Vol. 3 :: No. 9 September, 2001 (Bhadra-Ashoj)

Cover Feature

TAX is Taxing

The government has, for the first time, announced annual award for the top ten taxpayers of the country. The idea to award the top contributors to the government treasury is clearly an attempt to increase revenue mobilization by encouraging potential taxpayers to sincerely clear the taxes.

The announcement about the award came from Finance Minister Dr. Ram Sharan Mahat while presenting the budget for the fiscal year 2001/2002.

The awardees would be entitled to use the Commercially Important Person (CIP) lounge at the Tribhuvan international Airport (TIA), using an identity card issued by the Internal Revenue Department (IRD).

The scheme is targeted to complement the government efforts to boost revenue collection, which is projected at Rs 60.25 billion for the fiscal year, up from Rs 52.89 billion estimated for the current fiscal year.

The budgetary announcement to award the taxpayers comes along with reinforced pledges of the minister to increase the income tax base, along with bringing more effectiveness in the implementation of Value Added Tax (VAT), which the government created as the main base of resource mobilization since the previous budget.

Dr Mahat stressed that new Acts and Regulations would be introduced in the upcoming fiscal year to effectively check revenue leakage.

In what can be called as another innovative step, next to the awards, Dr Mahat announced to introduce a system of refunding a certain portion of VAT paid by customers back to them. However, such refunds would be made only after the customers claim it with the VAT receipts. Such a measure will certainly help in promoting the billing system at the retailers’ level, which so far has remained as the major challenge in successfully implementing the VAT system.

Dr. Mahat, in his budget speech, also announced a number of measures aimed at increasing the government revenue. In an attempt to bring potential taxpayers into the VAT net, the Finance Minister also announced a special drive to ensure that all firms dealing in vehicles and spare parts, computers and accessories, marble slabs and hardware are registered.

Furthermore, he threatened to take stringent steps against agents of any domestic or foreign development projects who do not show their sources of incomes to the Internal Revenue Department before mid-October. So much so, even the national and international non-government organizations are brought under the tax net.

In addition, taxpayers carrying out transactions of over Rs 1 million per year would compulsorily need to file tax returns at tax offices.

Why a new Income Tax Act?

The existing income tax act is based on several traditional concepts. For example, it is based on the officials assessment system; it specifies deductible expenses; it adopts itemized depreciation method and; it follows previous year basis. The existing income tax act does not cover many aspects of a modern income tax system. This law does not make adequate provisions regarding capital gains and loses, transfer pricing, thin capitalization, retirement fund, merger and de-mergers which need to be dealt under a modern income tax system.

This law also does not contain adequate and clear provisions regarding self-assessment system. While a self-assessment system was adopted in 1993 through the Finance Act, no attempts were made to amend the income tax act in line with the new system except a few changes introduced through the eighth amendment to the act in 1993. Instead, income tax regulation were drafted some time in 1994 to handle the situation but these rules were never approved. As a result, self-assessment system has been more in name than in practice.

The existing income tax act also lacks precision and clarity. Further, several provisions are introduced through restricted departmental circulars. Taxpayers do not know about them. Many issues are not clear, which create conflict between taxpayers and tax collectors. No demarcation has been made between civil and criminal role or tax administration in administering tax. Tax administration exercises both civil and criminal authorities.

Income tax provisions are also scattered in different pieces of legislation, including the Finance Act, the Industrial Enterprises Act, Foreign Investment and Technology Transfer Act, the Cooperative Act, and the Citizen Investment Fund Act. The Finance Act brings changes in the income tax almost every year. These changes are not included in the income tax act, however. This brings discrepancies between the income tax act and the Annual Finance Act. One has to consult many laws in order to have the proper understanding of the income tax system.

The structure of the existing income tax act is defective as well. All relevant procedures relating to a particular aspect are not put together. They are scattered throughout the act. For example, assessment and penal provisions are mentioned in many different places. Further, the law mixes up procedures relating to the system and administration of income tax, thereby making it unnecessarily complex.

