Section 47Ka of ITA: back to square one?

How did it all begin?

In the budget speech for the fiscal year 2010/2011, Surendra Pandey, the Finance Minister of Nepal, expressed a firm commitment to foster the consolidation of banks, finance, and insurance companies. Recognizing the importance of mergers in enhancing the efficiency and stability of the financial sector, Pandey announced significant measures through the Income Tax Act to incentivize and facilitate such consolidations through the Finance Bill 2011. To create a favorable environment for mergers, the Minister pledged to introduce amendments to the tax regulations, ensuring that the disposal of assets and liabilities during the merger would be exempt from taxation. Additionally, special arrangements were promised to safeguard the interests of shareholders, managers, and employees involved in the merger process. These proactive steps aimed to encourage greater synergy and stronger financial institutions, promoting the growth and resilience of Nepal’s economy.

Here is what Surendra Pandey said exactly through the budget speech:

English Budget Speech 2010/2011, Page 22

Increase in Tax Exemption and Facilities:
(d) In order to encourage the merger of banks, finance and insurance companies, changes in the provision of taxing assets and liabilities as disposal after merger will be introduced to make it non-taxable and special arrangements have been made in the context of shareholders, managers and employees.

Nepali बजेट बक्तब्य २०६७/२०६८, Page 21

कर सहुलियत तथा सुविधामा वृद्धि
(घ) बैक तथा वित्तीय संस्था र बीमा कम्पनीहरुलाई परस्पर गाभिन प्रोत्साहन गर्न आयकर ऐनमा भएको एक आपसमा गाभिएमा सम्पत्ती तथा दायित्वको निसर्ग मानी कर लगाउने प्रावधानमा परिवर्तन गरी कर नलाग्ने एवं शेयरधनी, व्यवस्थापक तथा कर्मचारी समेतको सन्दर्भमा विशेष व्यवस्था मिलाएको छु ।

The Income Tax Act, 2058 of Nepal was amended to that effect (discussed below) and measures were strategically designed to create a conducive environment that incentivized banks and insurance companies to pursue mergers, fostering a stronger and more resilient financial sector in Nepal which we will discuss below. One significant incentive was the revision of taxation provisions on disposal of assets during the merger which was treated as non taxable.

Some changes were made thereafter in ITA

[४७क. व्यवसाय गाभिएको कारणले हुने निसर्ग सम्बन्धी विशेष ब्यबस्था] [1]
(१) बैकिङ्ग तथा वित्तीय व्यवसाय वा बीमा व्यवसाय गर्ने एकै प्रकृतिका निकायहरू आपसमा गाभिएर (मर्जर वा एक्युजिशन) भएमा दफा ५७ को उपदफा (२) को खण्ड (क), (ख), (घ), (ङ), (च) र (छ) तथा सोही दफाको उपदफा (३) को व्यवस्था लागू हुने छैन ।
तर, गाभिएर अस्तित्वमा नरहेको निकायको कुनै कट्टी हुन नसकेको नोक्सानी भए त्यस्तो नोक्सानी दामासाहीले आगामी सात वर्षमा कट्टी गर्नु पर्नेछ । यसरी समान किस्तामा नोक्सानी कट्टी गर्ने निकाय उक्त पूरै नोक्सानी कट्टी नगर्दै पुनः विभाजन भएमा कट्टी भएको नोक्सानी बापत कट्टी भएको रकममा गाभिएको (मर्जर वा एक्युजिशन) आर्थिक वर्षमा कायम रहेको करको दरले कर तिर्नु पर्नेछ ।

