profit” under Section 53(4) of the Act. We can observe from the above that typically tax laws do not follow the definition of distributions like those in Company Law or Accounting Standards. Tax Laws generally define the terms in manner of characterization to act as an anti-abuse safeguard to the generally accepted definitions. While Company Law defines dividend as distribution of distributable profits – Tax Law defines the same as a distribution made when the market value of net assets exceeds the capital contribution to that excess. Such provisions prevent the taxpayers from manipulating books to skip / defer the tax liabilities of distributions.
Section 53(4) also provides that any capitalization of profit is also a “distribution of profit”. This provision is a direct classification of “distribution of profit” rather than “characterized / anti-abuse” definition as discussed above for dividend. This straightforward classification might have been assumed under the Tax Law because of the following reasons: (i) Generally Accounting Standards and Company Law do not allow capitalization of profit unless there are distributable profits, (ii) The capitalization of profits does not reduce the value of the net assets of the company and thus there less chance for the manipulation of the wealth and tax liabilities within the company, and (iii) The capitalization of earnings into shares in most entities represent that these earnings in the form of shares can be easily traded and cashed in.
Under Section 53(6) of the Act “distribution of profit” (including both distribution of dividend and capitalization of dividend) is inferred as “dividend”. Any distribution that is not a “distribution of profit” is termed as “distribution of capital” under Section 53(5) of the Income Tax Act. This implies the situation where the distribution is made by the company when the market value of net assets is less than the capital contribution.
५३. निकायबाट हुने वितरणः
५३(१): निकायबाट हुने वितरणमा देहायका कुराहरू समावेश गर्नु पर्नेछ :
(क) निकायबाट आफ्नो कुनै हिताधिकारीलाई कुनै पनि हैसियतले गरिएको भुक्तानी, वा
(ख) मुनाफाको पुँजीकरण ।
५३(२): उपदफा (१) मा जुनसुकै कुरा लेखिएको भए तापनि सो उपदफाको खण्ड (क) मा उल्लेख भएको कुनै भुक्तानी निम्न अवस्थाहरूमा मात्र वितरण भएको मानिने छ :
(क) निकायबाट हिताधिकारीले प्राप्त हुनसक्ने प्रतिफलको सट्टामा उक्त निकायलाई भुक्तानी गरेको रकमभन्दा सो भुक्तानी बढी भएमा, र
(ख) सो भुक्तानीमा निम्न रकमहरू समावेश नभएमा :
(१) हिताधिकारीको आयको गणना गर्दा समावेश भएका रकमहरू,
(२) वितरणको कारणले बाहेक अन्तिम रूपमा कर कट्टी भएको भुक्तानीहरू ।
५३(३): कुनै निकायको वितरणले सो निकायको सम्पत्ति र दायित्वको मूल्य घटाउने भएमा मात्र त्यस्तो वितरेण मुनाफाको वितरण वा पुँजीको फिर्ता मानिनेछ ।
५३(४): देहायका कुनै अवस्थामा कुनै निकायको वितरणलाई दफा ५५ को अधीनमा रही मुनाफाको वितरण मानिनेछ :
(क) उपदफा (३) मा उल्लिखित किसिमको वितरण भएमा र वितरणको समयमा निकायको दायित्वको बजार मूल्य तथा पुँजीकृत गरिएको मुनाफा समेत समावेश भएको पुँजी योगदान रकमको जम्मा रकमभन्दा सम्पत्तिको बजार मूल्य बमोजिमको रकम बढी भएमा,
(ख) मुनाफाको पुँजीकरण भएमा ।
५३(५): उपदफा (३) मा उल्लिखित वितरण मुनाफाको वितरण नभएको हदसम्म पुँजी फिर्ता भएको मानिनेछ ।
५३(६): कुनै निकायको वितरण पुँजीको फिर्ता नभएको हदसम्म सो निकायको लाभांश मानिनेछ ।
स्पष्टीकरण यस दफाको प्रयोजनको लागि “मुनाफाको पुँजीकरण” भन्नाले बोनस शेयर वा यस्तै कुनै हित जारी गरी पुंजिकृत गरेको वा सो निकायको हितको चुक्ता रकममा वृद्धि गरेको वा निकायको प्रिमियम तथा पुँजी खातामा नाफालाई आम्दानी बाँधेको समेतलाई जनाउँछ ।
The need for Distinction
One important question to be addressed is about the need for the distinction between “distribution of profit” and “distribution of capital” in the tax laws. The need for this can be understood by discussing how the distribution of profit and distribution of capital are subject to taxation.
