LEGAL SIDE

By B.M. Dhungana & Manish Amatya

Explanation of the Provision of Tax on Employee's Remuneration Under Income Tax Act 2058.

Repealing the Income Tax Act 2031 (let’s call it the “Old Act”), the Parliament has enacted the Income Tax Act 2058 (let’s call it the “New Act”) and it was promulgated on April 1, 2002. It will govern the income tax matter retrospectively starting from July 16, 2001; though some officials and legal practitioners argue that it comes into effect only from the date of enactment.

As per Section 3(a) of the New Act, the income tax is to be realised from every person who has a taxable income for the year. For the purpose of levying tax in Nepal, persons are classified into resident in Nepal and not resident in Nepal. In case of a person resident in Nepal, his total income, irrespective of whether it is earned in Nepal or at a place outside Nepal, is subject to tax in Nepal, while in the case of a non-resident, only the income that is earned from sources in Nepal is taxable in Nepal.

Income earned in Nepal is taxable under the following heads:

1.   Income from business (commonly know as Business Income)

2.   Income from employment; and

3.   Income from investments.

This article is about the tax on the second category of income. The New Act brings under the tax net any benefit, whether directly or indirectly earned by or accruing to an individual from his employment. Unlike the Old Act, the New Act brings the various perquisites provided to the employees by the employers under the tax net. Similarly, the New Act brings under tax net any contribution made by the employer towards the retirement benefit of its employees. Further, the New Act has withdrawn a number of concessions given by the Old Act (see box in the next page).

General

The New Act defines “Income from Employment” as individual’s remuneration from the employment for the year [Section 8(1)]. Section 8(2) spells down various payments made by the employer that are to be included in the total income of the employees. These are as follows:

1.   Wages, salaries, leave pay, overtime pay, fees, commission, prizes, gifts, bonus, and other facilities;

2.   Any personal allowances, including those paid as cost of living allowance, subsistence allowance, rent allowance, entertainment allowance and transportation allowance;

3.   Any discharge or reimbursement of cost incurred by the employee or his relative;

4.   Payment for any agreement/consent to conditions of the employment;

5.   Payment for termination, loss of service including compulsory termination of employment;

6.   Any contribution made by the employer towards the retirement fund including retirement payments;

7.   Other payment made in respect of the employment and

8.   Other amounts required to be included under Chapters 6 and 7; i.e. perquisites and any gains due to change in tax accounting.

However, the following shall not be included in calculating an employee’s income from employment:

1.  Income that is exempt under section 10 of the New Act and final withholding payments;

2.  Meals or refreshment provided at the place of employment by or on behalf of the employer to the employees that are available to all the employees on similar terms;

3.  Any discharge or reimbursement of cost incurred by an employee for the business purposes of the employer;

4.  Payment of prescribed small amounts that are administratively impracticable or unreasonable to be accounted for.

Perquisites Valuation

Perquisites generally mean any facility provided by the employer to its employees, the benefit of which is derived by the employees for which otherwise the employee has to pay in cash, e.g. rent free accommodation, use of the employer’s asset, interest free loans or loans provided at a concessional rate of interest etc. The Old Act provided for the inclusion of the amount of personal obligations of the employees that are met by the employer in the total income of the employee. However, due to the absence of any specific valuation norms and the lack of specific list of such obligations in the Old Act, these facilities were not considered while computing the income of the employees.

Under the New Act, the valuation of the various perquisites is provided under Section 27. As per this Section, the value of the perquisites provided by the employer will be determined as per the Rules and where the Rules do not provide for such valuation then it will be determined on the basis of arms length price at market value. The following may be noted in respect of valuation of perquisites:

1.   Where the employer transfers any of its assets in favour of an employee, then the value of such asset to be included in the income of the employee as income from employment would be the fair market value of the asset on the date of transfer. If the employee pays for the asset then the amount so recovered from the employee should be deducted from the market value so determined and the balance should be included in the income of the employee as income from employment.

2.   The valuation of the benefit derived by the employee from a vehicle provided by the employer wholly or partly for personal use will be determined in accordance with the Rules made thereunder. 

3.   The valuation of the benefit derived by the employee from a provision of a house provided by the employer will be determined in accordance with the Rules made thereunder. However, if an employee pays rent to the employer in respect of the house so provided, the total value to be included under income from employment will be the amount so determined as per the Rules as reduced by the amount of rent recovered from the employee.

4.   In respect of the following facilities provided by the employer to its employees, the amount to be included in the income of the employee as income from employment shall be the actual expense incurred by the employer in making available the facilities to the employees as reduced by the amount of contribution made by the employee:

      a) The service of a housekeeper, cook, chauffeur, gardener, or other domestic assistant;

      b) Any meal, refreshment or entertainment other than meals provided by the employer to its employees at the place of employment that are available to all the employees on similar terms;

      c) Drinking water, electricity, telephone and the like facilities at the employee’s residence;

5.   Where the employer provides its employees interest free loans, the value of such benefit shall be the prevailing market rate of interest and where such loan is provided at a concessional rate of interest, then the value of the benefit shall be the difference between the prevailing market rate of interest and the rate of interest charged by the employer to its employee.