(२) उपदफा (१) बमोजिम निकायहरू गाभिई सम्पत्ति र दायित्वको निःसर्ग भएमा देहाय बमोजिम हुनेछ:
(क) व्यापारिक मौज्दात तथा व्यावसायिक सम्पत्तिको निःसर्गको हकमा,-
(१) निःसर्गको तत्काल अघि त्यस्तो सम्पत्ति बापत भएको खुद खर्च बराबरको रकम त्यस्तो निःसर्ग बापत त्यस्तो व्यक्तिले प्राप्त गरेको मानिनेछ, र
(२) उपखण्ड (१) मा उल्लेख भए बराबरको रकम सम्पत्ति प्राप्त गर्ने व्यक्तिको लागत परेको मानिनेछ ।
(ख) हासयोग्य सम्पत्तिको निःसर्गको हकमा,-
(१) निःसर्ग हुँदाका बखत अनुसूची- २ को दफा ४ बमोजिम समूहको घट्दो प्रणालीको बाँकी मूल्य बराबरको रकम त्यस्तो निःसर्ग बापत प्राप्त गरेको मानिनेछ, र
(२) उपखण्ड (१) मा उल्लेख भए बराबरको रकम सम्पत्ति प्राप्त गर्ने व्यक्तिको लागत परेको मानिनेछ ।
(ग) दायित्वको निःसर्गको हकमा,-
(१) निःसर्गको तत्काल अघि त्यस्तो दायित्वको बजार मूल्य र खुद आम्दानीमध्ये जुन घटी हुन्छ सो बराबरको रकम निःसर्ग बापत सो व्यक्तिको लागत परेको मानिनेछ, र
(२) उपखण्ड (१) मा उल्लेख भए बराबरको रकम दायित्व बहन गर्ने व्यक्तिले त्यस्तो दायित्व बहन गरे बापत प्राप्त गरेको मानिनेछ ।
(घ) व्यवसाय गाभ्ने निकाय वा गाभिएर कायम भएको निकायले गाभिएको सम्पत्ति र दायित्वको लागत गणना गर्दा गाभिने निकायबाट त्यस्तो गाभिएको व्यवसाय सञ्चालन गरेका बखत (मर्जर वा एक्यूजिशन अगाडि) कायम रहेका सम्पत्ति र दायित्व बापतको लागत मात्र खण्ड (क), (ख) र (ग) बमोजिम गणना गर्नु पर्नेछ ।

(३) उपदफा (१) बमोजिम गाभिई निःसर्ग भएको निकायमा वा गाभिए पश्चातको निकायमा कार्यरत कर्मचारीहरूलाई सामूहिक रूपमा सेवाबाट अवकाश दिने प्रयोजनको लागि गरिने थप एकमुष्ट भुक्तानीमा (अवकाश कोष मार्फत गरिने भुक्तानी वा कर्मचारी सेवा शर्तमा उल्लेख भए अनुसार गर्नु पर्ने भुक्तानी बाहेकका) अवकाश भुक्तानीमा कर कट्टी गर्नु पर्ने दरमा पचास प्रतिशत छुट दिई भुक्तानीमा कर कट्टी गर्नु पर्नेछ ।

(४) उपदफा (१) बमोजिम गाभिई निःसर्ग भएको निकायमा कायम रहेका शेयरधनीहरूले आफ्नो शेयर गाभिएको दुई वर्षभित्र आफ्नो शेयर बिक्रीको माध्यमबाट निःसर्ग गरेमा त्यसरी निःसर्ग भएको शेयरमा भएको लाभमा पुँजीगत लाभ कर लाग्ने छैन ।

(५) उपदफा (१) बमोजिम गाभिई निःसर्ग भएको निकायले गाभिएको मितिले दुई वर्षभित्र गाभिएको अवस्थामा कायम रहेको शेयरधनीलाई वितरण गरेको लाभांशमा कर लाग्ने छैन ।

(६) उपदफा (१) अनुसार गाभिई [निःसर्ग हुन चाहने एकै वर्गका निकायले संवत २०७९ साल असार मसान्तभित्र] [2] गाभिने आशयपत्र आन्तरिक राजस्व विभागमा दिनु पर्नेछ ।

(७) उपदफा (१) बमोजिम गाभिनको लागि उपदफा (६) बमोजिम आशयपत्र दिने निकायहरूले गाभिने प्रक्रिया [संवत २०८० साल असार मसान्तभित्र] [3] पूरा गर्नु पर्नेछ ।

[(८) यो दफा प्रारम्भ भएपछि एकआपसमा गाभिई यस दफा बमोजिमको सुविधा उपयोग नगरेका निकायले समेत यसै बमोजिमको सुविधा उपयोग गर्न पाउनेछन् ।] [4]

[(९) उपदफा (६) मा तोकिएको अवधिभित्र आशयपत्र नदिने निकाय तथा उपदफा (७) मा उल्लेख भएको मितिसम्म गाभिने प्रक्रिया पूरा नगरेको निकायको हकमा यो दफाको व्यवस्था लागू भएको मानिने छैन ।] [5]

