Amendment of Section 57 of Income Tax Act Risks Loss of Capital Gains Tax by the Government

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Amendment of Section 57 of Income Tax Act Risks Loss of Capital Gains Tax by the Government


KATHMANDU: Experts have warned that recent changes to the Income Tax Act may increase the risk of evasion of capital gains tax. The government has amended the current arrangement regarding ownership through the Financial Act for the next fiscal year (FY 2081/82). A restrictive phrase has been added to Subsection (1) of Section 57 of the Income Tax Act 2058. This new provision states that ownership changes due to the addition of capital from partners do not constitute a change in ownership.

The newly added restrictive phrase specifies, "However, the provisions of this subsection shall not apply when the number of shares and capital of the former shareholders and partners remain the same, and new shareholders and partners are added, resulting in increased capital."

Previously, a company with more than 50 percent ownership change had to pay up to 25 percent tax on the profit. According to the new system, increasing a company’s capital through investment does not incur profit tax as per Section 57.

Although the government claims this change is to encourage investment, experts believe it might be misused. They warn that a small initial investment in a highly valuable company could lead to significant ownership changes without tax liability later, taking advantage of this provision.

Former minister and finance secretary Bidyadhar Mallik illustrated this risk with the example of TeliaSonera’s investment in Ncell. Despite a limited initial investment, the high valuation of Ncell resulted in substantial capital gains tax when sold to the Malaysian company Axiata. When TeliaSonera transferred Ncell's ownership to Axiata in 2072, the company was valued at $1.37 billion. TeliaSonera was supposed to pay 25 percent tax on the profit, but due to non-payment, Axiata had to pay Rs 47 billion in fines and interest.

A senior official from the Inland Revenue Department, who preferred not to be named, expressed concerns about potential losses to the government. They acknowledged that while the government could monitor the arrangement and amend it if misused, the risk remains significant.

Mallik emphasized that the new provision allows new investors to invest significantly in a company without triggering capital gains tax for the original owners, even if their shares become a minority. This means a private company owner could avoid paying capital gains tax when ownership changes through new investments.

A former director general of the Inland Revenue Department suggested that this new provision might enable internal share sales without paying taxes.

Officials from the Ministry of Finance, however, claim that the amendment was made with good intentions. Dhaniram Sharma, Head of the Revenue Division, explained that if a company's paid-up capital is Rs 100 and another person invests an additional Rs 200, no tax will be charged on the profit. This concession is designed to encourage capital increases for business expansion.

The finance minister also stated in a press conference that the new arrangement would benefit startups, venture capital, and private equity funds, particularly by alleviating tax burdens during significant investments in startups.

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