Getting to the crux of Ncell buyout deal

CAN NEPAL IMPOSE CAPITAL GAINS TAX ON NCELL BUYOUT DEAL?

This question has been making rounds ever since TeliaSonera, the largest shareholder in Nepali telecom operator, Ncell, announced its decision to sell 60.4 per cent of its stake in the telecom company to Malaysian giant, Axiata, for $1.03 billion.

Divergent views

One school of thought argues the government should tax the deal, as Nepal stands to generate tens of billions of rupees in revenue, considering Nepal’s capital gains tax rate of 25 per cent.

But the other school of thought says temptation to earn tens of billions of rupees in revenue should not prompt the government to impose the tax because the deal between TeliaSonera and Axiata, two non-Nepali companies, is taking place abroad, and the Income Tax Act does not have clear provisions on offshore deals.

A careless move, this group warns, could sour foreign investor sentiment towards Nepal, which badly needs funds from abroad to meet its development objectives.

TeliaSonera, a telecommunications service provider in the Nordic and Baltic countries, Eurasia and Spain, had entered Nepal in 2008.

Although the company is headquartered in Sweden, its investment in Nepal has been channelled through Norway-based TeliaSonera Norway Nepal.

TeliaSonera Norway Nepal, on the other hand, has 75.45 per cent stake in Reynolds Holdings, a firm registered in Saint Kitts and Nevis in the West Indies.

Another 24.55 per cent stake in Reynolds is held by SEA Telecom Investments BV a company owned by Kazakhstan-based Visor which owns 19.6 per cent of Ncell shares.

This company called Reynolds, in turn, holds 80 per cent stake in Ncell.

As per the ‘conditional sale and purchase agreement’ signed in December, Axiata is buying Reynolds for $1.365 billion. This amount includes payment of $335 million that the Malaysian company has agreed to make to SEA Telecom to acquire its 24.55 per cent stake in Reynolds.

“Since Axiata is not buying Ncell but Reynolds Holdings, which is located in Saint Kitts and Nevis, the government cannot impose tax on the deal,” says Umesh Dhakal, a chartered accountant and former director at the Office of Auditor General.

But others say Reynolds has not made investment in any company, other than Ncell. “This means the underlying asset of Reynolds is located in Nepal.

Since TeliaSonera is making such a huge profit by selling this underlying asset, profit made by the company from the deal should be taxed,” Corporate Lawyer Gandhi Pandit says.

By the book

Section 67 of the Income Tax Act does shed light on income, losses and gains made through foreign sources and says rules apply in proportion to income, losses and gains made in Nepal.

However, Section 6B of the same Act says income generated by a non-resident person from employment, business or investment shall be considered as assessable income, only if the income has a source in Nepal.

“This section makes it clear that Ncell buyout deal cannot be taxed because the income does not have a source in Nepal,” says Dhakal. “In this case, only the assets lie in Nepal, while the source of the income lies in foreign land because the investment has come from abroad.”

Others also point to Section 95A of the Income Tax Act to make a point. This section says natural residents will be levied a tax equivalent to 10 per cent of the gains made through disposal of assets that are not listed on the stock exchange.

This tax rate goes up to 15 per cent in the case of ‘others’, which, as per officials of the Inland Revenue Department (IRD), include foreigners.

But this section solely applies for advance tax declaration purpose and not tax collection, so this section is not relevant in Ncell case.

“Only Sections 67 and 6 of the Act speak about taxing income generated through foreign sources, but the provisions are not crystal clear,” says an IRD official on condition of anonymity. “This provides ample room for both sides to make their own interpretation of the law.”

In tax-related cases where there are confusions, Dhakal says, the benefit of doubt goes to the taxpayer.

However, Pandit does not buy this argument. “If there are confusions, the clause that says tax should be collected prevails because Nepal is not a tax haven,” he says.

Examples from abroad

While this debate is now heating up in Nepal, India had experienced a similar case in 2007.

That case surfaced in May of that year when Vodafone bought 66.98 per cent of Hutchison Telecommunications International (HTI)’s stake in Indian telecom company, Hutchison Essar India, for $11.2 billion.

Like in Ncell’s case, Hutchison had invested in the Indian telecom firm through a firm called CGP Investments registered in Cayman Island, a tax haven like Saint Kitts and Nevis. Vodafone then bought CGP’s shares to gain control of Hutch Essar.

A twist to this story came in August 2007, when the Indian tax authorities suddenly sprung into action and issued a notice to Vodafone seeking to hold it as an ‘assessee-in-default’ for its failure to withhold Indian taxes on payment of the sale consideration to HTI, a report prepared by PricewaterhouseCoopers says.

Vodafone then took the case to Mumbai High Court, which dismissed its petition. Vodafone then knocked on the door of the Supreme Court.

The apex court finally gave it a clean chit, saying no capital gains tax can be collected from the deal which took place between two non-residents outside the country.

This Supreme Court verdict prompted the Indian government to introduce a harsh measure called retrospective tax in 2012 by amending the Income Tax Act.

Although the move paved the way for the government to impose taxes on offshore deals, many called it regressive because the amendment made in 2012 was coming into effect from the day when India’s Income Tax Act was first introduced in 1962.

Based on this amendment, the Indian government, in May 2012, sought $4.5 billion, in tax and fine, from Vodafone.

Just today, Bloomberg reported that Indian taxman has warned to ‘seize Vodafone’s assets in the country if the company fails to pay a disputed INR 142 billion ($2.1 billion) tax bill’. The warning comes at a time when the case is undergoing international arbitration process.

Far-reaching impact

The Indian tax law, with retrospective effect, introduced to tame Vodafone, has, in fact, had far-reaching impact on India because it has affected all offshore deals that took place before 2012, including the one related to British oil firm, Cairn Energy, which is facing a tax bill of INR 102.47 billion.

This has drawn condemnations from foreign investors, as they say Indian taxation system is becoming more uncertain and unpredictable.

To prevent foreign investors from fleeing the country, Indian Premier Narendra Modi and Finance Minister Arun Jaitley have repeatedly said that they would not impose the tax randomly.

While law, with retrospective effect, was creating a furore, the Indian government, in 2012, had also started framing General Anti-Avoidance Rules to pave the way for the taxman to scrutinise offshore transactions conducted to evade local taxes.

But the government still has not been able to introduce the regulation due to objection from various quarters, especially foreign investors.

To restore investor confidence, Indian Finance Minister Jaitley, in March 2015, said the regulation would come into effect only in April 2017.

Awaiting rulings

Nepal’s Income Tax Act, in fact, has a provision on General Anti-Avoidance Rule.

“If Nepal wants to tax the Ncell buyout deal, then it should frame a regulation by referring to the provision laid in the Act. If not, there is no use of making a fuss about the deal,” says Dhakal.

Yet Dhakal questions: “Can Nepal afford to have such a regulation, which India has not been able to introduce? This is because Nepal does not have a huge consumer market like India.”

Says IRD Director General Chuda Mani Sharma: “We are still conducting studies on the matter. We are also awaiting rulings of parliamentary committees on Development and Public Accounts, as they have also taken interest in this case.”