History of Withholding Taxes on Distribution of Profit
मूल ऐनको व्यवस्थाः
८८(२): बासिन्दा व्यक्तिले नेपालमा स्रोत भएको लाभांश, लगानी बीमाबाट प्राप्त लाभ वा स्वीकृत नलिएको अवकाश कोषबाट प्राप्त लाभ भुक्तानी गर्दा कुल भुक्तानी रकमको दश प्रतिशतका दरले कर कट्टी गर्नु पर्नेछ ।
आर्थिक अध्यादेश, २०६० द्वारा कायम भएको व्यवस्थाः
८८(२): बासिन्दा व्यक्तिले नेपालमा स्रोत भएको देहायका भुक्तानी गर्दा देहायका दरले कर कट्टी गर्नु पर्नेछ ।
(क) लाभांश भुक्तानी गर्दा रकमको पाँच प्रतिशत
(ख) लगानी बीमाको लाभ भुक्तानी गर्दा भुक्तानी रकमको पाँच प्रतिशत, वा
(ग) स्वीकृति नलिएको अवकाश कोषबाट लाभ भुक्तानी गर्दा लाभ रकमको दश प्रतिशत ।
आर्थिक ऐन, २०६४ द्वारा कायम भएको व्यवस्थाः
८८(२): बासिन्दा व्यक्तिले नेपालमा स्रोत भएको देहायका भुक्तानी गर्दा देहायका दरले कर कट्टी गर्नु पर्नेछ ।
(क) लाभांश भुक्तानी गर्दा बासिन्दा व्यक्तिलाई भुक्तानी गरेकोमा भुक्तानी रकमको पाँच प्रतिशत र गैरबासिन्दा व्यक्तिलाई भुक्तानी गरेकोमा भुक्तानी रकमको दश प्रतिशत,
(ख) लगानी बीमाको लाभ र व्यक्तिगत दुर्घटना बापतको क्षतिपूर्ति भुक्तानी गर्दा भुक्तानी रकमको पाँच प्रतिशत, वा
(ग) स्वीकृति नलिएको अवकाश कोषबाट लाभ भुक्तानी गर्दा लाभ रकमको पाँच प्रतिशत ।
आर्थिक ऐन, २०६६ द्वारा संशोधन ।
दफा ८८(२): बासिन्दा व्यक्तिले नेपालमा स्रोत भएको देहायका भुक्तानी गर्दा देहायका दरले कर कट्टी गर्नु पर्नेछ:
(क) लाभांश भुक्तानी गरेकोमा भुक्तानी रकमको – पाँच प्रतिशत,
(ख) लगानी बीमाको लाभ भुक्तानी गर्दा भुक्तानी – रकमको पाँच प्रतिशत, वा
(ग) स्वीकृति नलिएको अवकाश कोषबाट लाभ भुक्तानी गर्दा लाभ रकमको पाँच प्रतिशत ।
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.
Distribution of Dividend as Final Withholding Taxes
मूल ऐनको व्यवस्थाः
९२(१): देहायका भुक्तानीलाई अन्तिम रूपमा कर कट्टी हुने भुक्तानी मानिनेछ
(क) बासिन्दा कम्पनीले भुक्तानी गरेको लाभांश,
आर्थिक ऐन, २०७३ द्वारा थप
९२(१): देहायका भुक्तानीलाई अन्तिम रूपमा कर कट्टी हुने भुक्तानी मानिनेछ
(क) बासिन्दा कम्पनी वा साझेदारी फर्मले भुक्तानी गरेको लाभांश,
For the period 2058.12.19 to 2073.03.32 the dividends distributed by the company were treated as final withholding taxes. But during that period the dividends distributed by the “entities” that did not meet the definition of “company” were not treated as being distributed as final withholding payments (e.g. the dividend distributed by the partnerships with less than 20 partners).
Distribution of Profit: Payment / Capitalization of Dividend
The withholding rate is applied on the amount being distributed. Since the withholding requirement falls on the entity distributing the dividend – the amount of dividend is grossed with the applicable dividend rate and the entire amount is approved as “proposed dividend” by the BoD and General Meeting of the entity as required. This is quite straightforward.
