Taxation in Nepal

Concept of Tax

A tax is a mandatory, non-penal financial contribution imposed by a sovereign government on individuals, businesses, property, or transactions under statutory authority, without any direct, proportional quid pro quo (immediate return service), for financing public expenditures and socio-economic development.

Permanent Account Number (PAN)

A Permanent Account Number (PAN) is a unique nine-digit alphanumeric identifier issued by the Inland Revenue Department (IRD) of Nepal to every registered taxpayer (individuals, firms, corporations, entities). It tracks income tax assessments, VAT returns, TDS reconciliations, and financial transactions across the country.

Income Year vs. Assessment Year

Canon of Economy

The Canon of Economy (formulated by Adam Smith) requires that the total administrative cost of collecting taxes should be kept to an absolute minimum relative to the net revenue delivered to the state treasury. Furthermore, it implies that the tax compliance burden and record-keeping costs for taxpayers should be as low as possible.

Non-Chargeable Business Assets

Non-chargeable business assets are assets held by an entity or enterprise that are statutory excluded from capital gains taxation upon disposal, or assets held strictly for personal consumption (e.g., personal clothing, furniture, or private motor vehicles of a natural person not used for generating commercial business income).

Remote Area Exemption Limits (Schedule 1)

Under Section 50 and Schedule 1 of the Income Tax Act, 2058, a resident natural person working in designated remote zones is entitled to the following statutory deductions:

1. Class ‘A’ (Most Remote): Rs. 50,000
2. Class ‘B’: Rs. 40,000
3. Class ‘C’: Rs. 30,000
4. Class ‘D’: Rs. 20,000
5. Class ‘E’: Rs. 10,000

Quantification of Vehicle and Accommodation Facilities

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

• Vehicle Facility Perquisite: $0.5\% \times \text{Basic Salary} = 0.5\% \times 600,000 = \mathbf{Rs.\; 3,000}$
• Accommodation Facility Perquisite: $2.0\% \times \text{Basic Salary} = 2.0\% \times 600,000 = \mathbf{Rs.\; 12,000}$

Total Perquisite to be Included in Employment Income:

Tax Liability of Miss Hira (Individual Status, Taxable Income: Rs. 1,120,000)

Tax Slab Calculation:

• First Rs. 500,000 @ 1% (Social Security Tax) = Rs. 5,000
• Next Rs. 200,000 @ 10% = Rs. 20,000
• Next Rs. 300,000 @ 20% = Rs. 60,000
• Remaining Rs. 120,000 ($1,120,000 - 1,000,000$) @ 30% = Rs. 36,000
• Gross Tax Liability: $5,000 + 20,000 + 60,000 + 36,000 = \mathbf{Rs.\; 121,000}$

Female Tax Rebate: Under Schedule 1 Section 1(10), a resident female deriving income solely from employment is entitled to a 10% tax rebate:

Allowable Repair and Improvement Cost (Section 16)

Step 1: Compute Depreciation Basis for Block ‘D’

• Opening WDV = Rs. 500,000
• Addition on 2nd Chaitra (2nd period: Magh to Chaitra $\rightarrow$ 2/3rd absorption):
  $$\text{Absorbed Addition} = 300,000 \times \frac{2}{3} = \text{Rs. } 200,000$$
• Depreciation Basis: $500,000 + 200,000 = \mathbf{Rs.\; 700,000}$

Step 2: Calculate Allowable Repair Limit (7% of Basis)

Conclusion:

• Allowable deductible repair expense for the year is Rs. 49,000 (the remaining Rs. 1,000 is capitalized to Block D).

Presumptive Tax Liability for Susan

Statutory Parameters:

• Annual Turnover = Rs. 3,000,000 (qualifies for presumptive tax under Sec. 4(4))
• Location: Kathmandu Metropolitan City

Statutory Tax Scale:

• For businesses operating within a Metropolitan City / Sub-Metropolitan City, the annual presumptive tax is fixed at Rs. 7,500.

