Supreme Court Halts Tax Exemption for Foreign Investor Dolma Impact Fund

The Supreme Court has issued an interim order to stop the implementation of the Inland Revenue Department's decision to grant capital gains tax exemption to foreign investor 'Dolma Impact Fund'.

A joint bench of Supreme Court Justices Mahesh Sharma Paudel and Balkrishna Dhakal issued this order on Wednesday. With the court's order, the decision to grant tax exemption to Dolma Impact Fund, which has invested in 16 companies in Nepal based on the proposal of Finance Minister Rameshwar Khanal, will not be immediately enforced.

The Cabinet meeting held on Kartik 12 decided to scrap the Double Taxation Avoidance Agreement (DTAA) with Mauritius. The treaty between Nepal and Mauritius for double taxation avoidance was signed on October 3, 1999. The government had used this very treaty as the basis for granting tax exemption to the Dolma Fund. The investment made by Dolma is expected to generate profit.

Capital gains tax should be levied if the shares of those companies are sold at a higher price than before. However, the tax exemption was arranged by citing the treaty. Tax administration experts have consistently argued that granting tax exemption based on the treaty is not permissible because the investment was made in companies operating with an office in Nepal and aiming to make a profit. They argue that tax should be levied according to the provisions of the Income Tax Act, 2058.

Hearing the writ filed by Bheshraj Luitel, the court ordered an immediate halt to the process of granting tax exemption and allowing funds to be taken abroad without paying tax. The Supreme Court issued an interim order in the names of the respondents, as per the Supreme Court Regulations, 2074, not to implement or cause the implementation of the Inland Revenue Department's decision dated 2082/06/28, and not to approve the transfer of any amount abroad without paying tax, until the final decision on the writ.

On Ashoj 28, 2082, the Inland Revenue Department had decided that 'Dolma Impact Fund 1', registered in Mauritius, would not be subject to capital gains tax on share sales in Nepal, citing the DTAA between Nepal and Mauritius. Based on this decision, CDS and Clearing Limited was corresponded with not to withhold tax.

Dolma Impact Fund is a company registered with an office in Cyber City, Mayawa Tower, Mauritius. It is a common practice to establish companies in countries like Mauritius, where scrutiny regarding the source of investment and investor identity is minimal, and channel investments into various countries through them. Therefore, investors from various countries establish 'shell companies' in countries such as Mauritius, Panama, British Virgin Islands, Cayman Islands, and Bahamas, and invest in various countries as Foreign Direct Investment through these entities. Shell companies are registered in such countries for this purpose. This practice has been active in Nepal since 2003.

The court cited four grounds and reasons for halting the proceedings related to Dolma Impact Fund.

1. Lack of Parliamentary Ratification of the Treaty: The agreement signed between Nepal and Mauritius in 1999 was not shown to have been ratified, acceded to, approved, or supported by the Federal Parliament (House of Representatives) as per Section 9(1) of Nepal's Treaty Act, 2047. The court determined that if a provision of a treaty not ratified by the parliament conflicts with prevailing national law (Income Tax Act), the national law shall prevail.

2. Violation of the Income Tax Act: While Section 73(4) of the Income Tax Act, 2058, provides for tax exemption through a treaty, subsection (5) of the same section specifies certain conditions. Accordingly, an entity where more than 50 percent ownership does not belong to residents of the contracting states of the treaty is not eligible for tax exemption. The court found that Dolma Impact Fund did not meet this condition and appeared liable to pay capital gains tax.

3. Direct Legal Error: The court's order mentioned that the decision made by the Director General of the Inland Revenue Department appeared, at first glance, to be contrary to the provisions of both the Income Tax Act and the Treaty Act.

4. Irreparable Loss to the State: The court stated that if the decision to grant tax exemption is implemented and funds are sent abroad, it would cause irreparable loss to the revenue that the state is entitled to receive, and this decision needed to be stopped from the perspective of 'balance of convenience' as well.