Understanding Section 57 (We CAN) PDF

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Section 57 of Income Tax Act 2058, Nepal...

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Understanding Section 57 Perspective of Tax Authority, Tax Payer and Investor Back grownd of Section 57 The person owning 50% (or more) in any entity controls the entity significantly. They get the benefit on disposal of asset and/or liability of such entity significantly. Transfer of such control without disposing the asset and/or liabity may be considered for tax arbitrage. If the assets (and liability) is transferred instead of transfering control; the enity would have to pay tax on gain and/or set-off the unused tax loss of the entity, if any. The intention of tax authority is to realise tax such gain from the entity upfront considering as it the entity has actually disposed its asset and liability at the time of change in control. This tends to recognize the fair value measurement of accounting standard (NFRS) at least at the time of transfer of ownership. Provision in the law (Section 57: Change in Control) (1)

Where there is a change of 50% or more in the ownership of an entity as compared with its ownership 3 years previously, the entity shall be treated as disposing off any assets owned by it and any liabilities owed by it.

(1a) For the purpose of computing change in ownership of 50% or more the change in ownership of the entity, only following ownership shall be considered: (a)

Change of ownership where the ownership holding is more than 1%

(b)

Change in ownership where the ownership holding is less than 1% but the owners are related to the person holding more than 1% ownership in total ownership of the entity. [this exclude the changes of ownership where each owner holds not more than 1% of ownership and not related person, with effect from Shrawan 2060]

(2)

Where there is a change in ownership of the type referred to in subsection (1), after the change the entity is not permitted to(a)

deduct interest carried forward under section 14(3) that was incurred by the entity prior to the change [Sec 14.3 refers interest paid to controlling person and/or related person];

(b)

deduct a loss under section 20 that was incurred by the entity prior to the change [this refers the unabsorbed loss of an income year, which is available for carry-forward for a period of 12 years in the case of manufacturing (other than cigarette, liquor, etc.) industry and in other case 7 years];

(c)

carry back a loss under section 20(4) that is incurred after the change to an income-year occurring before the change [this refers to the loss of

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long-term contract under global tender; where the loss may be carried back and set-off against the profit of previous year’s and claim tax refund];

(3)

(d)

in a case where the entity accounted for an amount or expense in terms of section 24(4) prior to the change and after that change the amount or expense is corrected in terms of section 24(4), make the adjustments referred to in section 24(4) [this refers to the exchange loss on FX asset/liability of the eneity prior to change in control];

(e)

in a case where the entity accounted for an amount in terms of section 25(1)(b) prior to the change and after that change the entity disclaims an entitlement to receive the a mount or, in the case where the amount constitutes a debt claim of the person, the person writes -off the debt as bad, make the adjustments referred to in section 25(1) [write-off of receiceivable, debt claim related to the period prior to the change of control is dereognised but no restriction in LLP for BFI and write-off by legal recources];

(f)

reduce under section 36 gains from the disposal of assets or liabilities after the change by losses incurred on the disposal of assets or liabilities before the change [this refers to the loss on disposal of non-business chargeable asset and liability];

(g)

in a case where the entity accounted for a premium in terms of section 60(2)(b)(1) prior to the change and the entity after that change returns the premium to the insured, claim a deduction under that provision [this refers or refund of insurance premium for the policy related to the period prior to the change of control]; or

(h)

carry forward foreign income tax under section 71(3) that is paid with respect to foreign income prior to the change [this refers to the unused foreign tax credit prior to the change of control].

Where there is a change in ownership of the type referred to in subsection (1) during the income-year of an entity, the parts of the income-year before and after the change in ownership are treated as separate income years. [Accordingly there shall be two income year in one financial year; first – from the first day of financial year till the date of change of ownership, and second – from the next day of change of ownership to the last day of financial year]

Directive Issued by IRD: 13.10.3 Disposal of Assets & Liabilities: If a change of ownership of 50% or more is made in any entity during a three years period (Moving 3 years), the entity shall be deemed to have made a disposal-off its assets and liabilities. Above provision may be clarified through given below example:

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Example: 13.10.4: Danfe Company Pvt. Ltd. has had a change in its change of ownership by 50 % on 2062 Chaitra 15. The company had the following assets and liabilities as on the date: Statement of Assets and Liabilities as on 2062 Chaitra 15

Share Capital Reserve

Capital & Liabilities Book Value Market Value 10,000,000 10,000,000

Other Liabilities

3,000,000

3,000,000

4,500,000

4,500,000

Gain from Disposal Total

17,500,000

Assets Book Value Closing Balance Depreciable Assets Pool “A” Land

Other Investment Cash Balance Bank Balance 4,350,000 Foreign Currency Balance 21,850,000 Total

500,000

Market Value 600,000

400,000

600,000

10,000,000

15,000,000

5,000,000

4,000,000

100,000

1,000,000

1,000,000

1,000,000

500,000

550,000

17,500,000

21,850,000

As per Section 57 of Income Tax Act, 2058, Danfe Company Pvt. Ltd. shall be deemed to have changed its ownership as on 2062 Chaitra 15 and hence shall be deemed to have disposed its Trading Stock, Depreciable Assets, Land, Investment, Foreign Currency Account as on such date. Gain or loss on such disposal shall be calculated on the Market Value as on such date and such gain or loss shall form part of taxable income of the entity.

