Merger and Acquisition in Nepal: Key Legal Insights

Mergers and Acquisitions (M&A) have emerged as strategic tools for corporate restructuring and growth in Nepal, allowing companies to expand operations, achieve economies of scale, diversify business portfolios, and gain competitive market share. In recent years, M&A activities have gained significant traction in Nepal, particularly in the banking and financial sector, driven by regulatory pushes for consolidation and increased competition.

This comprehensive guide provides detailed insights into the legal framework, procedures, regulatory requirements, tax implications, and key considerations for mergers and acquisitions in Nepal.

Legal Framework Governing M&A in Nepal

Merger and acquisition activities in Nepal are governed by multiple laws, regulations, and bylaws that establish the procedural requirements, approval mechanisms, and compliance standards:

Primary Legislation

Sector-Specific Regulations

Definition of Merger and Acquisition

What is a Merger?

A merger refers to the legal combination of two or more companies into a single entity. In a merger, the combining companies agree to consolidate their assets, liabilities, and operations to establish either a novel corporate entity or integrate into an existing one. The shareholders of the company whose identity has been merged are issued shares in exchange for their original shares in the merging company.

Under the Companies Act, 2063, merger involves the unification of two or more entities where one company survives while the other ceases to exist, or both dissolve to form a new company. The Office of the Company Registrar will not approve a merger if it appears to create a monopoly, unfair trade restriction, or is contrary to public interest.

What is an Acquisition?

An acquisition refers to a strategic business transaction wherein one company procures a controlling interest in another entity by purchasing a substantial portion or all of its shares, assets, or equity. The acquired company may continue to operate under its original name or be absorbed into the acquiring company.

BAFIA defines acquisition as the act by which a bank or financial institution acquires another bank or financial institution, having settled the entire assets and potential liabilities by winding up the legal capacity of such institution.

Types of Mergers and Acquisitions

Types of Mergers

Types of Acquisitions

Merger Procedure for Public Companies in Nepal

The merger process for public companies in Nepal involves several mandatory steps under the Companies Act, 2063 and Merger Bylaws:

Step 1: Board Resolution and Initial Decision

The merger process begins with the Board of Directors of both merging companies passing a resolution approving the merger proposal. The board evaluates:

• Strategic rationale for the merger
• Preliminary valuation assessment
• Structure of the proposed transaction
• Timeline and key milestones
• Appointment of advisors (legal, financial, valuation experts)

Step 2: Memorandum of Understanding (MoU)

Companies sign an MoU outlining basic terms of the merger including:

• Intent to merge and general transaction structure
• Preliminary share exchange ratio
• Confidentiality obligations
• Exclusivity period
• Due diligence scope and timeline
• Conditions precedent

Step 3: Due Diligence Audit

A comprehensive due diligence process is conducted covering:

• Financial Review: Auditing financial statements, checking debts, liabilities, revenue patterns, and financial obligations
• Legal Review: Reviewing contracts, intellectual property rights, litigation history, regulatory compliance, and legal obligations
• Operational Review: Assessing synergies in operations, workforce integration, and compatibility of business models
• Tax Review: Analyzing tax positions, pending assessments, and tax implications of the merger

Step 4: Valuation of Assets and Liabilities

Independent valuation is conducted using methods including:

• Net Asset Value Method: Book value of assets minus liabilities
• Market Value Method: Fair market value of assets
• Discounted Cash Flow Method: Present value of future cash flows
• Regulatory Guidelines: Sector-specific valuation standards (NRB guidelines for BFIs)

Step 5: Adoption of Special Resolution

A special resolution must be passed at the general meeting of each company involved in the merger. Under the Companies Act, 2063:

• At least 75% of shareholders present at the meeting must approve the resolution
• The resolution must specify the merger terms, share exchange ratio, and treatment of employees
• Shareholders who do not consent to the merger have the right to get their shares valued before the merger and receive proportionate return

Step 6: Public Notice

Under Section 178 of the Companies Act, a public notice must be published in a national daily newspaper announcing the proposed merger, allowing stakeholders to submit objections within the specified period.

