Bonus Issued from Share Premium | Taxable or Not?-Part 2 | Income Tax Act, 2058 | Banks vs IRD

This case provides a detailed constitutional interpretation regarding whether share premiums collected from Further Public Offerings (FPO) and Bargain Purchase Gains (BPG) arising from mergers and acquisitions can be taxed as income, particularly when such taxes are applied through retroactive procedural waivers.

Key Highlights of the Case:
The Initial Dispute: Between 2075 and 2076, several banks and insurance companies issued FPOs at a premium and later distributed bonus shares to shareholders using these premium funds. Simultaneously, following various mergers and acquisitions encouraged by national policy, these institutions recorded "Bargain Purchase Gains" (the difference when the purchase price is lower than the net value of assets) as capital reserves rather than taxable income.

The Tax Authority's Position: The government, through Sections 26 and 27 of the Economic Act, 2080, mandated that taxes must be paid on these amounts. They argued that while the Income Tax Act, 2058, already contained provisions (like Section 56(3)) to tax such distributions, the Finance Act merely provided a one-time waiver of interest and penalties if the principal tax was paid by mid-Poush 2080.

The Taxpayers' Defense: The petitioners argued that share premiums are capital contributions from shareholders, not income earned by the company, and thus should not be subject to corporate income tax. Regarding mergers, they contended that BPG is a purely accounting entry to adjust capital and does not represent a realized profit. They further argued that applying these taxes to past transactions was a retroactive application of law, violating Article 115(1) of the Constitution, which prohibits taxation without a clear law.

The Supreme Court’s Reasoning and Decision:
The Constitutional Bench, in a majority opinion, dismissed the petitions and upheld the government's right to tax these amounts on the following grounds:
1. Distribution as Taxable Event: The Court ruled that while share premiums held in a reserve might not be immediate income, their distribution as bonus shares constitutes a "dividend other than profit" under Section 56(3) of the Income Tax Act, 2058. Such distributions must be included in the entity's income calculation.

2. BPG as Realized Gain: The Court held that Bargain Purchase Gain (BPG) is a realized benefit for the acquiring institution resulting from business combinations. It ruled that under Section 7 of the Income Tax Act and established accounting principles, such gains are considered business income.

3. Nature of the Economic Act Provisions: The Court determined that Sections 26 and 27 of the Economic Act, 2080, were procedural in nature and did not impose a "new" retroactive tax. Instead, they offered a grace period and waivers for tax obligations that the Court deemed already existed under the Income Tax Act, 2058.

4. Limits of Legitimate Expectation: The Court rejected the argument that past internal letters from the IRD (suggesting these amounts weren't taxable) created a binding "legitimate expectation". It ruled that internal communications do not supersede the clear language of the law and that tax administration must prioritize public interest and statutory requirements.

Final Verdict:
The Supreme Court dismissed all writ petitions, declaring that the provisions in the Finance Act, 2080, were not unconstitutional. The majority held that these provisions were consistent with existing tax laws and did not violate the principle of no taxation without law. (Note: Justices Sapana Pradhan Malla and Kumar Regmi provided a dissenting opinion, arguing that the provisions were indeed retroactive and unconstitutionally imposed taxes on capital nature transactions.)

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