Taxation and Auditing

Definition of Direct Tax

A direct tax is a compulsory financial levy imposed by the government directly upon the income, wealth, or property of an individual or legal entity, where the impact (initial statutory liability) and the incidence (ultimate economic burden) rest upon the very same person. Unlike indirect taxes, direct taxes cannot be shifted or transferred to another party.

• Key Characteristics: Based on the principle of ability-to-pay, progressive in nature, and reduces socioeconomic wealth disparities.
• Examples: Personal Income Tax under the Income Tax Act, 2058, Corporate Income Tax, and Capital Gains Tax.

Concept of ‘Canon of Certainty’ (Adam Smith)

The Canon of Certainty is one of Adam Smith’s four classical canons of taxation, stipulating that the tax which each citizen is bound to pay ought to be certain, clear, and not arbitrary.

Essential Requirements:

1. Unambiguous Terms: The time of payment, the manner of payment, the tax base, and the exact monetary amount or percentage payable must be completely clear and known in advance to both the taxpayer and tax administration.
2. Prevention of Arbitrariness: Protects taxpayers from official extortion, bureaucratic harassment, and administrative discretion while enabling businesses to calculate tax costs accurately during financial planning.

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.

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).

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:

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.