Conclusion: Susan’s tax liability under presumptive taxation is Rs. 7,500.

Solution: Mrs. Muna’s Employment Income, Taxable Income, and Tax Liability

Step 1: Basic Salary Scale Determination (FY 2079/80 or Previous Year)

• Appointed: 1st Magh 2076 at Rs. 30,000
• Increments: Magh 2077 (Rs. 31,000), Magh 2078 (Rs. 32,000), Magh 2079 (Rs. 33,000).
• If evaluating 2079/80: 6 months @ 32,000 + 6 months @ 33,000 = $192,000 + 198,000 = \text{Rs. } 390,000$ (or assuming fully revised scale at 33,000 p.m. = Rs. 396,000; let us use Rs. 390,000 as standard).
• Dashain Allowance = 1 month salary = Rs. 33,000.

Part (a): Assessable Income from Employment (Section 8)

Part (b): Statement of Total Taxable Income

Part (c): Tax Liability (Individual Status)

• Since Taxable Income (Rs. 477,612) is within the first exemption slab of Rs. 500,000:
  $$\text{Social Security Tax (1\% on 477,612)} = \text{Rs. } 4,776.12$$
• Less: Female Tax Rebate (10%):
  $$\text{Rebate} = 10\% \times 4,776.12 = \text{Rs. } 477.61$$
• Less: Medical Tax Credit:
  $$15\% \times 3,000 = \text{Rs. } 450.00$$
• Net Tax Payable: $4,776.12 - 477.61 - 450.00 = \mathbf{Rs.\; 3,848.51}$

Solution: Auditor’s Professional Income, Taxable Income, and Tax Liability

Part (a): Assessable Income from Profession (Section 7)

Gross Professional Inclusions:

1. Audit Fees: Rs. 890,000
2. Consultancy Fees (Gross: $510,000 / 0.85$): Rs. 600,000 (TDS Rs. 90,000)
3. Commission on Audit Work: Rs. 50,000
4. Sale of Old Newspapers & Professional Journals: Rs. 4,000
5. Gifts & Presents from Clients: Rs. 30,000

• Total Gross Professional Receipts: Rs. 1,574,000 (Notes: Bank fixed deposit interest, government security interest, dividend, and lottery are final withholding taxes under Section 92).

Allowable Professional Deductions:

1. Office Salaries: $360,000 - 10,000 \text{ (domestic servant)} = \text{Rs. } 350,000$
2. Office Expenses: Rs. 90,000
3. Office Rent: Rs. 120,000
4. Newspapers & Professional Journals: Rs. 8,000
5. Stationery: Rs. 25,000
6. Travelling Expenses: Rs. 30,000
7. Miscellaneous Expenses: Rs. 20,000
8. General Office Expenses (from domestic): $50\% \times 80,000 = \text{Rs. } 40,000$
9. Car Expenses (80% professional): $24,000 \times 80\% = \text{Rs. } 19,200$
10. Depreciation on Office Equipment (Block B, 25% on Rs. 240,000 added in Bhadra): $240,000 \times 25\% = \text{Rs. } 60,000$

• Total Allowable Professional Deductions: Rs. 762,200

Part (b): Statement of Total Taxable Income

Part (c): Tax Liability (Individual Status)

• First Rs. 500,000 @ 0% (Business/Professional income) = Rs. 0
• Next Rs. 200,000 @ 10% = Rs. 20,000
• Remaining Rs. 47,460 @ 20% = Rs. 9,492
• Total Tax Liability: $20,000 + 9,492 = \mathbf{Rs.\; 29,492}$
• Less: Advance Tax Paid (Rs. 10,000) & TDS on Consultancy (Rs. 90,000) $\rightarrow$ Resulting in a net tax refund.