Illustrations of change in control: Illustration 1: Triggering of Sec 57 X Ltd. has the following shareholding as of Ashd end, 2073:     

Mr. Mr. Mr. Mr. Mr.

A – 15% B – 55% C – 10% D – 5% E – 15%

The following changes take place in the ownership   

“Mr. A” transferred his entire share (15%) to “Mr. F” on Poush 1, 2073 “Mr. B” transferred 25% shares in X Ltd. to “Mr. G” on Mangsir 1, 2074 “Mr. C” transferred his entire share (10%) to “Mr. G” on Ashwin 21, 2076

First transfer took place on Poush 1, 2073 and till Ashwin 21, 2076, 50% ownership of “X Ltd.” have been transferred. Hence Sec 57 shall apply on Ashwin 21, 2076. In such

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case Shrawan 1, 2076 to Ashwin 21, 2076 shall be one income year and Ashwin 22, 2076 to Ashad 31, 2077 shall be another income year in the FY 2076/77. Accordingly “X Ltd.” requires submitting first tax return with Poush 20, 2076 (three months from Ashwin 21, 2076) and second tax return shall be submitted by Ashwin-end 2077.

Illustration-2: Impact of change in ownership Assuming change in control took place in Chaitra 30, 2076 and the follwoings are the information as at Chaitra 30, 2076; a. b. c. d.

net income of the company - 5,000; depreciable fixed asset - 1,000 non-depreciable asset (land) – 2,000 market value of depreciable asset – 1,200

e. market value of non-depreciable asset – 2,500 The target company has to submit tax return by Ashad end 2077. In such return taxable income shall be computed as below: i. ii. iii. iv.

net income as above (a) – 5,000 add: Gain on deemed disposal of asset (d+e)-(b+c) – 700 total taxable income (i+ii) – 5,700 No depreciation claimable as the asset is deemed to have been dispossed

Resulting value of asset for tax accounting will be the market value and depreciation is chargeable in the assumed market value. Accordingly while submitting the tax return for the period from Baishakh 2077 to Ashad end 2077 depreciation is chargeable on new value of asset (i.e., 1,200). Subsequent change in control happened in in Poush 15, 2077. The gain on disposal of fixed asset shall be computed in the following manners: Gain on deemed disposal of depreciable asset: a. Cost of acquisition i. Market value of asset at the time of change of control in Chaitra 30, 2076 [i.e., 1,200] ii. Add: new purchases from Baishakh 2077 to Ashad-end 2077 iii. Less: disposal from Baishakh 2077 to Ashad-end 2077 iv. Less: depreciation for the period from Baishakh 2077 to Ashad-end 2077 v. Add: new purchases from Shrawan 2077 to Poush 15, 2077 vi. Less: disposal from Shrawan 2077 to Poush 15, 2077 b. Market value of asset as at Poush 15, 2077 c. Gain on deemed disposal = b-a Gain on deemed disposal of non-depreciable asset: a. Cost of acquisition i. Market value of asset at the time of change of control in Chaitra 30, 2076 [i.e., 2,500] ii. Add: new purchases from Baishakh 2077 to Poush 15, 2077 iii. Less: disposal from Baishakh 2077 to Poush 15, 2077

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b. Market value of asset as at Poush 15, 2077 c. Gain on deemed disposal = b-a Concept of valuation for sec 57

As per sec 57(1); where there is a change of 50% or more in the ownership of an entity as compared with its ownership 3 years previously, the entity shall be treated as disposing off any assets owned by it and any liabilities owed by it. And hence the enetity is required to consider market value of its asset and liability. Market value of asset and liability is equity valuation or not the value considered by the investors for transfer of share. The IRO may question the valuation, if the value offered for tax purpose does not reflaect the market value of asset and liability of the entity. Applicability of extension for the submission of tax return The Act refers submission of return for Income Year and not Finacial year. Where sec 57 is applied return is submitted u/s 96(1) and hence the taxpayer may request for extension of time u/s 98. General expection of investor Section 57 does not recognize the concept of corporate veil – where the owners of the entity is treated separately from the entity. Application of sec 57 is way of taxing twice in the same transaction; one on cpital gian on disposal of interest in the entity (paid by the owner) and second on gain on deemed disposal of asset and liabilities of the enity (paid by the target entity). Where the other owners of the entity also suffere as the target entity requires paying tax on unrelaised gain. This is also not practical in the case of transmission of share due to death of owner, family separation or any other similar activities amongst the owner controlling the entity. This also disclurages the merger and acquisition process. For developing cometativeness business combination by way of merger and acquisition is the need of current economy. Hence sec 57 either should be removed or made inaffective in the case of transmission of ownership and M&A.

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