However, in the case of Capitalization of Dividend – there is no actual cash payment to the shareholders – in fact there is no intrinsic increment in the wealth of the shareholder by the reason of capitalization of dividend. There may be some prospective increment in wealth by the reason of reinvestment but not any realized gains at the present. Capitalization of dividend in fact is only a restriction in the form of distributable profits. It sure seems there is no reason to withhold taxes on the capitalization of the dividend as it is only but only a change in the form of wealth without any realization. But the laws generally do not treat the capitalization of dividend separately from the distribution for taxation because the instruments representing the investment (i.e. share units) are generally tradable. This leads to the notion that when the dividends are capitalized they become realizable by the reason of being tradable. So there is no difference in the tax treatment for “payment of dividend” and “capitalization of dividend”.
See more discussion on this topic here: Taxation of Bonus Shares in Nepal
Example of Tax Treatment in Distribution of Profit:
- Distribution of Dividend: A company is proposing to distribute a cash dividend of Rs. 800,000. Grossing up with dividend tax the amount comes to Rs. 842,105 (Rs. 800,000 / 95%) which is approved by relevant authority as per the Company Law. The dividend tax comes to Rs. 842,105 × 5% = Rs. 42,105 and cash dividend of Rs. 800,000 will be distributed to the shareholders. Such distribution is termed as
- Capitalization of Dividend: A company is proposing to capitalize a dividend of Rs. 800,000. Grossing up with dividend tax the amount comes to Rs. 842,105 (Rs. 800,000 / 95%) which is approved by relevant authority as per the Company Law. The dividend tax comes to Rs. 842,105 × 5% = Rs. 42,105 and the amount of Rs. 800,000 will be capitalized to each shareholder’s shareholding proportionally.
Taxation of Distribution of Capital
The situation where the distribution is made by the company when the market value of net assets is less than the capital contribution is termed as “distribution of capital” as per Section 53(5) of the Income Tax Act. When the distribution is in the form of “distribution of capital” this leads to the diminution of the capital contribution of the company and is comparable to the situation of the buyback of the shares. In such a situation the shareholder is deemed to have disposed of his shares to that extent and the taxation that applies at the point of the disposal of the shares would apply – i.e. Capital Gain Taxes. When the amount of such “distribution of capital” is received the initial tax base of the capital contribution of the shareholder will reduce to the extent of such distribution. If the amount received is in excess of the existing tax base of the capital contribution of the shareholder such difference would be treated as gains and taxed in the form of gain on disposal of shares. See my other other post that discusses in detail about the regime of Capital Gain Taxes in Nepal: Capital Gains Tax in Nepal.
Distribution Requirement under Companies Act
Dividend can be distributed only from distributable profits. Statutory reserves cannot be used to distribute dividends. Sometimes an entity may have established other constructively restricted reserves – they too cannot be used to distribute unless the authority within the entity that creates such reserves permits its distribution. Typically, distributable profits are understood as accounting profit – that is derived by preparing the financial statements as per the prevailing accounting standards (i.e. NFRS in case of Nepalese Entities). But sometimes, in the case of industries with specialized regulators – the recognition rule for accounting purposes may be different and a different amount of profit may be derived – which leads to the accounting profit being different than those prepared under the Financial Reporting Standards. This is usually true in the case of the Insurance and Banking Sector in Nepal – whose distributable profit is quite different from the accounting profit. But for most entities accounting profit is the distributable profit.
One common confusion we all fall for is whether or not we can distribute dividends in excess of the taxable profit derived? The answer is Yes. Taxable profit is a construct for computing taxes. The main economic gain / loss is reflected in the accounting profit – which should be the amount available for distribution. Our Tax Laws or Tax Directive has also not treated this otherwise.
Although the principle of obtaining distributable profit is guided by the accounting standards applicable in the country – NFRS in case of Nepal, Companies Act, 2063 also has a limited guideline on what profit should actually be distributed as dividend.
As per Section 182(6) of the Companies Act, before paying or declaring a dividend out of the profits for any financial year, a company should fully deduct the followings from its profits/reserves:
- Preoperative expenses,
- Amount required to be depreciated in accordance with the prevalent accounting standards,
- Amount required to be paid or set aside out of the profits under the prevailing law,
- Accumulated loss in previous financial years,
- Amount for establishment of the funds as per the legal requirement
The indication is quite straightforward and is generally an accounting fundamental under most of the accounting practices. The Company Law adopted this minimum accounting fundamental to address the non-uniformity of the generally accepted accounting practices prevalent in Nepal before a formal adoption of the Accounting Standards introduced by the Institute of Chartered Accountants of Nepal. The requirement of Section 182(6) may not be very relevant from the accounting practices but it attracts some sanctions under Companies Act, 2063 – which is still very relevant.
