Taxation and Auditing 2025 Board Question Paper

Definition of Direct Tax with Example

A direct tax is a compulsory financial levy imposed by the government directly upon the income, profit, or property of an individual or corporate body, where the impact (statutory liability) and the incidence (ultimate financial burden) fall upon the same person. The taxpayer cannot shift the tax burden onto anyone else.

• Example: Personal Income Tax levied under the Income Tax Act, 2058, Corporate Tax paid by commercial banks, and Capital Gains Tax on share trading.

Meaning of Permanent Account Number (PAN)

A Permanent Account Number (PAN) is an exclusive, permanent nine-digit identification number issued by the Inland Revenue Department (IRD) of Nepal under Section 78 of the Income Tax Act, 2058.

Key Functions:

• Serves as the primary digital identifier for all tax filings, withholding transactions, customs clearances, and bank account verifications.
• Prevents identity duplication, curbs the informal shadow economy, and enables automated tax matching across businesses and government databases.

Concept of Output VAT with Example

Output VAT is the Value Added Tax charged and collected by a VAT-registered business from its buyers or clients on the taxable supply of goods or services made during the course of business at the statutory rate of 13%.

• Formula: $\text{Output VAT} = \text{Taxable Selling Price} \times 13\%$
• Example: If a registered hardware merchant sells construction materials for Rs 100,000, the merchant charges 13% VAT, collecting Rs 13,000 as Output VAT from the customer. The merchant offsets this against Input VAT paid on purchases and remits the net balance to the government.

Sources of Income under the Income Tax Act, 2058

Under Section 5 of the Income Tax Act, 2058, the taxable inflows of any taxpayer are classified into three substantive heads of income:

1. Income from Employment (Section 8): Remuneration, allowances, perquisites, and benefits earned from an employment relationship.
2. Income from Business (Section 7): Profits and gains derived from operating any commercial trade, manufacturing, or profession.
3. Income from Investment (Section 9): Dividends, interest, royalties, rent, and capital gains derived from holding or disposing of investments. (Note: Windfall gains from lotteries and prizes are taxed separately as final withholding under Section 88A).

Definition of Tax Audit with Example

A tax audit is an independent, specialized examination of a taxpayer’s financial statements, tax calculations, books of accounts, and underlying vouchers conducted by tax authorities (or appointed certified auditors) under Section 100/101 of the Income Tax Act, 2058.

Objectives & Example:

• Objective: To verify whether the taxpayer correctly reported all gross receipts, adhered to legal deduction ceilings (e.g., 7% repairs, Section 19 depreciation, Section 17 PCC), and paid the correct amount of tax.
• Example: An Inland Revenue Officer (IRO) audits the books of a pharmaceutical distributor, discovering that Rs 200,000 of staff salaries were paid without PAN and disallowed under Section 21, resulting in an amended assessment order.

Residential Status, Taxable Income & Tax Liability of Mr. Ramesh

1. Residential Status:

• Under Section 2(ah) of the Income Tax Act, 2058, an individual is a Resident if he/she resides in Nepal for 182 days or more in an income year.
• Ramesh’s Stay: 1st Magh 2080 to end of Baisakh 2081:
  • Magh (30) + Falgun (30) + Chaitra (30) + Baisakh (31) = 121 days.
• Since $121 \text{ days} < 182 \text{ days}$, Ramesh is a Non-Resident Individual.

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2. Taxable Income & Tax Liability:

• Under Section 6(1) and Schedule 1(2)(1), non-residents are taxed on Nepal-sourced income at a flat rate of 25% without basic exemptions:

$$\text{Taxable Income} = \mathbf{Rs \; 200,000}$$

$$\text{Tax Liability} = 25\% \times \text{Rs } 200,000 = \mathbf{Rs \; 50,000}$$

Tax Liability of Mr. Anish (Presumptive Taxpayer)

1. Presumptive Taxation Rules (Section 4(4) and Schedule 1(7)):

A resident individual carrying on business qualifies for presumptive taxation if:

• Annual turnover $\le \text{Rs } 3,000,000$ (30 Lakhs).
• Net taxable income $\le \text{Rs } 300,000$ (3 Lakhs).

