Nepal's Capital Gains Tax Cut: Government Reverses Course After Revenue Plummets Amidst Stock Market Slump

The Nepali stock market, NEPSE, has witnessed a significant downturn in capital gains tax (CGT) collection, prompting the government to reconsider its fiscal policies. Despite an ambitious move in the current fiscal year's budget to increase CGT rates with the aim of boosting state revenue, the actual collection has plummeted by more than half in the first two months. This stark reality has forced the government's hand, leading to a decision to reduce the capital gains tax rates, a move eagerly awaited by investors.

According to data from CDS and Clearing Limited (CDSC), the government managed to collect a mere NPR 1.2576 billion in capital gains tax from stock transactions during Shrawan and Bhadra (the first two months of FY 2083/84). This figure represents a staggering 54.42% decline compared to the NPR 2.7579 billion collected during the same period in the previous fiscal year, when the market was significantly more vibrant. This sharp contraction in revenue underscores the profound impact of market sluggishness and declining investor confidence.

The government's initial strategy, outlined in the current fiscal year's budget, was to increase the capital gains tax rate by 2.5 percentage points. This adjustment saw the short-term capital gains tax (for investments held 365 days or less) rise to 10%, while the long-term capital gains tax (for investments held over 365 days) was set at 7.5%. The rationale behind this increase was a clear attempt to enhance government coffers. However, the market's subsequent bearish trend, characterized by a significant drop in the NEPSE index and a drastic reduction in daily trading volumes, severely dampened investor morale. With fewer opportunities to book profits and many investors facing losses, the higher tax rates inadvertently led to a substantial decrease in overall tax collection, rather than the intended increase.

Even when examining the collection for Bhadra alone, the figures paint a challenging picture. While NPR 63.27 million was collected in Bhadra this year, a slight increase from NPR 60.14 million in the same month last year, the context is crucial. Last year's low Bhadra collection was primarily attributed to the 'Gen Z movement,' which led to a week-long market closure. This year, despite regular trading days, the NEPSE index continued its downward trajectory, hovering around the 2647-point mark, thereby preventing any meaningful recovery in tax revenue. The consistent decline in market activity, irrespective of trading days, highlighted the need for a policy intervention.

Recognizing the adverse impact of its tax policy on both market sentiment and state revenue, the Ministry of Finance swiftly moved to rectify the situation. Under the 'Capital Market Strengthening and Revitalization Action Plan, 2083,' the Ministry proposed a reduction in capital gains tax rates to the Cabinet. This proactive step aimed to inject much-needed liquidity and confidence back into the struggling market.

On Bhadra 31, the Cabinet officially approved the proposed reductions. As per the government's spokesperson, the revised capital gains tax rates are as follows:

• Short-term investors (holding investments for 365 days or less): The rate has been significantly reduced from the budgeted 10% to 5%.
• Long-term investors (holding investments for more than 365 days): The rate has been lowered from 7.5% to 3.5%. (It is worth noting that the Ministry of Finance's initial action plan had proposed 3.75% for long-term investors, but the Cabinet settled on 3.5%).

While this decision has been welcomed by market participants as a positive step towards revitalizing the NEPSE, its practical implementation faces a crucial hurdle: the official publication in the Nepal Gazette. Until the new tax rates are legally gazetted, and subsequently updated in the software systems of the Inland Revenue Department and CDSC, the reduced rates cannot be enforced. This delay creates an ongoing period of uncertainty for investors, who are currently operating under the old, higher tax regime.

The financial community and investors are now eagerly awaiting the Gazette's publication, which is expected to be a pivotal moment for the market. Once the reduced capital gains tax rates are formally implemented, it is widely anticipated that investor confidence will rebound, leading to increased trading volumes and, consequently, an improvement in the government's capital gains tax collection in the coming months. This policy reversal underscores the government's recognition of the delicate balance between revenue generation and fostering a healthy, vibrant capital market. The effectiveness of this measure will largely depend on its swift and clear implementation, paving the way for a potential recovery in the NEPSE.