Announcement and Approval
Dividend declaration is an investment decision. The BoD of a company generally proposes the rate of the dividend and it is presented to the higher level among the shareholders of the company at the company’s annual general meeting. The shareholders of the company at the general meeting by way of vote approve the dividend proposed by the BoD or an alternative amount not exceeding the rate proposed by the BOD. This is the typical process of dividend declaration by a company. Single Shareholder Companies and Private Companies may have their own process defied for the announcement and approval. Regulated industries like Insurance Sector, Banking Sector or Government Owned Companies etc. may require additional approval from the regulatory authority as well.
Timeline for Payment
Under Section 182 of the Companies Act, a company will have to credit the amount of a dividend to be distributed to its shareholders to a separate account within 45 days after the date of approval by the general meeting and pay the amount of dividend out of that account; and the company should not use such amount for any other purpose. The amount of dividend is required to be distributed to the shareholders within 45 days of the decision made to be provided unless (i) any law prohibits the distribution of dividend; (ii) the right to receive dividend is subject to any dispute; (iii) in a circumstance beyond control of the company or for any reason, dividend cannot be distributed within the time limit.
According to the notice published in the Nepal Gazette on 2053.11.22, if the dividend payment is delayed, it is arranged that the dividend payment shall be made with the addition of interest at the rate of 12% per annum. Link Here
Interim Dividend is distributed out of the previous financial year’s profit and cannot be distributed from the profit of the current year’s profit. A company can distribute interim dividends to the shareholders from the previous year’s profits. However, according to the provision made in Section 182(7) of the Companies Act, the following two conditions must be fulfilled to distribute interim dividend: (i) There should be a provision in the company’s regulations that interim dividends can be distributed. (ii) The annual financial statement of the financial year in which the interim dividend is to be distributed from the profits of the financial year must be verified by the auditor and approved by the board of directors.
Directors who distribute interim dividends without complying with the above-mentioned conditions can be fined up to 20,000 rupees through court. After distributing the final dividend in a financial year, the dividend cannot be distributed again in the name of interim dividend in the next year from the remaining profit of the same year. If no dividend has been distributed from the profit of the previous financial year, then interim dividend can be distributed in the following year. But in order to distribute the interim dividend in this way, the above mentioned 2 conditions must be fulfilled compulsorily. For example, a company may not distribute interim dividends again in the financial year 2063/064 from the remaining profit after distributing the final dividend from the profit earned in the financial year 2062/063. If the dividend is not distributed from the profit earned in the financial year 2061/062, the interim dividend can be distributed in the financial year 2062/063 from the amount of the profit, if the necessary conditions for the distribution of interim dividend are fulfilled.
The provisions made by the Companies Act regarding the fact that dividends should not be distributed from the company’s capital and that the company should not purchase its own shares except in the special circumstances determined in the Companies Act makes these provisions clear.
Sometimes the dividend declared by the company may remain unclaimed by the shareholder. Under Section 182 of the Companies Act the amount of dividend not claimed/received by any shareholder even after the expiry of a period of 5 years after the date of resolution adopted by the company in its general meeting to distribute dividend shall be credited to the investor protection fund.
Prior to the expiry of the 5 years time period the company should publish a notice in a national daily newspaper inviting the concerned to receive the dividend, within the time limit of at least 1 month. The amount credited to the investor protection fund is spent for the improvement in: capital markets, investment policy, companies law, law relating to trade, business and profession, training to the employees or any other activity relating to the company administration. The management and operation of the fund shall be as decided by a committee consisting of: (i) The Registrar, and (ii) The Chairperson of the Securities Board or his representative, and (iii) One representative appointed by the Securities Board from amongst the organization operating the stock exchange
General Reserve and Taxed Reserve
In general cases, the taxed reserve is always greater than the general reserve because tax regulations generally only defer the recognition of an expense but do not defer the recognition of income.
(i) When the recognition of an expense is deferred, deferred tax asset arises.
(ii) When the recognition of an income is deferred, deferred tax liability arises.
However, there may still be situations where General Reserve are greater than taxed reserve by the reason of: (a) Presence of Final Withholding Income Only, (b) Book Rate of Depreciation being greater than Tax Depreciation etc. In such cases, where deferred tax liability is arisen, the general reserve is greater than the taxed reserve.
