Income Tax Treatment of Retirement Savings
An Overview

By Rup Khadka

GENERALLY, pensions and gratuity constitute retirement incomes. Pension is a stream of income paid over a period of time while gratuity is a lump sum one-time payment. Sometimes employees receive income in other forms also such as termination payment.

In Nepal, retirement savings are largely managed by the Employees Provident Fund. However, some entities run their provident fund themselves but are controlled by income tax regulations. For example, they cannot deduct contribution made to the provident fund more than specified percentage of the salary of the employees. Citizen investment fund which is like a pension fund also handles citizen’s saving. Pension funds are likely to grow with the pace of economic development.

Retirement savings have been exempt completely from the income tax net. For example, amounts deducted from remuneration and credited to the provident fund up to 10 per cent of salary are deductible while assessing an income tax liability of the employees. Similarly, the amount credited to such fund by the employers, up to 10 percent of the salary of employees, is also deductible expense for the employers. It is, however, necessary to meet following condition for funds other than the Employees Provident Fund:

Deductions have been made from the monthly salary of the employee at rates not higher than those prescribed in the Employees Provident Fund Act. Only a matching contribution has been made to the amount deducted from employees’ salary; These amounts have been credited to a separate account in any bank within the Kingdom of Nepal or have been invested in loan bonds of HMG, Arrangements have been made so that income made from such investments cannot be incorporated in the accounts (of the employing institutions) of appropriated by it, arrangements have been made to return to the appropriate employee the amount credited in his name in case he leaves his service for any reason.

Further, income of the employees saving fund is exempt from income tax. Further the amount paid to any employee as principal, interest or bonus in consideration of his savings in the savings fund is also exempt. Thus retirement savings are exempt in both the way in and way out.

Similarly, the amount allocated on account of gratuity etc. is deductible expense for employers and it is exempt from income tax at the hand of employees also. Similarly, amount deposited to the citizen investment fund is also exempt from income tax. Not only that, income received from the fund is also exempt.

Such a system is prone to misuse. For example, it opens scope between the employers and employees to negotiate on the remuneration package in such a way that they can minimise their tax liabilities. For example, they can keep the normal salary low but keep high amount for gratuity or termination income. In this way, employers can separate high amount for gratuity and can claim for deduction. Later on when it is paid to employees no tax is levied on such payments. This erodes the tax base. Generally, high flyers take advantage of this system.

The draft income tax act 2001 tries to check such loopholes by bringing all sorts of income into the tax net.

This law makes detailed provision relating to the tax treatment of retirement savings. Tax treatment differs in the case of approved and unapproved retirement funds. According to this law, retirement fund means any entity established and maintained solely for the purposes of accepting and investing retirement fund contributions in order to provide retirement fund payments to individuals who are beneficiaries of the entity or a dependent of such an individual. Approved retirement funds are defined retirement funds that are approved by the Tax Department while all others are not approved retirement funds.

Retirement contribution means a payment made to a retirement fund for the provision or future provision of retirement payments. In case where a resident person files an application with the Tax Department intending to get approval for establishing a retirement fund, the Tax Department shall pronounce the approval as prescribed. An individual who is a beneficiary of an approved retirement fund may claim to have their taxable income for an income-year reduced by retirement contributions made by the individual during the year to the fund. However, the reduction claimed by an individual for any income-year shall not exceed the prescribed retirement limit.

The income of an approved retirement fund will be exempt from tax. Where an approved retirement fund ceases to be an approved retirement fund, it shall pay income tax in an amount equal to the company tax rate of 25 percent.

Retirement payments in the hands of employees are taxable. Retirement payments are defined as payments to an individual in the event of the individual’s retirement; or a dependant of an individual in the event of the individual’s death. For the purposes of calculating the income of an individual from an interest in an approved retirement fund there shall be included any retirement payment made by the fund in respect of the interest; and where the payment takes the form of a lump sum payment, it shall be treated as a gain from the disposal of a non-business chargeable asset of an investment of the individual.

With respect to the gain of an individual from an interest in an unapproved retirement fund in the case where the proceeds are paid by a resident person, it shall be taxed in the hands of the individual beneficiary in the form of a final withholding tax and in the case where a non-resident person pays the proceeds, it shall be included in calculating the income of the individual beneficiary.

Thus under the new law retirement savings will not be exempt fully. They will be exempt in the way in and taxed in the way out. It will be a tax deferral.

The Popular Weapon

By BT

STRIKES, bandhs, chakkajams, gheraos, picketing, lockups, pen-down, slogan shouting, display of dark flags, relay hunger strikes, rallies, effigy burning, protest letters, corner speeches, mass meetings- these are the activities that have set unprecedented records. If these were the measuring rods of social advancements, Nepal would have stood as a forerunner in the globe. Whenever we feel less than satisfied with anything related to us, our knee-jerk response is shout slogans and protest. And the steps mentioned above are the most popular and handy weapons.

The objective here is not to go against people’s rights to protest as guaranteed in the Constitution. The purpose is to try to examine if we are exercising them a bit too much besides the fact that too much of anything is not nice. Of course, it is being widely felt that these rights are being exercised a little too much. Couldn’t they be brought down to the level where it would be appreciated?

Everyone is capable of pontificating about his adhikar (rights) but blind about his responsibilities and obligations. It is this very attitude that is debilitating democratic institution, it seems. Democracy is not expected to deliver unless its practitioners shun the temptations to meddle in petty bickering. There is little potential to see real difference until the culture of honesty and hard work get the solid foundation. Great ideals could foster if they passed downward and spread effectively at the grassroots level.

Protests launched timely for larger cause with unity can change things. However, despite the strikes galore, we never get the expected fruits. The reason is obvious: the interests are narrow and partisan and the strength factional and fractional. Attainment of goals is no more than a moth’s desire for the moon. End is more important than the means. Therefore, protest for protest’s sake holds no substance.

The inheritance is a sort of top-down in structure as the trails are blazed by the political parties. The culture is passed to their sister organisations, educational institutions, health facilities, transport workers, local government units and even individuals. The love for hadtal (protest) only gives rise to mob culture which is, more often than not, more destructive than creative in nature.

If you have means and advantages at your disposal, immediate next thing you must have is the prudence as to how not to use them. Or you may end up making mean use of your means and impoverish the lofty purpose of your privilege. This kind of deviation from the golden path of propriety gives birth to the widely abhorred decadence. This might be because of sheer ignorance, haughtiness or due to the chasm existing between knowledge and wisdom.

Our revered Constitution has empowered us with rights and privileges that could not be even imagined under the totalitarian dispensation. We seem to be not just proud of them but try to apply them in hubris many a times. We try to make use of our rights in such a manner that the whole purpose of the provisions become cheap and the manner tend to show ugly form. When the concerned parties are not bound by strong culture, moral values and political standards, there is the danger of using the provisions enshrined in the nation’s supreme document to give vent to petty complaints.

Why the ignorance that the generous Constitution also binds us all by the terms and conditions regarding duties and responsibilities? Rights in the true sense may be for those who abide by the responsibilities laid down upon them. Responsibilities and rights are inseparable entities and both command equal attention and obedience. The problem may have cropped up from the fact that while we have over-emphasised the one while overlooking the other.