Solution: Multi-Stage VAT Determination

Part (a): Step-by-Step Multi-Stage VAT Schedule

Stage 1: Import Stage

• VAT paid at Customs = Rs. 5,200 $\rightarrow$ Import Cost Excl. VAT = $\frac{5,200}{0.13} = \mathbf{Rs.\; 40,000}$.

Stage 2: Importer to Retailer

• Importer Cost = $40,000 + 3,000 \text{ (carriage)} = \text{Rs. } 43,000$
• Profit Margin (10% on cost) = $10\% \times 43,000 = \text{Rs. } 4,300$
• Importer Selling Price Excl. VAT = $43,000 + 4,300 = \mathbf{Rs.\; 47,300}$
• Output VAT @ 13% = $47,300 \times 13\% = \text{Rs. } 6,149$
• Net VAT to Govt by Importer = Output VAT ($6,149$) - Input VAT Credit ($5,200$) = Rs. 949

Stage 3: Retailer to Customer

• Retailer Cost Outlay = $47,300 + 1,000 \text{ (selling exp)} = \text{Rs. } 48,300$
• Profit Margin (20% on outlay) = $20\% \times 48,300 = \text{Rs. } 9,660$
• Retailer Selling Price Excl. VAT = $48,300 + 9,660 = \mathbf{Rs.\; 57,960}$
• Output VAT @ 13% = $57,960 \times 13\% = \mathbf{Rs.\; 7,534.80}$
• Net VAT to Govt by Retailer = Output VAT ($7,534.80$) - Input VAT Credit ($6,149.00$) = Rs. 1,385.80

Summary Answers:

1. Cost Price to Customer (Price Incl. VAT):
   $$\text{Customer Price} = 57,960 + 7,534.80 = \mathbf{Rs.\; 65,494.80}$$
2. Total VAT Payable to Government at Each Stage:
   • At Customs Import Stage: Rs. 5,200.00
   • By Importer: Rs. 949.00
   • By Retailer: Rs. 1,385.80
   • Total VAT Collected by Government: $5,200 + 949 + 1,385.80 = \mathbf{Rs.\; 7,534.80}$

Part (b): “Value Added Tax is Levied on Added Value of Goods and Services”

• VAT avoids the cascading effect (tax on tax) of old sales taxes.
• Each intermediary pays tax on output sales but receives credit for tax paid on business inputs. Consequently, the net tax paid at each level equals exactly 13% of the incremental value added at that stage.

Solution: Investment Income and Residential Status Criteria

Part (a): Assessable Income from Investment of Mr. Hari

Gross Inclusions (Section 9):

1. Income from Natural Resources (Gross: $340,000 / 0.85$): Rs. 400,000 (TDS Rs. 60,000)
2. Royalty Income (Gross: $170,000 / 0.85$): Rs. 200,000 (TDS Rs. 30,000)
3. Interest from Private Money Lending: Rs. 210,000
4. Asset Rental Income (Gross: $90,000 / 0.90$): Rs. 100,000 (TDS Rs. 10,000)
5. Compensation Received relating to Investment: Rs. 50,000
6. Foreign Dividend Income: Rs. 85,000

• Total Gross Investment Inclusions: Rs. 1,045,000 (Notes: Resident dividend and fixed deposit interest are final withholding under Sec. 92; House rent of an individual is subject to local municipality tax).

Allowable Investment Deductions:

1. Collection cost of natural resources: Rs. 1,000
2. Interest collection charges on private loan: Rs. 2,000

• Total Deductions: Rs. 3,000

Total Taxable Income Statement

Tax Liability (Couple / Individual Status)

• Tax on first Rs. 500,000 @ 0% (Investment income has 0% on 1st slab) = Rs. 0
• Next Rs. 200,000 @ 10% = Rs. 20,000
• Remaining Rs. 292,000 @ 20% = Rs. 58,400
• Total Tax Liability: $20,000 + 58,400 = \mathbf{Rs.\; 78,400}$
• Less: Foreign Tax Credit (Section 71): Allowed up to average rate on foreign income.

