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Taxation Policy
Treating Losses Under Income Tax System

By Rup Khadka

INCOME tax is levied on net income (profit) which is obtained by deducting allowable income related expense from the gross income. Sometime, a taxpayer may face a situation where expenses may be more than income. The excess of expenses over income may be defined as loss. There is a common practice around the world to provide some sort of relief for losses incurred by a taxpayer.

Some countries allow taxpayers to carry over the loss to offset it against profit in the future years while others allow to carry back losses to offset it against profits in previous years while still some countries adopt a combination of both. Since carry back losses have both revenue and administrative implications, it is used to a limited extent by only a few countries. For example, it is justified in the case of long-term contract, where taxpayers bunch all expenses in
the beginning but receive income at the end.

Some countries allow taxpayers to carry back or forward loss for an unlimited period until it is adjusted fully while others fix some time limits. While unlimited carry forward or backward may be desirable from an economic point of view, limitation is desirable on the fiscal and administrative ground since unlimited carry back or forward of losses creates scope for abuse by so called loss companies.

Some countries allow taxpayers to set off loss against any source of income while others allow to adjust losses from the related source income only . Still some countries fix quarantine rules in a broad term for specific type or source of losses. For examples, foreign losses can be offset against foreign income only.

It is desirable to liberalise the rules relating the tax treatment of losses in order to make the tax system growth oriented. In this context, taxpayers may be allowed to deduct losses from any sources of income and carry back or forward for a relatively longer period. The Nepalese draft Income Tax Act 2001 has adopted more liberal provisions than the existing ones.

Nepalese Practice

In Nepal, under the 1962 act, a taxpayer that had been submitting tax returns and paying tax accordingly was allowed to carry forward losses for two years. Such losses could be deducted only from that source of income from which the loss had been incurred but could bot be offset against any other category of income.

Under the 1974 law also losses can be carried forward for two years. However, losses cannot be carried forward if a taxpayer has not submitted particulars of income. Similarly, net losses incurred during any period of income tax holiday or losses incurred in earning income from "other sources" also cannot be carried forward. Similarly, losses sustained because of the failure to conduct business throughout any year by the taxpayer himself shall not be deducted from the profits of the year in which business has been conducted.

Proposed System

The draft Income Tax Act 2001 has proposed more detailed and liberal provisions relating to the treatment of losses. Under this act for the purposes of calculating the income of a person for an income-year from a business or investment, any unrelieved loss of the year incurred by the person from any other business, and any unrelieved loss of the previous four (seven years under specified circumstances) income-years incurred by the person from any business will be deducted. Where a person may deduct an unrelieved loss in calculating the person’s income for an income-year from more than one business or investment, the person may priorities in which calculations the loss or part of the loss is deducted.

While losses are deductible but their treatment differs depending upon their nature and sources. Losses incurred from a domestic business are deductible against all types of income from any sources (domestic or foreign. Losses from a domestic investment can be deducted only against investment income whether domestic or foreign. Foreign losses can be offset against foreign source income only. Of the foreign losses, business losses can be offset against foreign business or investment income while the losses from foreign investment may be deducted from foreign investment income only.

Taxpayers may carry forward losses for the following four years. However, in the case of electricity projects that involve building power stations, generating and transmitting electricity and projects conducted by any entity involving the building of public infrastructure, which is owned operated and then transferred to HMG/N, any unrelieved loss of the previous seven years shall be deducted.

Taxpayers involved in banking, insurance and long-term contract businesses, in addition to the carry forward of losses, are also allowed to carrying back their losses. For example, where a person incurs a loss for an income-year from any banking business, the person may carry back the loss and deduct it in calculating the income from the business for any of the five preceding income-years subject to some limits. Like in the case of banking business, if a person involved in general insurance business incurs a loss for an income-year from any registered general insurance business, the person may carry back the loss and deduct it in calculating the income from the business for any of the five preceding income-years. However, the lsos can not exceed certain limit fixed by the law.

Similarly, if a long-term contract of the person’s business is completed or otherwise disposed of by the person, and the loss is attributable to the long-term contract, the Department may, by notice in writing , allow the loss to be (a) carried back to a proceeding income-year or years; and (b) treated as an unrelieved loss of that year or years in an amount not exceeding the amount by which inclusions in calculating the income from the business to which the long-term contract relates for that year or years exceed deductions relating to the contract.

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