If government doesn’t implement scientific taxation system then future of Nepali capital market looks grim; see each scenario why this system is illogical

-Yogesh Raj Niroula

Every Nepali Stock Investors are spooked and angry about the Capital Gain Tax policy introduced by Internal Revenue Department (IRD) on Sunday 3^rd June, 2018 as per the letter received by NEPSE which was published on the official website. When the Budget for the fiscal year 2075/76 was being announced, majority of the Investors were anticipating reforms and new policies that could have strengthened the Capital Market of Nepal. Instead, all the Investors were slapped will 50% increment in CGT in already ailing market where majority of Investors are in loss due to the bearish market.

Similarly, another subject of interest is that companies and industries with current paid up capital of 1 billion are being forced to issue stock to general public which might scare away the companies and industries who do not want to go public or will be reluctant to form capital more than the threshold. This might reverse what had been anticipated and lower our growth.

Since, this is the case of recent circular from IRD regarding CGT on right and bonus shares with base rate for tax calculation taken as par value of the concerned company’s shares; few calculations, facts and contemplation shall be the main focus. Capital Gain Tax’s definition as provided by Oxford Dictionary states “A tax levied on profit from the sale of property or an investment.” Similar definition is provided by IRD of Nepal in their published Tax Laws. The purpose of the definition is to stress on the fact that the Tax is to be paid only if there is gains made on Capital and the recent provision of CGT on right and bonus shares has defied the very foundation on which CGT is based.

IRD officials were already terrorizing the Capital Market with VAT previous to the Budget announcement which was cleared. However they threw terror card again onto the Capital Market with their scheming act of CGT on right and bonus shares which has made Investors angry and resulted in strike until the circular is called off. This very act of IRD operating under the Ministry of Finance, Nepal has created doubt among the general public with only one question “Have we left the economy of Nepal in incapable hands and ignorant minds?”

Right and Bonus Shares are popular medium to collect additional capital from the capital market for various purposes whether it is to expand the business or to meet regulatory requirements. In recent trend of Nepal’s capital market almost every NEPSE listed companies had to issue right and bonus shares to meet the regulatory requirements imposed by our Central Bank and Insurance Board. Even if there is no regulatory authority for hydropower sector, the hydropower companies jumped in the bandwagon to issue right and bonus shares to clinch capital from the already squeezed market. The effects of such short-term vision of the regulatory bodies has been seen through the rising interest rates jeopardizing the ability to pay the liabilities by many borrowers. Perhaps, someday the delinquencies will shoot through the roof, the bubble will burst and the borrowers filing for bankruptcies hope that doesn’t happen. Almost everyone has been feeling the wrath of inflation and is worried how to manage the living costs. Some Investors are being haunted with the thought of managing their margin calls and interest payments, while some are unable to deposit the call money for right shares because of which their shares are being sold off in auction ultimately reducing their stake in the company they helped build in the first place. There are so many untold and unheard stories built upon the foundation of the forceful rules and regulations yet they keep on coming without any ethics and vision and the recent CGT provision has made me spill the words which didn’t show up when I first heard “yo aile samma ko baliyo sarkar ho!”, a hint of fear passed through me and I gulped because I love the idea of freedom rather than anything else in this world.

The calculation of how an investor will be facing losses is all over the internet and most investors are aware of it but there are few more calculations that hasn’t showed up yet as I try to unravel them.

Scenario 1: Low priced stock vs High priced stock.

Suppose, an Investor had investable funds in his bank account and decided to enter stock market. Since he had heard that accumulating right shares and bonus shares is the highway to increasing his capital, he decides to buy 500 shares of low priced stock @300  and 100 shares of high priced stock @1500 both issuing 50% right shares making 150,000 invested as initial capital for both stocks. He purchased both scrips before book close date and the table shows how his capital decreases after the calculation of CGT on right shares. Surprisingly, the investor incurs more losses with his high priced stock.

So, higher priced stocks are not favorable and the new provision of CGT doesn’t treat differently priced stocks equally. High priced stocks will be selling off first due to investors trying to protect their capital.

 Scenario 2: Unsubscribed Right Shares.

If we take the same example as in scenario 1, the net worth of the investor will drop after book closure date. So, any rational investor will be wise to sell his shares before book closure rather than accumulating right shares.

The calculation clearly shows how an investor is well off selling their shares before book closure. But the catch is where will the market get the craziest investor who will book losses knowingly? So because of this we will have zero buyers making the market illiquid. Since, the market which works as per the auction theory will start trending downwards in search for buyers. But we have speed breakers in NEPSE at 2% of the current market price and finally at 10% of the previous close annoying the sellers to meet buyers price. The frustration of sellers will eventually make them quit the market forever promising never to return back as they could not sell when they wanted to and protect their capital. The capital market of Nepal shall lose investors day by day as liquidity dries up and turnover turns to almost zero. No company shall be able to raise capital through Nepal’s capital market ever again by issuing right shares. However, bonus shares being declared by the company itself is quite impossible for investors to not want it. But, most probably the Board of Directors will not be willing to declare bonus shares are they are investors themselves as well.

Scenario 3: Companies trading at discount to their net worth.

The bear market fuelled by investor’s dissatisfaction will lead to a very illiquid market where selling one’s shares will be very difficult. Previously, I said “turnover turns to almost zero” because there will be outstanding shares and few investors who would like to exchange shares of different companies or for some other form of gain like influence in company’s decisions rather than capital gain. Maybe some will say this scenario is impossible but look at the already trading scrip like NTC which is quite an illiquid share for big investor and it hovers near about its current net worth. Moreover, look at NAV and trading price of Mutual Funds, there you will see the story of every scrips of NEPSE in near term.

I have made my calculations and based my inferences on it, the consequences that the Nepalese Capital Market will face is depressing if the provision of new CGT law comes into effect. Perhaps, the only stock market of Nepal shall be the true representation of the economy of Nepal in near future. The new and existing companies that have been using right shares as a method of raising more capital will be left with almost all of the issued shares unsubscribed. With the current liquidity crisis looming our money market the unsubscribed shares will go to auction market and still be left unsubscribed. The companies being unable to raise capital to fulfill the regulatory requirements will most probably face fines and punishments weakening the financial status.

In the secondary market, first the stock price of the higher value shares will sell-off while the stock of the companies who dare to issue right and bonus shares will sell-off instantly as Investors will try to protect their capital by selling much earlier. Finally, the financial meltdown of Nepalese capital market will follow with sell-off of companies’ stocks that have already fulfilled the requirements, since the hopes of getting better policies and improvement of capital market from the regulatory authorities and government goes down the drain pipe. The victim will be the investors but the irony is, whole system will blame the innocent investors for speculation.

Disclaimer: I would like to remind you that the data contained in this article is not necessarily real-time nor accurate. All data are for example purpose only and do not necessarily reflect real prices and are taken only for calculation purpose. Please be fully informed regarding the risks and costs associated involved in Stocks and the scenarios are assumed as worst case that can happen but there is no guarantee similar outcome shall happen in realtime.

(The author of this article is an avid investor of Nepal and a keen observer of capital market)