Step 7: Application to the Office of Company Registrar (OCR)

Within 30 days of passing the special resolution, the company must submit an application to the Office of Company Registrar for merger approval with all required documents.

Step 8: Review and Evaluation by OCR

Upon receiving the application and required documents, the OCR will:

• Review documents for legality and propriety
• Check compliance with corporate governance policies
• Assess impact on stakeholders and public interest
• May seek clarifications or request additional documentation
• Consult other regulatory agencies if necessary
• Make a decision within three months

Step 9: Regulatory Approvals

Depending on the nature of companies involved, additional regulatory approvals may be required:

Step 10: Approval and Transfer of Assets and Liabilities

If the OCR approves the merger:

• All assets and liabilities of the merging company are deemed transferred to the merged company
• Share exchange is executed as per the approved ratio
• Legal documentation including asset transfer agreements and liability assumptions are executed
• The merging company ceases to exist as a separate legal entity

Step 11: Post-Merger Integration

After completion of the merger, the companies undertake integration activities:

• System and technology integration
• Human resource restructuring and harmonization
• Corporate governance formation
• Branding and marketing alignment
• Operational consolidation
• Customer communication and transition

Documents Required for Merger in Nepal

The merger application submitted to the OCR must include:

Tax Implications of Mergers and Acquisitions

The taxation regime governing M&A in Nepal is primarily derived from the Income Tax Act, 2058 and Income Tax Rules, 2059. Although these laws do not explicitly define "merger" or "acquisition," they address such transactions through provisions on share transfers, asset disposals, and changes in control.

General Tax Provisions (Non-Banking/Insurance Entities)

Disposal of Assets and Liabilities

Under Section 40 of the Income Tax Act:

• If ownership of any person over any property ceases, they are deemed to have disposed of that property
• Disposal includes amalgamation of property in other property or liability
• If the burden of liability of any person ceases, they are deemed to have disposed of that liability

Under Section 47 (Disposal upon amalgamation of property and liability):

• Assets and liabilities may be disposed at book value (net expenses incurred)
• This may result in no immediate tax liability on transfer of assets/liabilities
• The cost base for the acquiring company equals the value at which assets were transferred

Change in Control (Section 57)

A critical provision affecting M&A transactions:

• If ownership of an entity changes by 50% or more compared to ownership in the last three years, the entity is deemed to have disposed of all property and liabilities
• Disposal is deemed at market value, potentially triggering tax liability
• The following benefits are lost upon such change:
  • Unabsorbed interest carried forward (Section 14(3))
  • Losses carried forward (Section 20)
  • Adjustments for accrual basis amounts (Section 25(1))
  • Loss from disposal of property before change (Section 36)
  • Foreign income tax carry forward (Section 71(3))
• The parts before and after the change in ownership are treated as separate income years

Involuntary Disposal (Section 46)

Under Section 46(3) read with Rule 16:

• Where unification or restructuring of an entity replaces a person's interest with another interest, an involuntary disposal is deemed created
• Taxpayer can apply to IRD for approval
• If approved, the incoming and net expenses are treated as equal, resulting in no tax liability

Special Provisions for Banking and Insurance Mergers (Section 47A)

The Income Tax Act provides favorable treatment for mergers of entities carrying on banking, financial, or insurance business:

Key Benefits Under Section 47A

• Provisions of Section 57(2)(a), (b), (d), (e), (f), (g) and Section 57(3) do not apply
• Losses of the ceased entity can be deducted over the next seven years on a pro-rata basis
• Assets disposed at book value (no capital gains tax on transfer)

Treatment of Assets and Liabilities (Section 47A(2))

Additional Benefits Under Section 47A

• Retirement Payment Relief (Section 47A(3)): 50% rebate on TDS rate for additional lump sum retirement payments to employees
• Shareholder Capital Gains Exemption (Section 47A(4)): No capital gains tax if shareholders sell their shares within 2 years after merger
• Dividend Tax Exemption (Section 47A(5)): No tax on dividends distributed to shareholders existing at merger time within 2 years after merger