Are there any implications from the Tax Law or Company Law perspective when the General Reserve is less than the Taxed Reserves? A common question we all ask is: Is dividend distribution allowed when the general reserve is less than the amount of taxed reserve? The answer is “yes”. Taxable profit is a construct for computing taxes. The main economic gain / loss is reflected in the accounting profit – which should be the amount available for distribution. Our Tax Laws or Tax Directive has also not treated this otherwise.
See more discussion on the topic of General Reserve and Taxed Reserve here: Deferred Tax & Untaxed Reserve.
Thin Capitalization and Dividend Distribution
For the company’s shareholders, investors, creditors and also for the company’s own benefit, a special provision for maintenance of the company’s capital is made in the company law. In terms of protecting the company’s capital, the restrictive arrangements made about reducing the company’s capital, prohibiting the issuance of shares at a price lower than the face value, not distributing dividends from the capital, and not buying the company’s own shares by spending its capital are some of the important provisions laid down in the Companies Act regarding the prevention of thin capitalization.
Capital preservation and dividend distribution
Dividend is the return that the investors who invest in the company’s shares get on their investment. Therefore, in the year when the company earns profit, dividends can be distributed only from the amount of such profit. Dividends cannot be distributed from the capital of the company in the year when the company has no profit. Such restrictions are considered indispensable for the protection of the company’s capital. Therefore, in the Companies Act, 2063, it is stipulated that the company cannot pay or distribute dividends in any other way except from the amount of profit set aside for dividend distribution. The company can distribute dividends only from accumulated net profits. Therefore, from the amount of profit, the amount of pre-operating expenses, the amount to be deducted, the amount of accumulated loss in the previous financial years and other amounts that should be separated or distributed from the amount of profit according to the prevailing law. Then the dividend is only from the amount of the remaining net profit, which is approved by the general meeting of the company. But the general meeting cannot decide on the rate of dividend in such a way that it is higher than the rate determined by the board of directors.
Dividend should not be anything other than profit
Apart from the dividend approved by the general meeting, the company cannot pay or distribute any amount to the shareholders in the form of cash or kind, which will be a burden on its capital fund. Such a restrictive provision has been made in the Companies Act, 2063 to prevent the wrong practice of sharing expenses. Contrary to the said provision, if a company distributes any amount to the shareholders in the name of special allowance, general meeting allowance, lunch expenses or in any other way for attending the general meeting, the director could be fined from 5000 rupees to 20000 rupees.
The Company Law, 1993 had made a restrictive provision that no amount should be distributed to the shareholders from any amount other than the profit received by the company. But this type of restrictive provision was not made in the Company Acts introduced in 2007, 2021 and 2053 after that. Such a provision is considered necessary to protect the company’s capital and to prevent misuse of the limited liability facility given to companies. So the Company Act, 2063 has restored the provision which was neglected by the Company Acts of 2007, 2021 and 2053. It is stipulated in the Companies Act, 2063 that no amount can be paid or distributed to the shareholders of the company in the form of cash or in kind except as dividends declared from the profits of the company.
Dividend should not be from falsified profit
Dividends should be distributed to the shareholders only from the amount of profit earned by the company. It is the duty of the directors to propose the amount of dividend to be distributed to the shareholders based on the actual financial position of the company from the earned profits without adversely affecting the capital of the company. However, without complying with such duty, the directors must pay the company the excess dividend distributed on the basis of the false statement. Such directors can be fined up to 20 thousand rupees through the court order.