[1] आर्थिक ऐन, २०६७ द्वारा थप भई त्यसपछिका आर्थिक ऐनबाट संशोधन सहित निरन्तरता कायम भएकोमा आर्थिक ऐन, २०७५ द्वारा संशोधन कायम भएको ।
[2] आर्थिक अध्यादेश, २०७८ द्वारा (“निकायले निःसर्ग हुन चाहने निकायले संवत् २०७८ साल असार मसान्तभित्र” भन्ने शब्दहरुको सट्टामा) संशोधन भएकोमा आर्थिक ऐन, २०७८ द्वारा संशोधन कायम ।
[3] आर्थिक अध्यादेश, २०७८ द्वारा (संशोधन अघि “संवत् २०७९ साल असार मसान्तभित्र” भन्ने शब्दहरु रहेका) संशोधन भएकोमा आर्थिक ऐन, २०७८ द्वारा संशोधन कायम । यो व्यवस्था आर्थिक ऐन, २०६८ देखि निरन्तर रुपमा संशोधन हुँदै २०८० सालसम्मको लागि कायम भएको ।
[4] आर्थिक ऐन, २०७१ द्वारा संशोधित । साविकमा हालको उपदफा (९) को व्यवस्था रहेको ।
[5] आर्थिक ऐन, २०७१ द्वारा थप कायम । साविकमा हालको उपदफा (८) मा रहेको ।

The law provision from Income Tax Act, 2058 Section 47Ka above is related to the special provision on the disposal of assets and liabilities resulting from the merger of businesses in the banking and insurance sector. Here is an elaboration of the key points:

According to this provision, in the case of mergers or acquisitions involving entities of the same nature engaged in banking, financial, or insurance business, certain provisions of Section 57 and its sub-sections related to taxation shall not apply.
If there is any remaining loss of the entity that ceased to exist due to the merger and couldn’t be deducted, such loss shall be deducted proportionately over the upcoming seven years. However, if the entity deducting the loss is subsequently divided before the complete deduction of the loss, the tax shall be paid on the amount deducted for such loss based on the prevailing tax rate at the time of the merger or acquisition.
Regarding the disposal of property and liability during the merger, specific rules are outlined:
1. For stock-in-trade and business assets, the amount equal to the net expenses for the property immediately before the disposal shall be deemed received by the disposing party, and the acquiring party is deemed to have spent the same amount.
2. In the case of depreciable property, the remaining value based on the written down group depreciation system specified in Schedule 2 at the time of disposal shall be deemed received by the disposing party, and the acquiring party is deemed to have spent the same amount.
3. Regarding the disposal of liabilities, the amount equal to the market value or net income of the liability, whichever is lesser, shall be deemed spent by the disposing party, and the same amount shall be deemed received by the party assuming the liability.

When an entity is not specifically provided an exemption 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 cases the acquiree entity will obtain the identifiable assets allocated to their respective values based on the proportion of their market values. When a 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 methodical and satisfying too.

Then OAG published its benighted comment

The 58th, 58th and 60th annual report of the Office of the Auditor general raised an audit comment that the entities in banking and insurance industry undergoing the mergers were not being subjected to the asset and liabilities disposal taxes under Chapter 8 of the Income Tax Act, 2058. The specific comments were as per below:

58th Annual Report

59th Annual Report

60th Annual Report

58th Annual Report

59th Annual Report

60th Annual Report

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 acquired entities 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 a tax perspective. The view from the 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, IFRS 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 was not correct.

Did IRD “gave in” to OAG?

As explained above – the intention of the introduction of this provision, the logic of transfer of losses of the acquiree entity and the non recognition of the accounting profit quite comprehensively and clearly explains the meaning of the Section 47Ka. This was quite clear to start with. But instead of responding to the OAG’s benighted taxation logic – the bill was introduced in the parliament.

What we are suggesting is that the transfer of losses from the acquired entity and the non-recognition of accounting profit were logical and well-understood from the beginning. However, rather than addressing the taxation logic presented by the OAG, the matter was taken in the form of a finance bill “retrospectively repealing” the provision of Section 47Ka (and oh how we all agree, the finance bills “do” get discussed in parliament of Nepal). This is an implication that the response to the OAG’s perspective on taxation was not directly addressed or taken into consideration. Instead, the issue was escalated to the legislative body for further deliberation and decision-making. I used the term “benighted taxation logic” to suggest that the OAG’s viewpoint on taxation of accounting profit, while specific relief exists under Section 47Ka, may have been perceived as lacking understanding or being misguided.