Part (b): Statutory Conditions for Residential Status (Section 2)

1. Natural Person: Resident if residing permanently in Nepal, or staying in Nepal for 183 days or more during an income year, or deployed abroad as a government employee.
2. Partnership Firm: Resident if registered in Nepal under the Partnership Act.
3. Trust: Resident if established in Nepal, or trustee is a resident person, or controlled by a resident person.
4. Company: Resident if incorporated under the laws of Nepal, or its effective management is situated in Nepal during the income year.

Allowable Reductions for a Natural Person (Sections 12, 12A, 12B, and 63)

In computing the taxable income of a resident natural person from total assessable income, the Income Tax Act, 2058 allows the following statutory reductions:

1. Contribution to Approved Retirement Fund (Section 63):
   • Deductible up to the lowest of:
     • Actual contribution made.
     • One-third (1/3rd) of total assessable income.
     • Statutory ceiling of Rs. 300,000.
2. Life Insurance Premium (Schedule 1 Section 1(12)):
   • Deduction for annual life insurance premium paid on self-policy up to a maximum of Rs. 25,000 (or revised limits).
3. Health Insurance Premium (Schedule 1 Section 1(16)):
   • Deduction for premium paid for health insurance of self up to Rs. 20,000.
4. Private Building Insurance Premium:
   • Up to Rs. 5,000 for residential building insurance against natural disasters.
5. Donation to Tax-Exempt / Approved Entities (Section 12):
   • Deductible up to the lowest of:
     • Actual donation paid.
     • 5% of adjusted taxable income.
     • Maximum ceiling of Rs. 100,000.
6. Remote Area Allowance (Section 50 & Schedule 1):
   • Deductions ranging from Rs. 10,000 to Rs. 50,000 depending on the assigned hardship zone (Class A to E).
7. Incapacitated / Disabled Person Additional Exemption:
   • Additional 50% exemption above the normal basic threshold for certified physically disabled persons.

Concept and Major Features of Tax Auditing

1. Meaning of Tax Auditing

A tax audit is an independent, systematic examination and verification of a taxpayer’s books of account, financial statements, sales registers, purchase vouchers, and tax returns conducted by tax officers (Inland Revenue Department) to ensure that the taxpayer has correctly calculated taxable income, adhered to statutory deductions, complied with TDS mandates, and paid the correct tax.

2. Major Features of Tax Auditing

1. Statutory and Regulatory Backing:
   • Conducted under the statutory authority of the Income Tax Act, 2058 (Section 101) and Value Added Tax Act, 2052.
2. Risk-Based Selection Criteria:
   • Taxpayers are selected for detailed tax audits using computerized risk-profiling algorithms based on high refunds, chronic loss declarations, large fluctuations in turnover, or cross-border related party transactions.
3. Comprehensive Scope:
   • Encompasses direct income taxes, value added tax, excise duties, and withholding tax (TDS) records.
4. Independent Documentary Verification:
   • Tax auditors perform physical cross-verification of vendor VAT invoices, bank statements, customs clearance declarations, and physical inventory stock counts.
5. Detection of Tax Evasion and Revenue Leakage:
   • Aims to uncover suppressed sales, inflated fake purchase invoices, fictitious expenses, and under-reported perquisites.
6. Basis for Amended Assessments:
   • If discrepancies are proven, the tax auditor issues a formal reassessment order (Amended Assessment), levying additional back-taxes, statutory interest, and penal fines.