View of Mechanism of the Distributions other than Profits
Meaning and Provisions of the ITA
निकाय र हिताधिकारी बीचको कारोबार
५६(३): कुनै निकायले कुनै हिताधिकारीलाई लाभांशको रूपमा मुनाफा बाहेकको लाभांश वितरण गरेमा त्यस्तो लाभांशको रकमलाई सो निकायको आय गणना गर्दा समावेश गर्नु पर्नेछ । तर तोकिएको कुनै अवस्थामा यो उपदफामा उल्लेख गरिएको कुरा लागू नहुने गरी व्यवस्था गर्न सकिनेछ ।
लाभांशको रकमलाई निकायको आय गणना गर्दा समावेश गर्नु नपर्ने
१८(१): ऐनको दफा ५६ को उपदफा (३) को प्रतिबन्धात्मक वाक्यांशको प्रयोजनको लागि कुनै निकायले देहायको कार्यको लागि कुनै हिताधिकारीलाई सो निकायको व्यवसाय सञ्चालनको सिलसिलामा नभई अन्य कारणले मुनाफा बाहेकको लाभांश वितरण गरेमा आय गणना गर्दा समावेश गर्नुपर्ने छैन:
(क) सो निकायबाट हिताधिकारीलाई उपलब्ध गराइएको सेवा, वा
(ख) हिताधिकारीको प्रयोगको लागि उपलब्ध गराइएको सो निकायको स्वामित्वमा रहेको सम्पति ।
१८(२): उपनियम (१) बमोजिमको अवस्थामा त्यस्तो सेवा वा सम्पत्तिको सम्बन्धमा ह्रास कट्टी लगायत कुनै पनि खर्च कट्टी गर्न पाइने छैन ।
Under Section 56(3) of the Act If any entity distributes dividends except profits as dividends to any beneficiary, the amount of such dividends shall be included in computing the income of the entity. However, under Rule 18 of the Income Tax Rules, clarification has been provided that in cases of the “distribution other than profits” made by the entity to its beneficiaries in non-business transaction (The service provided by that entity to the beneficiary , or The property under ownership of that entity, which has been provided for the use of the beneficiary) is not required to be included in calculating the income of the entity – but the company is not allowed to deduct the expense for such expenses.
So the clarification in Rule 18 has actually made the entire provision under Section 56(3) defunct and has allowed for misinterpretation of the provision under Section 56(3) under many occasions – that we will discuss below.
Office of Auditor General’s View
In short – OAG thinks – capitalization of the share premium into capital is “distribution other than profit”. Extract from OAG’s 2078 report: Link Here
६२. मुनाफा बाहेकको लाभांशमा कर – आयकर ऐन, २०५८ को दफा ५६(३) मा उल्लेख भएको मुनाफा बाहेकको लाभांश रकममा तोकिएको अवस्थाभन्दा बाहेकमा निकायको आयमा आयकर लाग्ने व्यवस्था छ । आयकर नियमावली, २०५९ को नियम १८ मा मुनाफा बाहेकको रकममा हिताधिकारीलाई सेवा उपलब्ध गराइएको वा निकायको स्वामित्वमा रहेको सम्पत्ति हिताधिकारीलाई प्रयोगका लागि उपलब्ध गराइएको अवस्थामा निकायको आयमा समावेश गर्नु नपर्ने गरी तोकेको छ विभागले आयकर निर्देशिका (संशोधन सहित) २०६६ को परिच्छेद १३ को बुँदा नं. १३.९ मा मुनाफा बाहेकको वितरणको रूपमा शेयर प्रिमियमबाट बोनस शेयर वितरण भएमा सोलाई सोही ऐनको दफा ५३(१) (क) अनुसार निकायबाट हुने वितरण मानी अन्तिम रूपमा कर कट्टी विधिमा कर लाग्ने उल्लेख गरेक छ सोही ऐनको दफा ५६(३) मा आय गणना गर्न नपर्ने सम्बन्धमा स्पष्ट व्याख्या नभएको अवस्था छ । तर विभागले सो मुनाफाबाट भएको वितरणमा निकायलाई आयकर नलाग्ने दफा ५३(१) को वितरण मानी अन्तिम कर कट्टी विधिले कर असुल गर्ने उल्लेख गरी व्याख्या गर्दा त्यसबाट दफा ५६ (३) अनुसार सिर्जित हुने निकायको कर दायित्व नै खारेज वा खण्डित भएको देखिन्छ । आयकर ऐनमा नियमावलीले तोक्ने उल्लेख भए तापनि निर्देशिकामा शेयर प्रिमियमबाट भएको वितरणमा मुनाफा बाहेकको लाभको अवधारणा लागू नहुने नियमावलीले तोकेको भन्दा फरक व्याख्या गरिएको छ । उक्त व्याख्या आयकर ऐन र नियमावलीसँग बाझिई आयकर ऐनको दफा १३९ र १४२ विपरीत देखिन्छ । यस सम्बन्धमा गत वर्षको प्रतिवेदनमा ठूला करदाता कार्यालयअन्तर्गत दर्ता भएका ५ वाणिज्य बैङ्क र १ बीमा कम्पनीको मुनाफा बाहेकको लाभांश वितरण रू.७ अर्ब १३ करोड २३ लाखमा रू.२ अर्ब १३ करोड ९७ लाख राजस्व छुट हुन गएको व्यहोरा उल्लेख गरिएको छ। तर आन्तरिक राजस्व विभाग र ठूला करदाता कार्यालयले उक्त कर छुट रकम असुल गर्ने प्रक्रियाको अवलम्बन नगरी आन्तरिक राजस्व विभागको महानिर्देशकस्तरको २०७८।१।२० को निर्णयबाट शेयर प्रिमियमलाई निकायको आय गणना गरी समावेश गर्नु नपर्ने भनी आयकर निर्देशिकाबाट व्याख्या भएको उल्लेख गरे तापनि सो व्याख्या आयकर ऐनको दफा १३९ र १४२ प्रतिकूल देखिन्छ यस वर्ष पनि २४ वाणिज्य बैङ्क र १३ बीमा कम्पनीले विभिन्न मितिमा फर्दर पब्लिक अफरिङ्ग र शेयर लिलामीमार्फत् २०७३ । ७४, २०७४।७५, २०७५ । ७६ र २०७६ । ७७ मा आम्दानी गरेको रू. ११ अर्ब ६३ करोड ३० लाखमा ३० प्रतिशत हुने कर रू.३ अर्ब ४८ करोड ९९ लाख राजस्व छुट हुन गएको सम्बन्धमा छानबिन गरी असुल गर्नुपर्ने देखिन्छ ।
This view of the OAG is quite absurd because Share Premium is not a form of income to the entity – it is a kind of capital contribution. More discussion here in my other post: Taxability of Share Premiums.
