Basic Allowances Under the Nepalese Income Tax System

By Rup Khadka

THE basic allowance, which is provided under almost all income tax systems, is simply a slice of income received free of tax by every taxpayer. While there is no hard and fast rule regarding the appropriate level of basic allowance, it is generally granted to relieve the minimum subsistence level of income of an average family from income tax. Other factors that need to be considered at the time of determining the level of basic allowance may be per capita income, equity and administration. Because of large number of low income earners are relieved from the tax net. It simplifies the tax administration.

Under the basic allowance system, large income groups get more benefit than the lower income groups due to the applicability for lower marginal rate to high income. In response to this, some recommended the vanishing formula system. Under this system, the level of basic allowance decreases with an increase in the level of income. However, since the vanishing formula system is administratively complicated, countries have hardly adopted it.

Some countries have adopted the tax credit system in place of basic allowance. Since the tax credit system simplifies tax administration, relieves lower income group from the burden of taxation, improves equity but at the same time enhance collection it has been becoming popular.

Under the tax credit system, a certain amount is deducted from the liability rather than from the net income. Under this system, taxpayers received a tax credit i.e. specified amount is deducted from his total tax liability rather than from his income and tax is not levied on income, corresponding to the amount of tax credit to keep low-income earners of out of the tax net.

Since every taxpayer gets the same amount relief irrespective of their level of income under the tax credit system, it eliminates the difference in benefits among the levels, of income that exist under the basic allowance system. This is equitable since value of the tax credit, as proportion of income is greater for lower income group, while the rupee value of the credit is the same for all taxpayers.

Nepal has been providing basic allowance for taxpayers since the inception of income tax in 1959 /60. The basic allowance was available to all kinds of taxpayers including temporary residents from 1959/60 to 1964/65. However, it has not been granted to temporary resident taxpayers since 1968/69.

The same level of basic allowance was fixed for all types of taxpayers between 1959/60 and 1966/67. This system, however, was changed in 1967/68, when separate levels of allowances were fixed for individuals, married couples and families. The same level of basic allowance was fixed for both married couples and families in 1974/75. However, a separate level of basic allowance was fixed for couples and families in 1975/76. Again in 1978/79, the same level of basic allowance was fixed for married couples and families and this practice continues to date.

For the purpose of basic allowance, business firms were treated as individuals from 1967/68 to 1974/75 but since 1975/76 the basic allowance to business firms has been provided according to the marital status of the owners of such firms.

The original level of basic allowance was Rs. 7000. However, in the light of rising prices, upward revisions were made, as indicated in the following table, from time to time in the level of the allowance and the current level is Rs. 55,000 for individuals and 75,000 for married couples and families.

Thus, the first slice of income generally required for the minimum subsistence has always been exempt from income tax. Whether such a limit is fixed revised from time to time according to minimum subsistence levels is questionable. An examination of the period and rate of revision of the allowance indicates that such revisions were effected on an ad hoc basis: sometimes revisions were made year after year whilst at other times the level of allowance remained unchanged for several years and the rate of change has varied considerably. There appears to be no correlation with the rate of inflation, which has far exceeded the rate of increase of basic allowances.

Some suggestions were made in the past: that the level of basic allowances should be lowered or that no upward revisions be made, at least for some years. Such a view, however, cannot be justified in the face of persistently high inflation and also on administrative grounds. Reduction in the level of basic allowance would increase the number of taxpayers thereby entailing, inter alia, administrative problems and, in addition revenue benefits would probably be out weighted by other factors.

Since the Nepalese income tax law does not provide for dependency allowances except that a higher level of basic allowance is provided for married couples and families than for individuals. The higher allowance, however, is not enough to meet the cost of caring dependents. Thus, the system of allowances is biased in favour of individuals. Then again, as the basic allowance for married couples and families is the same, the system totally ignores the cost of caring for children and other dependents.

Thus, under the existing system, families get relatively little relief compared with married couples, whilst individuals get more relief than both families and married couples. It is an inescapable fact that the cost of caring for dependents is closely linked to their number and their age. This demands for a higher level of basic allowance for families than for the married couples, in a country where separate allowance for dependents is not granted. On the other hand, basic allowance system based on the number of children might be misused by some taxpayers who create artificial children. For simplicity sake, it is a desirable to limit the type of allowance but to fix it at the higher level. There will be even more justification for a higher level of basic allowance with the implementation of the draft Income Tax Act 2001 which will bring many sources of income in the income tax net which are currently kept outside the tax net.

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