Retirement Funds

The New Act envisages the concept of a Retirement Fund that may be approved or unapproved. A fund which is approved by the Department of Internal Revenue is known as an Approved Retirement Fund and a fund, the approval of which is pending or not given is known as an Unapproved Retirement Fund. The employer may contribute to an Approved Retirement Fund towards the retirement benefit of his employees. Where the employer wishes to maintain its own retirement fund towards which he makes his contribution, he can do so with approval from the department. Any contribution made by the employer to an Approved Retirement Fund is allowed as deduction in computing the total income of the employer.

As per the provision of Section 63 of the New Act, an individual is allowed to claim deduction in respect of the contribution made by him to the Approved Retirement Fund. Hence an employee shall be allowed deduction from his total income in respect of the employee’s contribution to an Approved Retirement Fund.

Any income derived by an individual from a retirement fund whether approved or unapproved is included under Income from Investment under Section 9. Section 9(2)(a) provides that Income from Investment shall include “…….. any gain from unapproved retirement fund or retirement payment made by an approved retirement fund referred to in section 63(1).”

Section 65 of the New Act governs the provision relating to retirement payment and income derived from the retirement fund. Sub-section 1 provides that any retirement payment made from an approved retirement fund to the individual who has an interest in such fund shall be included in his income as Income from Investment. However as per sub-section 2, where the payment is made in lump sum, 50% of the amount so paid or Rs. 5 lakhs whichever is more, is allowed as deduction and the balance shall be treated as gain from disposal of a non-business chargeable asset of an individual and considered as Income from Investment of the individual.

Where an individual derives any gain from an interest in an unapproved retirement fund, it shall be chargeable to tax as follows:

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 which is fixed at 10%;

Where the proceeds are paid by a person not resident in Nepal, it shall be included in the income of the individual beneficiary as Income from Investment.

Medical Tax Credit

The New Act has come out with a concept of Medical Tax Credit. Under this concept an individual is not allowed deduction in respect of his medical expenses but allowed a rebate from his total tax liability. Under Section 51 of the New Act, an individual is allowed a rebate from his total tax liability of an amount equal to 15% of approved medical expenses incurred by him. However, the rebate allowed in a particular year is restricted to the limit as prescribed by the Department or the amount of tax liability whichever is less. In case where 15% of the approved medical expenses exceeds the limit as prescribed by the Department or the amount of tax liability, the balance of such credit is allowed to be carried forward and included in Medical Tax Credit of the next year for claiming rebate.

Hence, where the medical expenses incurred by an employee is reimbursed by the employer, such reimbursement is included in the income of the employee as income from employment and the employee is allowed a rebate in respect of the approved medical expenses as discussed above.

Withholding of taxes

Section 87 of the New Act casts an obligation on the employer, who is resident in Nepal, to withhold tax at the rates as specified in Schedule 1 (as given in the accompanying box) in respect of the payment made by him,  that is required to be included in the total income of the employee as income from employment.

In case of computing the tax liability of an individual living in a remote area, the exemption limit of Rs. 55,000/75,000 is increased by the amount as may be prescribed in the rules not exceeding Rs. 30,000. Hence if the employer pays a remote allowance to the employee then it shall be included in the income from employment of the employee and his tax liability will be calculated by increasing the tax exemption limit by the amount as may be prescribed in calculating his tax liability.

In view of Section 87, an employer has to compute the total tax payable by the employee for the year according to the various provisions of the New Act and deduct tax proportionately on a monthly basis as and when the salary is disbursed. In such a situation an employer is faced with practical difficulty in estimating the amount of medical expense that will be incurred by the employee during the year. This difficulty may be resolved by asking the employees to make a declaration at the beginning of the year about the estimated amount of approved medical expenses that he is likely to incur. His total tax liability for the year may be computed by allowing rebates on the basis of the declaration so made and tax deducted accordingly. However, if the employee before disbursing the salary for the last month of the year fails to commit his declaration, his tax liability would be recomputed disallowing the rebate previously allowed and tax computed and deducted accordingly.

The amount of tax deducted is required to be deposited with the department within 15 days of the subsequent month. Where the employer has deducted tax from the remuneration paid to his employees, he is required to issue a certificate of tax deducted to the employee in the form as may be prescribed. Such certificate is required to be issued within a period of 30 days from the end of the year and where the employee leaves the employment during the year, within 30 days from the day when the employee left the employment.

Section 88 provides that where a person paying retirement payment is an approved retirement fund and the payment has a source in Nepal, the person shall withhold tax on the gross amount of the payment at the rate of 15%. However, in case a payment is made under provident fund and gratuity by an approved retirement fund, it shall be withheld at the rate of 6%.

Dhungana & Amatya are associated with N. Amatya & Co., Chartered Accountants and can be reached at nemlal@wlink.com.np

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