Procedural Requirements

• Entity must submit letter of intent to merge to IRD within prescribed time (Section 47A(6))
• Merger must be completed within time prescribed by Section 47A(7)

Capital Gains Tax on Share Transactions

Competition Law Considerations

The Competition Promotion and Market Protection Act, 2063 is crucial in assessing M&A transactions that might reduce market competition:

Key Provisions

• 40% Market Share Threshold: Mergers, acquisitions, or amalgamations resulting in combined entity having more than 40% market share in Nepal are prohibited
• No Exception: There is generally no room for exception if market share exceeds this limit
• Abuse of Dominance: Even without direct monopoly, post-merger dominant position abuse (predatory pricing, limiting output) faces legal action
• Competition Commission Review: Large mergers approaching 40% threshold may require detailed impact assessments and public consultations

Exemptions

• Small cottage industries
• Agricultural production and cooperatives
• Activities related to research and development

M&A in Banking and Financial Sector

M&A activities have been particularly prominent in Nepal's banking and financial sector due to NRB's consolidation policies:

Reasons for BFI Mergers

• Capital Requirements: NRB mandates minimum paid-up capital (NPR 8 billion for commercial banks)
• Financial Stability: Reducing non-performing loans and improving service delivery
• Regulatory Compliance: Meeting capital adequacy requirements
• Operational Efficiency: Economies of scale and cost reduction
• Market Competition: Preparing to compete with foreign banks

NRB's Role in BFI Mergers

• Supervision of all BFI mergers
• Capital adequacy assessment
• Fit and proper test for management
• Branch integration approval
• Post-merger reporting requirements
• May order compulsory mergers for weak institutions

Timeline for M&A Transactions

The timeline for M&A in Nepal varies significantly based on complexity:

Benefits of Mergers and Acquisitions

• Stronger Capital Base: Combined financial strength and resources
• Economies of Scale: Reduced operational costs through consolidation
• Market Expansion: Access to new markets, customers, and distribution channels
• Improved Competitiveness: Better positioning against competitors
• Technology Upgrade: Access to superior technology and systems
• Talent Acquisition: Acquiring skilled workforce and management expertise
• Diversification: Reducing business risk through portfolio diversification
• Regulatory Compliance: Meeting capital and other regulatory requirements
• Shareholder Value: Increased value through synergies
• Tax Benefits: Utilization of losses and other tax advantages (for BFIs)

Challenges in M&A Transactions

• Lengthy Regulatory Approvals: Multiple approvals from OCR, NRB, SEBON, etc.
• Valuation Disputes: Disagreements on fair value of assets and share exchange ratio
• Employee Resistance: Uncertainty causing decreased morale and increased turnover
• Tax Complications: Complex tax implications, especially Section 57 provisions
• Cultural Integration: Combining different corporate cultures and management styles
• System Integration: Technical challenges in merging IT systems and processes
• Market Uncertainty: Economic and political instability affecting transaction value
• Legal Ambiguity: Lack of clear provisions in certain areas of tax law
• Creditor and Stakeholder Concerns: Managing multiple stakeholder interests
• Competition Law Restrictions: 40% market share ceiling limiting large mergers

Key Considerations for Successful M&A

Pre-Transaction

• Clear strategic rationale and objectives
• Thorough due diligence covering all aspects
• Realistic valuation based on multiple methods
• Early engagement with regulators
• Comprehensive tax planning
• Competition law analysis

During Transaction

• Clear communication with all stakeholders
• Proper documentation and compliance
• Management of regulatory approval process
• Employee engagement and retention strategies
• Protection of confidential information

Post-Transaction

• Structured integration planning and execution
• Cultural integration initiatives
• Retention of key personnel
• System and process harmonization
• Ongoing regulatory compliance
• Performance monitoring and synergy tracking

Related Services

For comprehensive legal support in merger and acquisition transactions:

• Company Registration in Nepal
• Foreign Direct Investment in Nepal
• Corporate Law Firm Nepal
• Banks and Financial Institutions Act Nepal
• Income Tax Rate Nepal
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