It is, therefore, necessary to restructure the income tax law thoroughly. First of all it is necessary to distinguish between the income tax system and its administration. Then it is necessary to restructure both parts in a more systematic manner.

There are discrepancies between the existing act and the tax treaties concluded with trading partners regarding the mechanism of the avoidance of international double taxation. The income tax act makes provision for tax deduction method while tax treaties follow the tax credit system. Under the former system, foreign tax is deducted from taxable income while under the latter system, foreign tax is deducted from the tax liability.

System of self-assessment was introduced by 8th amendment in the Income Tax Act and procedure were prescribed, though not adequately. The same amendment also enhanced the power and authority of tax officers by entrusting him with the authority to make final assessment in contrary to the submissions duly certified by the registered tax auditors. Therefore the basic concept and principle of self-assessment has been refused importance by diminishing the professionals like tax auditors, whereas the discretionary power of the tax officer to make final assessment has been reinforced. In addition to this, while issuing such final assessment by tax officer, if tax difference occurs, 50% fine on the amount of such difference on tax has been imposed on tax payers. This authority of the tax officer absolutely superceded the role of registered tax auditors, which in turn helped to increase distrust between the taxpayers and the tax officers. The total liability of such distrust had to be borne by the taxpayer and the tax officers have been immunized from any and all such responsibility arising out of or in connection with the mistakes done by him. Thus role of tax auditor virtually remained dominated and existed in compliance of procedures only.

Provision of tax auditing is practically an additional liability on the taxpayer with adverse effect in tax assessment. The system of self assessment should therefore be regarded as a complete failure. It is advisable that the authority of the tax auditors should be strengthened and discretionary power of the tax officers should be minimized and made more responsible and accountable.

Some of the expenses have ceilings prescribed by the Act itself but related with unascertainable figure or imaginary business transaction during the days to come. Such unascertainable figure relates to future anticipated transactions, gross annual income/gross profit, which has not yet been defined by the law. The definition of gross income or gross profit can only be complete once the meaning of direct expense is clarified. It seems the drafting of the tax law has intentionally left such situations unclear in order to leave the discretion of the tax officers alive at all times whenever he wants to use. Determination of gross income makes it uncertain for the taxpayer to predict the ceiling for such expense, thereby leading them to pay fines and charges.

At the same time, the calculation of the expected income in terms of periodical payment of Advance Tax in installment has been a debatable issue, because of the charges associated with the tax officer’s discretion. Till date a clear procedure has not been prescribed by the relevant authority. Despite the Forms for Self Assessment developed by the Director General elaborating the required list of documents to be attached with the Tax Return, the application of general provisions relating to Section 45 and 31 A of the Income Tax Act 2031 requiring the tax payers to prepare additional charts and lists "to dig mistakes out of it" are prejudicial and contradictory to the procedures of self assessment. It is a pity that the tax payers have to bear with all costs and consequences arising out of or in connection with unclear legal provisions, unmatchable procedures and misinterpretation of statutes. The benefit of interpretation should go to the tax payers and not the State.

Uncertainty in tax assessment for unlimited period of time due to random recall for payment of additional tax or fine without prescribing any procedure of the Act are development of recent days. Sometimes the reason shown for such recall for additional payment is said to be attributable to report of the Auditor General’s Office and named as "Beruju". By Income Tax Law, the taxpayer has no direct link with the Auditor General and that the Auditor General’s report is simply targeted towards the tax officer’s failures to comply with their duties during the assessments. Before passing over of such inflated liability so easily and without any responsibility, the tax officer should:

a. either accept that he made a mistake in his assessment and should be liable for action for his mistake, or

b. he should defend his own action and justify that his action was in accordance with Law and accordingly convince the Auditor General Office.

Legally speaking there is no provision either in constitution or in any Law to pass on liability unilaterally shown in the report of the Auditor General, which is merely a remark on the act of Revenue Office and not the tax payers.