2. Geographical Slabs:

• Metropolitan / Sub-Metropolitan City: Flat tax of Rs 7,500.
• Municipality: Flat tax of Rs 4,000.
• Rural Municipality: Flat tax of Rs 2,500.

3. Determination:

• Mr. Anish’s turnover is Rs 2,600,000 and taxable income is Rs 300,000, which satisfies the threshold.
• His business is situated in Lalitpur Metropolitan City.
• Tax Liability: $\mathbf{Rs \; 7,500}$.

Quantified Amount of Interest Subsidy for Mr. Dahal

1. Statutory Provision:

Under Section 27(1)(b) of the Income Tax Act, 2058:

• When an employer provides a loan to an employee at an interest rate lower than the prevailing market interest rate, the interest differential (subsidy) is treated as a taxable employment perquisite.

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2. Computation:

• Loan Amount: $\text{Rs } 3,000,000$
• Prevailing Market Interest Rate: $10\% \text{ p.a.}$
• Interest Rate Charged by Bank: $8\% \text{ p.a.}$
• Interest Rate Differential: $10\% - 8\% = 2\% \text{ p.a.}$
• Loan Duration (1st Marga to end of Ashad): 8 months

$$\text{Interest Subsidy} = \text{Rs } 3,000,000 \times 2\% \times \frac{8}{12} = \mathbf{Rs \; 40,000}$$

Final Answer: Rs 40,000 must be included in Mr. Dahal’s taxable employment income.

Monthly Salary, Taxable Income & Tax Liability of Ms. Thapa

1. Derivation of Monthly Salary:

• Approved Retirement Fund (ARF) deduction for Nepal Government employees is 10% of monthly basic salary.
• Annual ARF deducted = $\text{Rs } 60,000$.
• Annual Basic Salary $= \frac{60,000}{0.10} = \mathbf{Rs \; 600,000}$.
• Monthly Basic Salary: $\frac{600,000}{12} = \mathbf{Rs \; 50,000 \text{ per month}}$.

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2. Statement of Taxable Income:

• Basic Salary (12 months): $\text{Rs } 600,000$
• Dashain Allowance (1 month basic salary): $\text{Rs } 50,000$
• Employer Contribution to ARF (10%): $\text{Rs } 60,000$
• Total Assessable Employment Income: $\mathbf{Rs \; 710,000}$
• Less: ARF Contribution Deduction (Sec 63): Employee (60,000) + Employer (60,000) = $\mathbf{(Rs \; 120,000)}$
• Net Taxable Income: $710,000 - 120,000 = \mathbf{Rs \; 590,000}$

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3. Tax Liability (Couple / Family Status):

(Assuming Married Slabs: First Rs 600,000 @ 1% SST)

• Since Taxable Income (Rs 590,000) falls entirely within the first slab of Rs 600,000:
  $$\text{Gross Tax Liability} = 1\% \times 590,000 = \mathbf{Rs \; 5,900}$$
• Less: TDS already deducted: $\text{Rs } 20,000$
• Net Tax Position: $\mathbf{Rs \; 14,100 \text{ (Refundable)}}$.

Capital Gain and Tax Liability of Mr. Pandey

1. Computation of Capital Gain (Section 31A / 95A):

• Sales Proceeds: $\text{Rs } 1,200,000$
• Less: Cost of Acquisition: $\text{Rs } 500,000$
• Net Capital Gain: $1,200,000 - 500,000 = \mathbf{Rs \; 700,000}$

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2. Tax Liability:

• Case I: If Shares are Listed on NEPSE (Held for 2 years > 365 days): Under Section 95A, the applicable Capital Gains Tax rate for individual resident investors holding listed shares for more than 365 days is 5%:
  $$\text{Tax Liability} = 5\% \times \text{Rs } 700,000 = \mathbf{Rs \; 35,000}$$
• Case II: If Shares are Unlisted: The statutory CGT rate for individual investors on unlisted shares is 10%:
  $$\text{Tax Liability} = 10\% \times \text{Rs } 700,000 = \mathbf{Rs \; 70,000}$$

Tax-Exempt Incomes under Section 10 of the Income Tax Act, 2058

Section 10 enumerates specific categories of income that are completely exempt from income tax in Nepal:

