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The TeliaSonera Deal - How Nepal can charge tax on indirect transfers?

Nepal Government has started discussing on how TeliaSonera can be charged to tax in Nepal for its deal with Axiata. Bizmandu reports that the government would proceed with collection of tax once official notification is received from NCell. We have seen in the first article how the proposed transaction does not fall within the ambit of current Nepal tax provisions. So, is collection of tax so straightforward for the government? Questions that arise are:
  1. Is tax on indirect transfer of shares an international practice and will it be a possibility for Nepal Government to tax the transaction with or without amendment in the current law?
  2. Is there any provision in DTAT between Nepal and Norway that affects the outcome of this transaction?
This article discusses impact of Double Tax Avoidance Treaty between Nepal and Norway with reference to the fact that Reynolds Holdings Ltd. is owned by a company based in Norway. We will also look into recent development and international practices regarding indirect transfer of share.
It is now clear that the immediate parent company of NCell Nepal is Reynolds Holdings Ltd., incorporated in a Carribean island and Reynold Holdings is further substantially owned by TeliaSonera associated company based in Norway.
Can Nepal Norway treaty be invoked by TeliaSonera?
Benefits of Nepal Norway DTAA treaty can be invoked by companies that are residents in Nepal, Norway or both. This technically means that TeliaSonera can benefit from the treaty provisions if the company is resident in Norway.
However, Nepal Tax Act Sec. 73(5) contains a Limitation of Benefit clause that allows IRD to restrict treaty benefit to any company if 50% or more underlying ownership of that company is not held by residents of that country. This requires further analysis of ownership pattern of holding companies and their residential status to ascertain if IRD can decline treaty benefit to TeliaSonera.
The DTAA do not have specific provision applicable for sale of shares, and so sale of shares should be addressed with Article 13(5) of the agreement that makes gains from the alienation of any property other than prescribed to be taxable only in the Contracting State of which the alienator is a resident (Here Norway).
Can indirect transfer of shares brought into legal ambit?
Taxation of indirect transfer of shares is inserted into local laws, especially by developing countries, to prevent erosion of tax base from developing countries to tax haven or developed countries. Both of our neighboring countries, India and China have law that charges indirect transfer of shares. Australian provisions normally apply to land rich companies. In case of US, shares gain of non-resident are generally considered sourced outside US.
Taxation of indirect transfer is a growing phenomenon, as an anti avoidance measure, to combat arrangements that do not have reasonable commercial purpose. The tax authorities in such case may deny the existence of intermediate holding company (For e.g. Reynold Holding here) and regard that the non-resident company has directly transferred the equity interest in local company and subject the gain to taxation.
But those indirect transfers of shares should be built in the local law or be covered by double tax agreement signed by the country. The latest OECD model tax treaty provides that “Gains derived by a resident of a Contracting State from the alienation of shares deriving more than 50 per cent of their value directly or indirectly from immovable property situated in the other Contracting State may be taxed in that other State.”
Though the Indian government resorted to retrospective amendment in law after Vodafone case, the implementation so far has been full of legal issues. In case of Sanofi Holdings, where offshore transactions of shares took place of a French company, the Andhra Pradesh court ruled in favor of tax payer. The basis being that the French holding company was not a sham.  In case of Copal case (Moody), the court took 50% test as outlined in OECD and UN Model treaties as the basis for defining transfer of substantial ownership in India, and said that for indirect transfer provisions to apply at least 50% of the value of shares transferred should be from assets in India. Vodafone case is still under dispute with both government and Vodafone prepared for out of court settlement.
From the above discussions it is clear that taxation of indirect transfer is a growing practice to prevent shifting of tax base and to curb using intermediary structures or tax haven to avoid taxation. But creation of wholly owned subsidiaries or joint ventures for investment in other countries is globally established practice and the tax authorities should have enough evidences to challenge a legitimate practice or structure while implementing indirect transfer provisions.
There are some other issues too that needs to be considered. Such as:
  • Are all indirect transfers subject to tax or only for substantial transfers or land rich companies?
  • What proportion of gain should be attributed to local tax law? This should be as per the underlying assets, but calculation basis should be clear.
  • What happens if the shares that are subject to tax on basis of indirect transfer are further directly sold. For e.g. if sold by Reynold Holding in case of NCell deal that we are discussing. We need to have credit mechanism in place to avoid double taxation if such indirect transfers are to be taxed.
To conclude, the Nepal Government should carefully consider these technical issues in deciding appropriate tax measure to address transactions such as of TeliaSonera, instead of any hasty implementation of law.

CA. Mukunda Pokharel