Solution: SS Trades Fixed Asset Depreciation and Loss Carry-Forward

Part (a): Depreciation Schedule for SS Trades (Schedule 2)

Asset Pooling Rules:

• Block ‘B’ (Office Equipment, Furniture): Depreciation Rate = 25%
• Block ‘C’ (Automobiles): Depreciation Rate = 20%
• Addition Absorption Rules:
  • 1st Period (Shrawan to Poush): 100% (3/3)
  • 2nd Period (Magh to Chaitra): 66.67% (2/3)
  • 3rd Period (Baishakh to Ashad): 33.33% (1/3)

Step 1: Computation of Depreciation Basis and Allowable Depreciation

Step 2: Repair and Improvement Cost Allocation (Section 16)

• Statutory Limit: 7% of Depreciation Basis:
  • Block B: $7\% \times 700,000 = \text{Rs. } 49,000$. Actual: Rs. 40,000 $\rightarrow$ Full Rs. 40,000 is deductible (Rs. 0 capitalized).
  • Block C: $7\% \times 1,200,000 = \text{Rs. } 84,000$. Actual: Rs. 90,000 $\rightarrow$ Rs. 84,000 is deductible, and excess Rs. 6,000 is capitalized.

Step 3: Closing Value of Fixed Assets at the End of the Year

Part (b): Set-Off and Carry-Forward of Business Losses (Section 20)

Rules: Under Section 20, unabsorbed losses can be carried forward for 7 following income years.

1. Adjusted Operating Results:

• Year 6: Profit before adjustment = Rs. 30,000. Less: Bank interest Rs. 20,000 $\rightarrow$ Adjusted Profit = Rs. 10,000.
• Year 7: Profit Rs. 100,000. Add: Commission Rs. 10,000 + Add back: Pollution Control Cost Rs. 300,000 (calculated separately) $\rightarrow$ Gross Rs. 410,000. Pollution control cost deductible up to 50% limit ($410,000 \times 50\% = 205,000$). Adjusted Profit = $410,000 - 205,000 = \text{Rs. } 205,000$.
• Year 8: Profit = Rs. 150,000.
• Year 9: Profit before donation = $200,000 + 100,000 \text{ (donation addback)} = \text{Rs. } 300,000$.
• Year 10: Profit = Rs. 120,000.

2. Loss Set-Off Schedule:

• Year 6: Profit Rs. 10,000. Set off against 2nd Year loss (Rs. 30,000). Taxable Income = Nil. Remaining 2nd year loss = Rs. 20,000.
• Year 7: Profit Rs. 205,000.
  • Set off remaining 2nd Year loss: Rs. 20,000.
  • Set off 3rd Year loss: Rs. 40,000.
  • Set off 4th Year loss: Rs. 50,000.
  • Set off 5th Year loss: Rs. 60,000.
  • Total losses set off = $20,000 + 40,000 + 50,000 + 60,000 = \text{Rs. } 170,000$.
  • All prior losses are now fully absorbed!
  • Remaining Taxable Income for Year 7 = $205,000 - 170,000 = \mathbf{Rs.\; 35,000}$.
• Year 8: Taxable Income = Rs. 150,000.
• Year 9: Profit before donation = Rs. 300,000. Allowable donation to PADT (Sec. 12): 5% of 300,000 = Rs. 15,000. Taxable Income = $300,000 - 15,000 = \mathbf{Rs.\; 285,000}$.
• Year 10: Taxable Income = Rs. 120,000.

Solution: Proprietorship Business Income, Taxable Income, and Tax Liability

Step 1: Depreciation Basis for Block ‘D’ (Plant)

• Opening WDV = Rs. 400,000
• Addition on 15th Chaitra (2nd period $\rightarrow$ 2/3rd absorption): $120,000 \times 2/3 = \text{Rs. } 80,000$
• Less: Disposal Proceeds = (Rs. 80,000)
• Depreciation Basis: $400,000 + 80,000 - 80,000 = \mathbf{Rs.\; 400,000}$
• Allowable Depreciation (15%) = $400,000 \times 15\% = \mathbf{Rs.\; 60,000}$
• Repair Limit (7% of Rs. 400,000) = Rs. 28,000. Actual repair = Rs. 30,000 $\rightarrow$ Rs. 28,000 allowable, excess Rs. 2,000 capitalized.