1. Bilateral and Diplomatic Immunities: Incomes earned by foreign diplomatic representatives, ambassadors, and consular officials under reciprocal bilateral treaties.
2. Foreign Aid Project Personnel: Remuneration derived by foreign expatriates employed under bilateral development agreements funded by foreign governments or international organizations.
3. Pensions of Foreign Military Veterans: Pensions received by Nepali citizens retired from the Gurkha military services of the British Army, Indian Army, or Singapore Police.
4. Social Security Allowances: Elderly citizen allowances, widow allowances, and disability allowances disbursed by the Government of Nepal.
5. Accidental & Life Insurance Death Claims: Capital proceeds received by beneficiaries upon the demise of an insured individual.
6. Bequests, Inheritances, and Gifts: Assets or money received through genuine personal inheritance or ancestral wills.

Installment Method of Tax Collection (Section 94)

Under Section 94 of the Income Tax Act, 2058, every person deriving taxable income from a business or investment must pay their estimated annual tax in three structured installments during the income year:

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1. Statutory Due Dates and Cumulative Payment Percentages:

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2. Practical Illustrative Example:

Suppose ABC Trading Pvt. Ltd. estimates its total tax liability for the fiscal year to be Rs 1,000,000:

1. By Poush End (1st Installment): Must deposit $40\% \times 1,000,000 = \mathbf{Rs \; 400,000}$.
2. By Chaitra End (2nd Installment): Cumulative must reach 70% (Rs 700,000). Deducting the Rs 400,000 already paid, the company deposits Rs 300,000.
3. By Ashadh End (3rd Installment): Cumulative must reach 100% (Rs 1,000,000). Deducting Rs 700,000 already paid, the company deposits Rs 300,000. (Failure to pay results in interest under Section 118 at 15% p.a. on the shortfall).

Concept and Incomes of Final Withholding Payments (Section 92)

A final withholding payment is an income payment from which the payer (withholding agent) deducts tax at source, and this deducted tax represents the final, conclusive tax settlement for that income. The recipient is not required to include this income in their annual assessable income return, nor can they claim any tax credit or expense deductions against it.

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Five Key Final Withholding Incomes in Nepal:

1. Dividends Distributed by Resident Companies (Section 88): Dividends paid to natural person residents and non-exempt entities (subject to 5% final withholding).
2. Bank Interest Paid to Natural Persons (Section 88): Interest earned by individuals on savings, fixed deposits, and debentures from licensed banks and financial institutions (taxed at 5%).
3. House Rent Received by Natural Persons (Section 88): Rental income received by an individual from leasing a residential house or land not associated with a sole proprietorship business (taxed at 10% local/municipal tax).
4. Windfall Gains (Section 88A): Earnings from lotteries, betting, gambling, and game prizes (taxed at 25% flat).
5. Retirement Payments from Government / Approved Funds (Section 88): 5% final withholding on gain on retirement payments disbursed to retiring employees.

Multi-Year Business Loss Carry-Forward & Taxable Income Schedule

1. Critical Scrutiny Adjustments:

• Year 1 Donation: In Year 1, a donation of Rs 300,000 was deducted, showing a net loss of Rs 200,000. Under Section 12, donations are deductible only from positive income and cannot create a business loss. Therefore, Year 1 adjusted income before donation is a profit of Rs 100,000 ($300,000 - 200,000$). Allowable donation is $\min(5\% \times 100,000 = 5,000, \; 100,000, \; 300,000) = \text{Rs } 5,000$. Net taxable income Year 1 = Rs 95,000.
• Year 4 Pollution Control Cost (PCC): Calculated after deducting Rs 400,000 PCC. Operating profit before PCC was $400,000 + 400,000 = \mathbf{Rs \; 800,000}$.
• Year 5 Interest: Calculated before deducting loan interest of Rs 50,000. Adjusted profit = $200,000 - 50,000 = \mathbf{Rs \; 150,000}$.

