Introduction
What is share premium?
The amount by which the amount received by a company for a stock issue exceeds its face value. In most corporate capital increases, where new shares are issued the company usually determines the selling price, adding an additional sum to the nominal value of the shares. The difference between the nominal value and the selling price of the shares is known as the share premium.
Why are share issued in premium? The purpose behind it.
The reason that a company issues its shares at a premium is that their market value is usually higher than their par value, since the latter is typically set at a minimum value. However, the real function of the share premium is to ensure that the selling price of the shares is consistent with their real market value. This prevents new shareholders from reaping undue benefits from the higher value of the shares, which is derived mainly from the activities of existing shareholders in developing the business. Thus, one of the purposes of the share premium is to balance the position between new and old shareholders.
If new shareholders were allowed to acquire new shares at par value, they would be able to take advantage of the net assets or equity of the company, which includes available reserves accrued by the old shareholders (eg, through total or partial dividend waivers, allowing profits to be reinvested the company, rather than distributed).
Nature of receipt of share premium
In further public offerings additional capital is injected into the company in the form of face value of shares and share premium associated with it. Hence, the entire amount (face value + share premium) is the capital contribution made by the new shareholders into the company. Face value and Share premium amount during the FPO represents the amount paid in by new shareholders to acquire the right to participate in the existing capital, existing reserves and future profits of the company. Hence, it can be wisely established that the entire amount is the amount od capital contribution.
How are shares issued in premium in Nepal?
Section 29 of Companies Act 2064 provides provision relating to issuing shares in premium in Nepal.
Definition
Section 2(La): “Premium share” means a share so issued by a company as to sell it for a value in excess of its face value.
Conditions
- Section 29(1): With prior approval of the Office, companies with positive net worth may issue shares at premium by adopting a resolution at the general meeting. However, public companies permitted to publicly issue securities under the Securities Act may issue shares at a premium in accordance with the Securities Act.
- Section 29(4): In making a request for approval of the Office to issue shares at a premium pursuant to Section 29(1), the audited financial statements for 3 years shall be provided to the Office.
Share premium account
Section 29(2): Where the shares are sold at a premium pursuant to Section 29(1), a sum in excess of the face value, out of the proceeds thereof, shall be deposited in a premium account to be opened to that effect.
Utilization of Share premium account
Section 29(3): The company may use the moneys in the account as referred to in Section 29(2) in the following acts:
- Paying up unissued share capital to be issued to the shareholders as fully paid bonus shares,
- Providing for the premium payable on redemption of any redeemable preference shares,
- Writing off the preliminary expenses made by the company,
- Bearing or reimbursing the expenses of, or the commission paid or discount allowed on, any issue of shares of the company.
Taxation of Share Premium
At the point of issue of shares
The amount of equity injected in public offering along with share premium is received as a capital contribution. However, if the price of public offering exceeds the prevailing market price of the shares, it essentially is a non-market transfer.
Non-market transfers that are received
♦ without consideration being paid, or
♦ with payment of consideration but whose market value exceeds the market value of the consideration being paid
are subject to inclusion as per Section 7(2)(e) or Section 7(2)(h) of Income Tax Act 2052.
Any excess capital contributions (face value + share premium) received above the MV should be included in incomings of the entity and will be subject to taxation as per the Income Tax Act 2058.
How is the market value for the purpose of taxation determined?
Section 2(sSha): Market value of an asset and services denotes the normal buying and selling price for the asset or services in the ordinary course of a business amongst unrelated parties.
For listed shares, the prevailing market trading price before the public offering is considered to be the best estimate of the market value.
MV = Trading Price
For unlisted shares, under NOPAT approach
MV = NOPAT × [Price to NOPAT Multiple of Similar Listed Companies] – Debt Adjustment
These principles of MV based assessment are not actually provided in the Income Tax Act but the authorities can take dissenting view in this regard. When the fog around the taxability of share premium clears, anti-abuse provisions such as these could be relevant to actually come to the mid-point of the differing opinions between Office of Auditor General and the tax practitioners. Here is the link to ACAN’s assessment on the taxation of the share premium.
The differing views thus ranges from (i) share premium being an income to the entity to (ii) share premium is a capital contribution so not an income to the entity. The market value view above is just a example of coming to a midpoint of both the view – so that neither the capital contributors can abuse the provision nor the tax authorities can collect unjustified taxes in capital contributions.
At the point of capitalization or writing off share premium amount
It is understood that share premium is not created out of profit of the company but it is collected as part of capital. When it is not created out of profit, it cannot be treated as distribution of profit or capitalization of profit. Hence it cannot be treated as distribution made by the entity under Section 53(1) of Income Tax Act 2058 and further it cannot be treated as distribution of dividend under Section 53(4) of the Act. Hence no tax is applicable even at the time of capitalization or writing off the share premium amount.
However, in cases where the any excess capital contribution (face value + share premium) is received above the MV which is included in incomings of the entity (as per the MV concept discussed above), the distribution of such incomings will be treated as distribution of profit as per Section 53(4). Dividend taxes as per Income Tax Act 2058 will be applicable in such distribution of profit.
A caveat from Income Tax Manual
From Income Tax Manual: Chapter 13
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 । ऐन र नियमावलीका 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 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 बापत 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 बढी 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 खर्च शोधभर्ना गर्न प्रयोग भएको हो सोही आय वर्षमा सो कम्पनी वा निकायको आयमा समावेश गर्नु पर्दछ ।
So Income Tax Manual has considered Share Premium as Income?
Share premium is not an income to a company. Share premium is simply a capital contribution made by the new shareholders.
An incoming shareholder doesn’t bring profits with him into a company. He injects capital. That capital is utilized to generate profits in future, which is subject to taxation. The taxation of share premium (other than those received in non-market terms, like discussed above) is a taxation on capital investment.
However, Income Tax Manual Nepal has provided that “ऐन र नियमावलीको 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 ।” and has considered share premium to be an income of the entity. Share premium has no bearing on income of entity. It doesn’t fit the meaning of income.
What is income?
Income is an increases in assets or decreases in liabilities that result in increases in equity, other than those relating to contributions from holders of equity claims.
What is contribution from holder of equity claims? It’s equity. What is equity?
Equity is the residual interest in the assets of the entity after deducting all its liabilities.
We know that share premium reflects a residual interest. Just imagine a case where company liquidates. Share premium also reflects the equity’s interest at the point of liquidation but it is not a earnings of a company, so by definition it is a capital contribution.
Let's dumb it waaaay down ! Just in case.
Let’s say a company has a paid up capital of CU 100,000 (CU 100/Unit) and reserves of CU 100,000. It capitalized the reserves and paid applicable dividend taxes and the share capital became CU 200,000 (CU 100/Unit). The company then decided to alter the Face Value of the shares from CU 100 to CU 200. Then the total units of shares becomes 1,000 units from 2,000 units. This all arrangement is very much doable from Companies Law perspective.
With this change in face value, the CU 200/Unit now represents the actual market value of the shares and there is no need to issue share at premium as face value of the share is equal to the market value. So in this case, share premium amount that needs to be accounted that would have been accounted had the company issued shares before the change in face value of the shares.