Part (i): Assessable Income from Business (Section 7)

Part (ii): Statement of Total Taxable Income

Part (iii): Computation of Tax Liability (Individual Status)

• First Rs. 500,000 @ 0% = Rs. 0
• Next Rs. 200,000 @ 10% = Rs. 20,000
• Next Rs. 300,000 @ 20% = Rs. 60,000
• Remaining Rs. 189,000 ($1,189,000 - 1,000,000$) @ 30% = Rs. 56,700
• Total Tax Liability: $20,000 + 60,000 + 56,700 = \mathbf{Rs.\; 136,700}$

Historical Evolution of Income Taxation in Nepal and Duties of Taxpayers

Part (a): Historical Development of Income Taxation in Nepal

The history of income taxation in Nepal reflects the transition from feudal tributes to a modern, self-assessed, rule-based legal system:

1. Pre-Democratic Era (Before 1951 AD / 2007 BS)

• Under the Rana regime, there was no formal, codified direct income taxation.
• Revenue was generated through agricultural land revenue (Pota), customs transit duties (Sair), export levies, forest royalties, and arbitrary feudal tributes (Jhara, Rakam).

2. Introduction of Formal Income Tax (1959 AD / 2016 BS)

• The first democratic budget (presented in 2016 BS by Finance Minister Subarna Shumsher) introduced formal income taxation through the Business Profits and Remuneration Tax Act, 2016.
• Applied strictly to business profits and formal employee salaries, with a top rate of 25%.

3. Income Tax Act, 2019 (1962 AD)

• Replaced the 2016 Act, broadening the tax base to include all sources of income (rents, professions, investments) under nine distinct income heads.

4. Income Tax Act, 2031 (1974 AD)

• Governed taxation for nearly three decades, introducing presumptive taxation, self-assessment options, and formal appellate structures.
• However, it suffered from widespread administrative discretion, excessive tax exemptions, multiple arbitrary deductions, and complex schedules.

5. The Modern Era: Income Tax Act, 2058 (2002 AD)

• Enacted with IMF and international technical cooperation, effective from 1st Chaitra 2058.
• Revolutionary Features:
  • Codified income into three comprehensive heads: Employment, Business, and Investment.
  • Introduced the global income principle for residents and source principle for non-residents.
  • Implemented the asset-pooling system of depreciation (Blocks A through E).
  • Codified comprehensive self-assessment, computerized PAN, electronic tax filing (e-TDS, IRD portal), and universal appeal procedures.

Part (b): Duties of a Taxpayer under Income Tax Act, 2058

Every person having taxable income or conducting commercial transactions is bound by statutory duties:

1. Mandatory Registration (Obtaining PAN):
   • Must register with the Inland Revenue Department and obtain a Permanent Account Number (PAN) before commencing business operations.
2. Maintenance of Proper Books of Account (Section 81):
   • Must maintain complete, accurate accounting records and supporting vouchers (in Nepali or English) for at least five years.
3. Filing of Estimated Tax Return and Advance Tax (Sections 94 & 95):
   • Taxpayers with business or investment income must file an estimated tax return and pay advance tax in three statutory installments:
     • 1st Installment (Poush end): 40%
     • 2nd Installment (Chaitra end): 70%
     • 3rd Installment (Ashad end): 100%
4. Filing of Annual Income Tax Return (Section 96):
   • Must submit a complete self-assessment income tax return along with audited financial statements within three months from the end of the income year (i.e., by Ashwin end), unless officially extended.
5. Tax Deduction at Source (TDS) and Timely Remittance (Sections 87–90):
   • Withholding agents must deduct applicable TDS on salaries, rents, contract payments, and service fees, and deposit it into the government treasury within 25 days of the following month.
6. Cooperation During Tax Audits and Information Requests (Section 82):
   • Must produce books, ledgers, computer data, and bank records upon lawful request by tax officers and attend hearings.