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2. Loss Carry-Forward Schedule (Section 20 FIFO):

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3. Detailed Calculation for Year 4:

1. Operating profit before loss and PCC: $\text{Rs } 800,000$
2. Less: Carried-forward Y2 loss absorbed: $\text{Rs } 225,000$
3. Adjusted Taxable Income (ATI) before PCC: $800,000 - 225,000 = \mathbf{Rs \; 575,000}$
4. Allowable Pollution Control Cost (Section 17):
   • Actual: $\text{Rs } 400,000$; Limit: $50\% \times 575,000 = \mathbf{Rs \; 287,500}$
5. Taxable Income Year 4: $575,000 - 287,500 = \mathbf{Rs \; 287,500}$.

Comprehensive Statement of VAT on Television Import & Distribution

(VAT Rate: 13% under Value Added Tax Act, 2052)

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1. Reverse Derivation of Selling & Import Prices:

Stage 2: Retailer

• Customer Paid (Selling Price Incl. VAT): $\text{Rs } 339,000$
• Retailer Selling Price (Excl. VAT):
  $$\text{Selling Price} = \frac{339,000}{1 + 0.13} = \mathbf{Rs \; 300,000}$$
• Retailer Profit Margin (10% on Selling Price):
  $$\text{Profit} = 10\% \times 300,000 = \mathbf{Rs \; 30,000}$$
• Retailer Additional Incurred Cost: $\text{Rs } 1,000$
• Retailer Cost Price / Importer Selling Price (Excl. VAT):
  $$\text{Purchase Price} = 300,000 - 30,000 - 1,000 = \mathbf{Rs \; 269,000}$$

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Stage 1: Importer (Mr. Sundar)

• Importer Selling Price to Retailer (Excl. VAT): $\text{Rs } 269,000$
• Importer Profit Margin (10% on Selling Price):
  $$\text{Profit} = 10\% \times 269,000 = \mathbf{Rs \; 26,900}$$
• Importer Additional Incurred Cost: $\text{Rs } 1,000$
• (a) Import Price of TV (Excl. VAT):
  $$\text{Import Price} = 269,000 - 26,900 - 1,000 = \mathbf{Rs \; 241,100}$$

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2. (b) VAT Payable to Government at Each Stage:

At Customs (Import Stage):

• VAT paid on import: $13\% \times 241,100 = \mathbf{Rs \; 31,343}$

At Importer Stage:

• Output VAT: $13\% \times 269,000 = \text{Rs } 34,970$
• Less: Input VAT on import: $\text{Rs } 31,343$
• VAT Payable by Importer: $34,970 - 31,343 = \mathbf{Rs \; 3,627}$

At Retailer Stage:

• Output VAT: $13\% \times 300,000 = \text{Rs } 39,000$
• Less: Input VAT paid to importer: $\text{Rs } 34,970$
• VAT Payable by Retailer: $39,000 - 34,970 = \mathbf{Rs \; 4,030}$

Verification: $\text{Total VAT Collected} = 31,343 + 3,627 + 4,030 = \mathbf{Rs \; 39,000}$ (exactly 13% of Rs 300,000).

Computation of Depreciation, Repairs & Ending Asset Value for Block ‘D’

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1. Absorbed Additions Calculation (Schedule 2):

• 1st Marg (Shrawan–Poush): $3/3$ ($100\%$) absorbed: $100\% \times 100,000 = \mathbf{Rs \; 100,000}$
• 15th Falgun (Magh–Chaitra): $2/3$ absorbed: $\frac{2}{3} \times 120,000 = \mathbf{Rs \; 80,000}$ (Unabsorbed: Rs 40,000)
• 20th Jestha (Baisakh–Ashadh): $1/3$ absorbed: $\frac{1}{3} \times 180,000 = \mathbf{Rs \; 60,000}$ (Unabsorbed: Rs 120,000)
• Total Absorbed Additions: $100,000 + 80,000 + 60,000 = \mathbf{Rs \; 240,000}$

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2. Depreciation Base & Allowable Depreciation:

• Opening WDV: $\text{Rs } 600,000$
• Add: Absorbed Additions: $\text{Rs } 240,000$
• Less: Disposal Value: $\text{Rs } 20,000$
• Depreciation Base: $600,000 + 240,000 - 20,000 = \mathbf{Rs \; 820,000}$
• Block ‘D’ Rate: $15\%$
• Allowable Depreciation: $15\% \times 820,000 = \mathbf{Rs \; 123,000}$