Income Tax Directive
Extract from Income Tax Directive 2066:
१३.९. मुनाफा बाहेकको रकमबाट हुने लाभांशको वितरण
कुनै निकायले सो निकायको मुनाफा वा लाभ वा आय बाहेकको अन्य कुनै रकमबाट लाभांश वितरण गरेमा त्यसरी वितरित रकम सो निकायको आय हुने व्यवस्था ऐनले गरेको छ । यस सम्बन्धमा ऐनको दफा ५६ (३) र नियम १८ मा व्यवस्था रहेको छ ।
ऐन र नियमावलीका उपर्युक्त व्यवस्था अनुसार कुनै पनि निकायले आफ्ना हिताधिकारीलाई नियमावलीको नियम १८ को उपनियम (१) मा उल्लिखित रकम बाहेक मुनाफा बाहेकको अन्य कुनै रकमबाट लाभांश वितरण गरेमा त्यस्तो लाभांश रकमलाई सो निकायको आय गणना गर्दा आयमा समावेश गर्नु पर्दछ ।
ऐन र नियमावलीको उपर्युक्त व्यवस्था बमोजिम कुनै निकायले आफ्नो नाफा नोक्सानमा प्रतिविम्बित नभएको कुनै मुनाफा वा लाभ वा आयको रकम लाभांशको रूपमा वितरण गरेमा त्यसरी वितरण भएको रकमलाई वितरण भएको आय वर्षको आय गणना गर्दा सो निकायको आयमा समेत समावेश गर्नु पर्दछ । कुनै निकायको नाफा नोक्सानमा प्रतिविम्बित नभएको मुनाफा वा लाभ वा आयको उल्लेखनीय उदाहरण शेयर प्रिमियम वापत प्राप्त हुने रकमलाई लिन सकिन्छ । कम्पनी ऐन, २०६३ को दफा २९ ले सोही दफामा तोकिएका शर्त पूरा गर्ने कुनै कम्पनीले कम्पनी रजिष्ट्रारको कार्यालयको पूर्व स्वीकृति लिई प्रिमियम मूल्यको शेयर जारी गर्न सक्ने व्यवस्था गरेको छ । यसरी प्रिमियम मूल्यमा शेयर बिक्री गर्दा प्राप्त भएको रकममध्ये शेयरको अंकित मूल्यभन्दा वढी भएको रकम प्रिमियम खाता खोली जम्मा गर्नुपर्ने समेत व्यवस्था छ । त्यसैगरी, प्रिमियम खातामा रहेको रकम बोनस शेयर जारी गर्न, अग्राधिकार शेयरको प्रिमियम भुक्तान गर्न, प्रारम्भिक खर्चको शोधभर्ना गर्न र कम्पनीको शेयर जारी गर्दा भएको खर्च व्यहोर्न प्रयोग गर्न सक्ने व्यवस्था समेत रहेको छ । सो व्यवस्था अनुसार प्रिमियम मूल्यको शेयर बिक्री गर्दा प्राप्त भएको रकममध्ये अंकित मूल्य बराबरको रकम शेयर पुँजीमा थप भई दायित्वमा वृद्धि हुने हुँदा सो रकमले शेयर जारी गर्ने कम्पनीको आय वा मुनाफामा कुनै असर गर्दैन । तर शेयर प्रिमियम खातामा आम्दानी बाँधिएको रकममध्ये बोनस शेयर जारी गर्न प्रयोग भएको अवस्थामा ऐनको दफा ५३(१) (क) बमोजिमको भुक्तानी सरह मानी अन्तिम रूपमा कर कट्टीको विधिले कर लगाउनु पर्दछ साथै कम्पनिको विगत वर्षका वा प्रारम्भिक खर्च वा ऐनले छुट नपाउने खर्च शोधभर्ना गर्न प्रयोग भएको हदसम्मको रकमलाई जुन आय वर्षमा बोनस शेयर जारी गर्न वा कम्पनीको सर्च शोधभर्ना गर्न प्रयोग भएको हो सोही आय वर्षमा सो कम्पनी वा निकायको आयमा समावेश गर्नु पर्दछ ।
This view of IRD in regard to (i) defining the term “distribution other than profit” and (ii) taxability of the share premium is both equally as insane as the view of the OAG. More discussion on taxability of share premium here: Taxability of Share Premiums.
