Understanding the legal essentials for companies not distributing profits

Company not distributing profits and its rationale

At first glance, the term ‘company’ typically refers to an entity created primarily to generate profits and distribute those earnings to its shareholders. However, this definition can overlook the complexities of different business models. While many companies focus on maximising financial returns, others, such as companies not distributing profits, operate with a unique purpose aimed at societal benefit rather than only profit generation.

Section 166 of the Companies Act, 2063 of Nepal provides for the establishment of companies to develop and promote a profession or occupation, protect the collective rights and interests of individuals in a particular field, or conduct an enterprise to achieve scientific, academic, social, benevolent or public utility or welfare objectives on condition that they do not distribute dividends.

In Nepal, non-profit organisations were traditionally the sole entities working for societal welfare, formed and governed under the Associations Registration Act, 2034 and overseen by the District Administration Office. These organisations, however, lacked operational autonomy. To address this, the concept of ‘company not distributing profits’ was introduced in the Companies Act, 2063. This new framework aimed to ensure greater autonomy for these entities while requiring them to meet certain legal compliances. Based on data released by the Office of the Company Registrar (OCR) on September 25, 2022, a total of 4,305 companies were identified as not distributing profits.

Before the Supreme Court's decision (Corporate Social Consortium v. Ministry of Finance, NKP 2069 No. 3, Decision No. 8785), the concept of non-profit organisations and companies not distributing profits were considered differently. Earlier, only non-profit organisations were subjected to tax exemptions. The Supreme Court's decision erased the distinction between non-profit organisations and companies not distributing profits by interpreting that the two entities have equal footing in the eyes of the law; therefore, companies not distributing profits were also subject to tax exemptions. The distinction made by the decision was in terms of registration and regulatory authorities. The registration and regulatory authorities for non-profit organisations and companies not distributing profits are the District Administration Office and the Office of the Company Registrar (OCR), respectively.

Registration process of a company not distributing profits

To register a company not distributing profits, the initial step is to propose and apply for name reservation through the OCR’s online portal. Once the OCR approves the name, the next step is to prepare constituent documents, including the Memorandum of Association (MOA) and Articles of Association (AOA) for incorporation of the company. These documents lay the foundation of the organisation and must meet certain key requirements.

Firstly, it is essential to have at least five promoters involved in the formation. The involvement of these promoters not only fulfils legal requirements but also encourages collaborative decision-making and effective governance. However, these five persons should be individuals holding a Nepali citizenship certificate, and foreign individuals or entities are not allowed to formulate a company not distributing profits.

Secondly, the organisation’s objectives must be articulated clearly and precisely. These objectives should reflect the purpose of the organisation and guide its activities, providing a roadmap for its mission and goals.

After preparing these documents, the final steps involve submitting them through the OCR portal, paying the necessary registration fee, and awaiting approval.

Challenges in the registration process

1. Name Reservation: The OCR often rejects names containing terms like ‘Association’, ‘Federation’, or ‘Society’, citing internal policy rather than legal directives, which lack any explicit restriction on such terms.

2. Initial Capital Requirement: Despite legal provisions stating no share capital is needed, the OCR pressures these companies to show initial capital, contradicting their ability to rely on membership fees and donations.

3. Objective Clause: OCR mandates clear income sources, creating hurdles for promoters to justify income-generation capacity and financial backing, posing challenges to new companies with limited resources.

4. Delayed Registration Timeline: Inter-departmental opinions delay the registration process, creating unpredictability and hampering timely decision-making.

Post registration compliances

After registering a company not distributing profits, it is essential to comply with the legal and regulatory requirements applicable to public companies. This includes maintaining transparent financial records, conducting regular audits, and submitting annual reports to the relevant authorities to ensure accountability and compliance with the law.

One of the key compliances, which is distinct from public companies, is that the annual budget shall be passed by the general meeting of the company and submitted to the OCR. Such a budget shall not exceed administrative expenses by more than 25% of its total expenditure. Further, the company not distributing profits must include 'Pvt Ltd' or 'Ltd' after its name. Unlike a public company, there is no concept of shares in a profit-not-distributing company, and membership is not transferable. The profit earned by these companies shall be utilised to achieve the purpose of the company. A company not distributing profits is not allowed to merge with a profit-distributing company, however, its branch can be expanded with prior approval from the OCR.

Moreover, to access grants and donations, the company must establish an affiliation with the Social Welfare Council. This affiliation not only enhances the organisation's credibility but also opens opportunities for funding from various sources dedicated to supporting non-profit initiatives. Adhering to these compliance requirements is crucial for the sustainability and effective operation of the company, as it builds trust with stakeholders and fosters a strong reputation within the community.

Conclusions and way forward

Understanding the legal essentials for companies not distributing profits is crucial in fostering a robust non-profit sector that effectively addresses societal needs while ensuring compliance with applicable laws. As outlined, the Companies Act, 2063 of Nepal provides a framework that allows for the establishment of these entities, aimed at promoting various professional and benevolent objectives without the expectation of profit distribution. However, the registration process has revealed significant challenges, particularly regarding name reservation, initial capital requirements and the clarity of operational objectives.

To improve this, the Office of Company Registrar must enhance transparency and ensure its guidelines align with the legal framework, streamlining the registration process. Engaging with stakeholders, particularly potential promoters, will yield insights that lead to more practical regulatory solutions. By prioritising collaboration, the OCR can better support companies not distributing profits, ultimately strengthening their capacity to contribute to societal welfare in Nepal.