However, the reliefs under Section 47Ka still didn’t extend to the taxes that applied 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 applied to the 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 the 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

Finally, Did Finance Bill 2080 retrospectively repeal Section 47Ka? We Don’t Know

Finance Minister Prakash Sharan Mahat presented the Nepal budget 2080/81 and Finance Bill 2080 in a joint meeting of the House of Representatives and the National Assembly in Kathmandu, on Monday, 2080.02.15. Here we will look particularly into the Section 27 of the bill:

Here is what Section 27 of the Finance Bill 2080 provides:
२७. मर्जर वा एक्विजिसनको लाभमा लाग्ने करमा शुल्क र ब्याज मिनाहा सम्बन्धी विशेष व्यवस्थाः निकायहरु आपसमा गाभिदा वा प्राप्ति (मर्जर वा एक्विजिसन) मा सौदाबाजी गर्दा प्राप्त लाभ (बार्गेन पर्चेज गेन) बापतको आयलाई कर प्रयोजनको लागि आयमा समावेश गरी कर दाखिल नगरेको भए आर्थिक वर्ष २०७८/७९ सम्मको त्यस्तो आयमा लाग्ने कर संवत् २०८० साल मंसिर मसान्तभित्र दाखिल गरेमा सोमा लाग्ने शुल्क तथा ब्याज मिनाहा हुनेछ।

Now here are a few things: Section 27 of Finance Bill 2080 doesn’t specifically retrospectively / repeal Section 47Ka, it still stands the same Section 47Ka in the Income Tax Act, 2058. Section 27 of the Finance Bill doesn’t specifically mention the “banking, finance or insurance sector”. So there effectively is no change in the implication and benefits of Section 47Ka. But then, why was this specific Section 27 introduced? Was this the development led by the comments of OAG regarding the “non-collection of taxes” under Section 47Ka or something else? If something else – who does this provision apply to? We don’t hear much about the mergers and restructuring arrangement other than in the banking and insurance industries and even if there was, there already is a robust mechanism for taxation on disposal of assets and liabilities, so why is this Section 27 introduced? Is it a ploy to retrospectively in-effectuate the provision of Section 47Ka? Well that is one valid fear. We are not new to seeing tax amnesties being introduced before the amendment in laws.

Our esteemed BND also shares the same fear:

मर्जरको कानूनको सुविधा शुरुदेखि नै खारेज । बैंक डुब्ने हैनन्?
— दाहाल (@BhavaNathDahal) May 29, 2023

आयकर ऐनको दफा ४७क को सुविधा पहिलो मितिबाटै अर्थात २०६७ मंशिर ४ देखि लागु हुने गरी खारेज भएछ । दफा ५६(३) चाँही २०५८ चैत्र १९ देखि लागु हुने गरी संशोधन पो भएछ ।
— दाहाल (@BhavaNathDahal) May 29, 2023

If this actually is a retrospective “repeal” of the provision under Section 47Ka it raises legal concerns, particularly regarding the principles of legality and the doctrine of legitimate expectations. Tax laws are typically governed by the principle of legality, which states that individuals and businesses should have certainty and predictability regarding their tax obligations. Retrospectively repealing a tax provision undermines this principle by altering the tax consequences of past transactions. It introduces uncertainty and disrupts the legitimate expectations of taxpayers who had relied on the law as it stood at the time of the merger. The doctrine of legitimate expectations is rooted in fairness and the idea that individuals should be able to rely on government representations and assurances. In this case, banks and insurance companies may have entered into mergers, taking into account the “non-taxable” or “non-recognition rule” status of the disposal of assets and liabilities as provided by the law. Retrospectively repealing this provision frustrates the legitimate expectations of these entities, as they reasonably relied on the law when making decisions.

Also, in general, retroactive legislation, particularly in the realm of taxation, is disfavored. Retroactively changing tax laws creates uncertainty and disrupts the settled expectations of taxpayers. It is often seen as unfair and inconsistent with principles of legal stability and predictability.

And let’s not forget, financial institutions are not exactly your sweet little sisters who bake you cookies. No, no! They are sharks and “harams” running after your money. But hey, even in the wild world, everyone deserves the right to have legitimate expectations under the law.

Well, let’s end and wrap up this seemingly never-ending discussion. View my some other related topics:

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