Models of Taxing Distributions other than Profit
For example, a company may have a property available for rent but permits a shareholder to stay in it for free. There are two approaches to the taxation of this type of benefit. One is the same as is used in the context of employee fringe benefits. The notional income of the company may be ignored and the benefit fully included in calculating the income of the beneficiary.
An important question that may arise is: Why is the act of providing the facility of the property to the shareholder not a “distribution of profit”? Why does it need to be a “distribution of a collateral benefit” or “distribution other than profit”? The reason for the concept of “distribution other than profit” is to capture the collateral benefits provided to shareholders that typically may not have alternative commercial value to the company (i.e. in the above example the company does not have the capacity to derive the benefit from the vacant properties) but still do provide the benefit to the beneficiary. Any distribution of an entity that is not a distribution of profits or a repayment of capital is a “distribution of a collateral benefit / distribution other than profit”.
Taxing the distributing Company, or
Allowing Expenses and Including Deemed Income
One mechanism of taxing the collateral distributions other than profit is by
(i) allowing the company from claiming deduction for such distributions (by way of expense or depreciation) but
(ii) including the value of the benefit to that extent as the deemed income of the company
This way effectively the company will not be able to take tax advantage against the in kind dividend distributions.
Disallowing Expenses and Excluding Deemed Income: That ITA Follows
Other mechanism of taxing the collateral distributions other than profit is by
(i) disallowing the company from claiming deduction for such distributions (by way of expense or depreciation) but
(ii) not including the value of the benefit to that extent as the deemed income of the company
Just like above, in this model too – the company will not be able to take tax advantage against the in kind dividend distributions.
Taxing the Recipient
The effect of taxing the distributions of this type on the recipient is to cause an entity to not derive income but, rather, provide a benefit directly to the beneficiary, i.e. the distribution to the beneficiary represents notional income of the entity. So the taxing approach should be consistent with basic taxation principles. It should not be included as a notional income to both the entity and its beneficiaries.
So the alternate approach is to include the notional income in calculating the income of the entity and otherwise treat the distribution of a collateral benefit in the same manner as any other distribution of profits. This issue could also be addressed through an equalization tax by requiring entities to match distributions with taxed profits and to the extent they cannot impose a make-up tax. However, an equalization tax will have other effects. It may also tax distributions of unrealised gains and wash out other preferences such as direct exemptions and foreign tax relief. This treatment is inconsistent with the treatment of income derived directly by individuals. A more principled approach to the quasi-realisation of unrealised gains, e.g. characterized income.
Nevertheless, the approach of taxing the notional income of the “distributions other than profit” to the individual still does create some inconsistency with the treatment of individuals. Individuals are not taxed with respect to notional income, e.g. notional rent is not allocated to individuals who live in their own homes. In the context of an individual, this is consistent with the basic taxiing approach of not taxing wealth created unless it is paid for by a third party. In the context of an entity, it may be argued that the entity is being paid for wealth created that is represented by distributions of collateral benefits, i.e. the beneficiaries pay in the form of allowing the entity to use their capital. Even if the entity is looked through, often it will be a group of persons managing and owning the entity that will be receiving the payment in the form of the use of capital. In these circumstances, the taxation of the notional income to the entity may be justified.
Nevertheless, this approach is not followed by the Income Tax Laws in Nepal.