What is the Contention Surrounding New Taxation Provisions for FPO Premium and M&A Gains ?

Government Intervenes in Tax Controversy Surrounding FPO Premium and Merger Gains: Public Companies and Shareholders Express Concerns over New Tax Provisions

In a significant development, the government has intervened in a long-standing conflict between the Office of the Auditor General and the Inland Revenue Department (IRD) regarding the taxation of premium amounts from Follow-on/Further Public Offerings (FPOs) and profits gained through mergers and acquisitions. The Economic Bill, 2080 has introduced provisions to collect income tax on bonus shares distributed from FPO proceeds and on the gains obtained during merger and acquisition transactions.

Previously, public companies such as banks, insurance companies, and hydroelectricity firms were not required to pay taxes on such profits. However, the Auditor General's office has consistently argued that these profits should be subject to taxation. The conflict between the two entities has resulted in a significant tax liability, with an outstanding amount of Rs. 6.80 Arba for FPO and auction share premiums and an additional Rs. 7.10 Arba for merger and acquisition gains, as per the statistics of the Auditor's General Office. The total tax recovery under these two categories amounts to 13 Arba 90 crores and 64 lakhs.

The government's decision to address this issue through the economic bill has raised concerns among affected companies and shareholders. They argue that premiums and bargain purchase gains during the merger/acquisition process are not considered profits but rather investments, and therefore, should not be subject to taxation. Banks, financial institutions, insurance companies, and hydropower firms have consistently maintained this position. Despite the Auditor General's office advocating for tax collection, the IRD has been unable to enforce the tax.

The 57th report of the Auditor General emphasized the need to collect income tax on dividends derived from FPO premiums and auction shares, citing relevant provisions in the Income Tax Act, 2058. Similarly, section 9(2)(g) of the Act states that profits and gains from business operations should include amounts specified in section 56. However, the Internal Revenue Department chose not to levy taxes on such income, referring to the income tax guidelines that indicated share premiums should not be considered part of the entity's income.

Director General of the Inland Revenue Department (IRD), Dirgha Raj Mainali, has recently stated that the previous decision was revoked as it was found to be unlawful. He clarified that regulations, guidelines, and circulars contradicting the law have been invalidated, including the letter that influenced the decision at the time.

While the government insists that there is no alternative to paying taxes, stakeholders such as the Nepal Bankers Association (NBA) challenge the tax liability based on the interpretation of the Income Tax Act 2058. They argue that the premium and bargain purchase gains are not taxable income. The association asserts that since tax and profit tax have already been paid by beneficiaries when receiving bonus shares, collecting tax again on the same amount goes against the law. They express concerns that imposing taxes on these gains could discourage mergers and acquisitions and deem it unfair to retroactively demand tax payment from companies that had previously received certificates of tax clearance. 'It is contradictory to enourage mergers on the one hand and to tax bargain gains on share swap ratios on the other hand," Sunil KC, President of the Nepal Bankers Association and CEO of NMB bank was quoted as expressing the opinion.  

The spokesperson for Nepal Rastra Bank, Dr. Gunakar Bhatt, was quoted as clarifying that the final approval of mergers will be granted only after paying the specified taxes in accordance with merger regulations. He emphasized that the decision to levy any special  tax matters falls outside the jurisdiction of the central bank.

As the government's economic bill seeks to resolve the controversy surrounding FPO premiums and merger gains, public companies and shareholders anxiously await the outcome, concerned about the potential financial impact and its implications for future business transactions.