Coronavirus is yet again posing threat to viability of business throughout the world. As per the Central Bank of Nepal (NRB) survey, the pandemic forced closure of more than 61% of businesses and resulted in lay-off of one fourth of workforce. In response to Covid 19 crisis, the government had introduced fiscal measures relaxing the timeline f0r payment of direct and indirect taxes. The NRB also introduced moratorium on payment of interest, relaxation on prudential measures of Banks and Financial Institutions (BFIs) and enacted refinancing regulations to keep businesses afloat.
Due to recent increases in infection rates and casualties, business activities have yet again been affected. Government has restricted movement and mandated closure of business, especially the hospitality sector. The business community has requested new relief measures in light of these developments. While the government had acted swiftly to provide relief measures in the first wave, it did not identify structural problem in some laws which may not be helpful towards sustaining business. While the relief measures are important, it must also be backed by laws which will ensure troubled businesses – especially Small and Medium Enterprises (SMEs) and Micro Small and Medium Enterprises (MSMEs) – can continue to run without risk of becoming insolvent. These laws are discussed below and are the ones that have escaped the attention of lawmakers and regulators. They extend beyond typical fiscal and relief measures that dominate regulator agenda post Covid response.
Was Payment Moratorium Enough?
The NRB introduced payment moratorium vide its circular dated March 29, 2020. Due to the nature of regulations, NRB could only impose moratorium on class “A”, “B”, “C” and “D” licensed institutions. This implied that loan advanced by certain institutions like employee provident fund, foreign financial institutions, unsecured creditors, preferential shareholders could still request payment and were still able to initiate insolvency measures under the Nepali law. While the NRB was without authority to extend moratorium to these institutions, the lawmakers were required to envisage a more holistic approach to ensure troubled business were attaining relief and were not forced to close business.
This could be done through reform of the insolvency regime where the initiation of insolvency could have been suspended by amending the Insolvency Act 2063. The effect of such suspension was widely utilised by other jurisdictions to ensure troubled businesses were not subject to insolvency measures by any type of creditors and not just the secured creditors. While the moratorium relief suspended the payment of interest from licensed Nepali BFIs, it practically could not prevent the initiation of insolvency from other creditors.
Covid 19 has also exposed the cumbersome regime of business restructuring in Nepal. Nepali law only envisages business restructuring once insolvency procedure is initiated under the supervision of the respective High Courts under the court system. However to maintain business continuity and to avoid impairment in its reputation and value, restructuring may have to be commenced before it is affected by material adversity. This has been recognised by certain jurisdictions most notably in the United Kingdom where Corporate Insolvency and Governance Act 2020 permits troubled businesses to restructure through agreement with creditors. This restructuring scheme can be initiated by the company itself or creditors or shareholders through scheme of arrangement which has been adopted by more than 75% of creditors. Once the company’s general meeting has adopted the resolution, the restructuring measures are binding to “all creditors” and not just licensed BFIs as in Nepal. These measures are very helpful for businesses facing financial difficulties, and provide some relief from debt payment requirement. The benefit of this law is that it provides mechanism for temporary relief from all kinds of creditors.
Further Nepali insolvency law also doesn’t envisage out-of-court restructuring popularly known as pre-packs in certain jurisdiction. Pre-packs allow companies and creditors to agree on the resolution plan outside of court for the companies that are likely to close due to financial difficulties. Nepal can also adopt such measures as there has been an alarming increase in business closure. Such businesses – especially start-ups – require prompt assistance in restructuring as they may not have expertise and financial knowledge to deal with external shocks despite having a robust business plan and intangible value. To ensure transparency, Nepal like India can require such resolution to be submitted to the High Court for approval.
Insolvency Act 2063 of Nepal doesn’t provide clear timelines for completing restructuring/liquidation. Therefore, restructuring manager is not bound to resolve restructuring on time. Bidders of the restructuring plan may adopt delay tactics as they are not incentivised to formulate timely plan to revive the business. This may not be helpful for businesses which require quick resort to ensure business are supplied with working capital financing for uninterrupted supply of goods and services. Business will need to ensure material contracts with suppliers, maintain sound relations with regulatory bodies, and retain the confidence of customers to ensure viability in the market. The current legal regime does not aid prompt resolution and is cumbersome in terms of timely revitalisation of troubled business.
Taxing Troubled Business
Nepali taxation regime too does not provide any clarity on tax implications of troubled business restructuring. Practically troubled companies may require transferring the shares or business unit within the group holding to manage the assets and operations in more efficient manner and to realise economy of scale from parent company. This transfer may also follow due to the right of creditors to step in as shareholders pursuant to equitization of debt. This type of reorganisation is not a transfer of assets to the third party and is not taxed in other jurisdictions like in India and the USA. However, these types of transfers may still be subject to taxation in Nepal.
Section 57 of the Nepali Income Tax Act 2002 has a provision which requires reevaluation of assets and liabilities when there is more than 50% change in control (in terms of shares) in a testing period of the last three financial years. Any gain realised from revaluation of assets and liabilities is subject to taxation at the rate of 25%. Further carrying forward of losses, bad debts is also restricted after occurrence of such changes in shareholding. However, the law doesn’t specifically provide exemption to internal reorganization within parent or affiliate/s of group of companies where the ultimate owner remains the same and the shareholding has not changed hands. The creditors who have equitized their debt pursuant to resolution plan in an insolvency scenario may also be counted as being shareholders thus triggering revaluation requirement and taxation at the rate of 25% to the company. This may discourage businesses to restructure owing to tax implications that may arise from these transactions. Further, Nepali capital gains provision also may arise on such transfers within a group of companies or creditors ranging from 10% to 25% depending upon the nature of seller. Due to lack of clear carve-outs these may subject businesses to additional dispute with taxmen. As these provisions are not clearly laid down, challenging such assessments may subject business to accruing fines and interest.
Business growth may not always be a linear curve. Operating business is fraught with the uncertainty and risks. It is inevitable that business may face volatility and market shocks. But to manage the risks, concerned regulators should look beyond fiscal and monetary measures. While some of the problems can be addressed through stimulus package and payment relief, others may have to be addressed through commercially sound laws. One of these laws can be corporate insolvency law which would encourage prompt and efficient restructuring of business to maximize value of business and to keep business afloat. Further, taxation law should also foster such restructuring by providing tax exemption.