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3. Allowable Repair & Maintenance (Section 16(2)):

• Actual Repair Incurred: $\text{Rs } 60,000$
• Statutory Limit: $7\% \times \text{Depreciation Base } (820,000) = \mathbf{Rs \; 57,400}$
• Allowable Repair Expense: $\min(60,000, 57,400) = \mathbf{Rs \; 57,400}$
• Excess Repair Capitalized: $60,000 - 57,400 = \mathbf{Rs \; 2,600}$

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4. Value of Fixed Assets at Fiscal Year End (Opening WDV for Next Year):

$$\text{Ending Asset Value} = (\text{Depreciation Base} - \text{Allowable Depreciation}) + \text{Unabsorbed Additions} + \text{Capitalized Repair}$$

$$\text{Ending Asset Value} = (820,000 - 123,000) + (40,000 + 120,000) + 2,600$$

$$\text{Ending Asset Value} = 697,000 + 160,000 + 2,600 = \mathbf{Rs \; 859,600}$$

Professional & Taxable Income Statement of Mrs. Barsha (Advocate)

(Maintained on a Cash Basis under Section 22)

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(a) Net Assessable Income from Profession

Items Excluded:

• Lottery, Dividend & Bank Interest: Final withholding under Section 92/88A.
• Birthday gifts: Personal non-business receipt.
• Outstanding salary (Rs 20,000): Disallowed under cash accounting until paid.

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(b) Statement of Taxable Income

Depreciation Provisions under Section 19 and Schedule 2 of the Income Tax Act, 2058:

1. Classification of Depreciable Assets into Blocks:

• Block A (Building, structures, waterworks): $5\%$ declining balance.
• Block B (Office equipment, furniture, computers): $25\%$ declining balance.
• Block C (Automobiles, buses, transport equipment): $20\%$ declining balance.
• Block D (Plant, heavy machinery, manufacturing equipment): $15\%$ declining balance.
• Block E (Intangible assets: patents, trademarks, software): Straight-line basis over useful economic life.

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2. Time-Based Absorption Rules for Additions:

• Additions during First Half (Shrawan to Poush): $3/3$ ($100\%$) of cost is added to base.
• Additions during Second Period (Magh to Chaitra): $2/3$ ($66.67\%$) is added; $1/3$ capitalized next year.
• Additions during Third Period (Baisakh to Ashadh): $1/3$ ($33.33\%$) is added; $2/3$ capitalized next year.

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3. Formula for Depreciation Base:

$$\text{Depreciation Base} = \text{Opening WDV} + \text{Absorbed Additions} - \text{Disposal Proceeds}$$

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4. Special Provisions & Additional Concessions:

• Special Industries (Manufacturing, Mining): Entitled to an additional 1/3 (33.33%) of the normal depreciation rate.
• Full Absorption of Disposals: If disposal proceeds exceed the depreciation base, the surplus is treated as taxable business gain, and the pool base becomes zero. If all assets in a pool are disposed of, the unabsorbed base is written off as allowable terminal depreciation.

“Self-Assessment of Tax System is Effective in Developed Countries” — Critical Analysis

Self-assessment relies on voluntary declaration, where taxpayers compute, report, and remit taxes independently, subject to selective risk-based audit by the state. While highly successful in advanced economies, its implementation in developing nations faces unique structural hurdles.

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1. Why Self-Assessment is Highly Effective in Developed Countries:

1. Universal Financial Digitization: Almost 100% of transactions occur via electronic banking, credit cards, and computerized payroll, creating an immutable digital audit trail.
2. Robust Third-Party Data Interoperability: Central tax agencies (like the IRS or HMRC) automatically receive real-time data from employers, investment banks, and brokers, making underreporting nearly impossible.
3. High Civic Awareness & Deterrent Penalties: Strong tax culture coupled with strict civil and criminal penalties for fraud creates high voluntary compliance.
4. Sophisticated Risk-Based Auditing Algorithms: Advanced predictive analytics flag suspicious returns with extreme precision.

