- within Tax topic(s)
- in United States
- within Tax, Government, Public Sector and Intellectual Property topic(s)
Q1. What exactly did the Inland Revenue Department clarify in its recent notice?
The Inland Revenue Department ("IRD"), through its recent notice dated 27th January, 2026 ("IRD Notice"), clarified how preference shares are to be treated when determining whether a company has undergone a "change in ownership" under Section 57 of the Income Tax Act, 2058 ("Tax Act").
As per the IRD Notice, preference shares will not be included in calculating the 50% ownership change threshold under Section 57 unless those preference shares carry voting rights.
In other words, the IRD has drawn a distinction between:
- Economic participation in a company; and
- Voting control over a company.
If preference shares do not carry voting rights (or only carry limited class-based voting rights), their issuance or transfer does not count toward the 50% change in ownership test. However, if the preference shares carry voting rights that affect corporate control, they may be included in determining whether a change in ownership has occurred.
Q2. Why was this clarification necessary?
Section 57 of the Tax Act does not define "ownership." It simply states that if 50% or more of a company's underlying ownership changes within a three-year period, the company is treated as having disposed of all its assets and liabilities at market value immediately before the change.
The absence of a statutory definition raised several interpretative uncertainties:
- Does "ownership" mean shareholding percentage?
- Does it include non-voting shares?
- Does it refer to voting power?
- Does it refer to beneficial ownership?
- Do economic rights alone trigger the provision?
In practice, companies issuing preference shares for capital raising faced real risk: if a large block of preference shares was issued to new investors, could this inadvertently trigger Section 57?
The IRD notice addresses this ambiguity directly by clarifying that non-voting preference shares, in themselves, do not constitute ownership change for Section 57 purposes.
Q3. What is Section 57 of the Income Tax Act, 2058?
Section 57 is a change-of-control anti-avoidance provision.
It provides that if 50% or more of a company's ownership changes within a three-year period, the company is deemed to have disposed of all its assets and liabilities at market value immediately before the change.
Importantly, this is not a tax on shareholders. It is a tax imposed at the company level.
Once triggered, the company is treated as though it has sold:
- Land and buildings,
- Equipment,
- Inventory,
- Intangible assets such as goodwill and brand value,
- Financial assets.
Any unrealised gains embedded in those assets become taxable.
Section 57 therefore functions as a "deemed asset sale" rule. Its policy objective is to prevent indirect transfers of appreciated assets or trafficking in tax losses through share transfers.
We have previously analysed the broader scope of Section 57 including its interaction with underlying ownership and judicial interpretation in the context of cases such as Ncelland Bottlers Nepal. You can read here.
Q4. What are preference shares in this context?
Under Section 65 of the Companies Act, 2063, a company may issue preference shares, and the terms of issuance must clearly specify whether those shares carry voting rights.
Preference shares typically provide:
- Fixed or preferential dividend entitlement,
- Priority in return of capital upon liquidation,
- Limited or no voting rights (unless specified).
However, preference shares can be structured to include voting rights. Where voting rights are attached, those shares may influence corporate decision-making and therefore affect control.
It is this distinction that becomes critical under the IRD notice.
Q5. What is the impact on M&A and investment structuring?
The clarification has significant consequences for transaction design.
In a conventional share acquisition, if an acquirer purchases more than 50% of ordinary voting shares within three years, Section 57 will likely be triggered. The target company would then face deemed disposal taxation.
However, under the IRD clarification, an investor may:
- Subscribe to a large volume of non-voting preference shares,
- Acquire substantial economic exposure,
- Secure dividend and liquidation priority,
- Avoid immediate triggering of Section 57,
provided that voting control remains unchanged.
This introduces structuring flexibility in:
Private equity investments,
Venture capital financing,
Recapitalisations,
Family business succession planning,
Staged acquisitions.
For example, an investor may initially enter through non-voting preference shares and later convert into ordinary shares, subject to careful timing and tax analysis. However, if conversion results in crossing the 50% voting threshold within the relevant three-year window, Section 57 implications may arise at that stage.
Therefore, while the clarification reduces uncertainty, it does not eliminate tax risk in phased acquisition models.
Q7. Does this eliminate all Section 57 risk?
No.
The clarification addresses the narrow issue of whether non-voting preference shares count toward the ownership change test. It does not override broader anti-avoidance principles.
If, in substance, control shifts through contractual arrangements or otherwise, the tax authorities may still scrutinise the arrangement.
Moreover, the three-year aggregation rule remains critical. Multiple transfers within that period must be examined cumulatively.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