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2. Challenges Confronting Developing Economies (e.g., Nepal):

1. Predominance of Cash Transactions: Large informal and shadow economies operate via unrecorded cash, evading VAT and income tax.
2. Under-Invoicing & Dual Bookkeeping: Widespread commercial practices of maintaining parallel books of account to conceal revenue.
3. Limited Technological Infrastructure: Fragmented integration between land revenue registries, customs points, banking channels, and the Inland Revenue Department.
4. Low Taxpayer Literacy: Widespread lack of understanding of complex tax statutes.

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3. Policy Reforms to Enhance Effectiveness in Nepal:

• Universal enforcement of digital electronic fiscal billing devices (EFT/POS).
• Mandatory PAN quotation for all banking transactions exceeding Rs 100,000.
• Modernization of risk-based audit units within the IRD.

Tax Assessment of Mr. Kamal (Investment Income, Taxable Income & Tax Liability)

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(a) Statement of Assessable Income from Investment

Items Excluded (Final Withholding / Non-Taxable under Section 92):

• Gain from investing insurance (Rs 190,000): Final withholding tax.
• Fixed deposit bank interest (Rs 20,000): Final withholding tax.
• Client gift (Rs 9,000) & Personal expenses (Rs 20,000): Disallowed.
• Windfall gain (Rs 15,000): Final withholding under Sec 88A (Lottery ticket cost Rs 500 disallowed).

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(b) Statement of Total Taxable Income

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(c) Computation of Tax Liability (Individual Status):

(Assuming FY 2080/81 Individual Slabs)

• First Rs 500,000 @ 0% (Investment income has no 1% SST): Rs 0
• Next Rs 200,000 @ 10%: Rs 20,000
• Next Rs 300,000 @ 20%: Rs 60,000
• Balance Rs 387,000 ($1,387,000 - 1,000,000$) @ 30%: Rs 116,100
• Total Tax Liability: $20,000 + 60,000 + 116,100 = \mathbf{Rs \; 196,100}$
• Less: Advance TDS Credited:
  • Natural resources TDS ($75,000 + 1,500$): Rs 76,500
  • Royalty TDS: Rs 15,000
  • Private interest TDS: Rs 30,000
  • Machinery rent TDS: Rs 40,000
  • Total TDS: Rs 161,500
• Net Tax Payable to IRD: $196,100 - 161,500 = \mathbf{Rs \; 34,600}$

Employment Tax Assessment of Mr. Rohit (Nepal Government Employee)

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1. Computation of Monthly Basic Salary from Pay Scale:

• Appointment Date: 1st Baishakh 2075
• Pay Scale: $\text{Rs } 54,000 - 2,000 - 60,000 - \text{EB} - 3,000 - 75,000$
• Years of Service Completed up to Previous Year:
  • Year 1 (2075/76): Rs 54,000
  • Year 2 (2076/77): Rs 56,000
  • Year 3 (2077/78): Rs 58,000
  • Year 4 (2078/79): Rs 60,000 (Crosses Efficiency Bar)
  • Year 5 (2079/80): Rs 63,000
  • Year 6 (2080/81 - Previous Income Year): $\mathbf{Rs \; 66,000 \text{ per month}}$
• Annual Basic Salary: $12 \times \text{Rs } 66,000 = \mathbf{Rs \; 792,000}$

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(a) Statement of Assessable Income from Employment

Excluded Items:

• Saving from TADA (Rs 50,000): Official travel reimbursement $\to$ Exempt under Sec 8(3).
• Bank dividend (Rs 19,000 net) & Meeting allowance (Rs 20,000 net): Final withholding tax.
• Part-time teaching salary (Rs 170,000 net): Professional income.

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(b) Statement of Total Taxable Income

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(c) Computation of Tax Liability (Individual Status):

(Assuming FY 2080/81 Individual Slabs)

• First Rs 500,000 @ 1% SST: Rs 5,000
• Next Rs 200,000 @ 10%: Rs 20,000
• Balance Rs 209,600 ($909,600 - 700,000$) @ 20%: Rs 41,920
• Total Tax Liability: $5,000 + 20,000 + 41,920 = \mathbf{Rs \; 66,920}$
• Less: Medical Tax Credit: $15\% \times 30,000 = 4,500$, subject to statutory maximum: (Rs 750)
• Net Tax Payable to IRD: $66,920 - 750 = \mathbf{Rs \; 66,170}$