Apart from the above, the assessment done beyond a period of four years upon submission of the tax return or action for reassessment beyond prescribed period are examples of bad-governance in the taxing part. If the lawmakers are really interested in system improvement and are duty bound and responsible, it is advisable that the closure of the files for any particular financial year should be effectuated within a very short time and re-opening of the assessment should be allowed only if specific evidences are secured within a short period only.

Proposed New Income Tax Act 2001

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 prioritise in which calculations the loss or part of the loss is deducted.

While losses are deductible 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 business, in addition to the carry forward of losses, are also allowed to carry 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 only registered 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 loss 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 the year or years exceed deductions relating to the contract.

Birds Eye view on New Draft Bill on

By Gandhi Pandit
Attorney at Law

The government is planning to introduce new bill on new income tax act with view to modernize and reform tax system in Nepal. The purpose of bringing new tax law while replacing old one is to widen tax base in order to raise government revenue and lowering tax rates on one hand and to incorporate new taxation theory and system on other hand thereby making tax system more systematic and modern.

Why do we need new tax law? What flaws were there in our existing tax law that we are preparing new one? To what extent this new bill is trying to rectify the old mistakes and weaknesses in the laws? I will also try to focus on the issues and disputes that have been raised in various forums concerning this new tax bill.

The government has felt that the existing tax law has many short-falls, which need to be improved if effective, and generic tax system is to introduce. By looking into new tax law, it seems that instead of amending the existing income tax, it was felt appropriate to come up with new draft giving new look and shape. From drafting point of view, it is wise to bring new enactment than to amend on it if you were to revamp tax. This must be the reason why the government is bringing new bill to replace old one.

By going through the bill, I must confess that the draft bill is most sophisticated and complex. It has tended to incorporated general global trend of tax reform that is taking place in other countries. It seems from outset that it is very difficult to implement given the socio economic condition of the country. But it shall have long term benefit if we were to develop a new set of tax law to meet the need of emerging economic activities of the country.

The present bill has intended to modernize tax system by adopting following concept in it:

a. It has scientifically classified the assessable tax income in three categories such as income generated through Commercial activities, Employment and Investment.

b. It has also defined the tax net in clear way thereby bringing many types of investment income and fringe benefits with the net of taxable income.

c. The present bill intends to cover such earning activities within tax net which was not covered by present income tax of Nepal, e.g. income coming out from house rent, private school and NGO’s.

d. It has incorporated the concept capital gain as taxable income, which is not being tax under present tax law.

e. The new bill has given very conclusive definition of person, which help the government to levy tax on the income of resident and non-resident person.

These are few of the provisions that I am discussing here to give you some glimpse of new tax law. It is not possible to discuss all of the provisions of that bill in this article. What I am more interested is bring some discussion on policy issues that have been hotly debated in various forums ranging from Parliamentary Committee to the meeting of various stakeholders. The sum of the issues being raised are as follows:

a. The new bill is very confusing and the language is so sophisticated and complex that is difficult to understand the meaning and spirit of the bill.

b. It does not take care of the problem of misuse of power by taxman in assessing the income tax. The excessive discretionary power of the taxman to reassess the tax assessment submitted by taxpayer and impose excessive tax is mostly criticized issued which has not been properly addressed by the present tax bill.

c. They also expressed view that these is no need for new draft to be brought in. It is advisable to made necessary amendment in the existing income tax law which is more understandable and is in practice for very long time.

These and many more arguments are given by the taxpayers and other interest groups who oppose the introduction of new law.

From outset, it seems that the bill has many more sections than the old income tax Act. It has also incorporated very new and modern concepts of tax law. The new bill has been able to overhaul our existing tax system which was based on very conventional and outdated system. Our country is slowly venturing into international market. We are, knowingly or unknowingly, exposing ourselves to international business transactionals. Many foreign investors are coming into our country to make new investments. Every investor who is showing their interest to invest in Nepal first looks into what kind of investment and tax law we have. If we do not have investment and tax laws up to their expectation or, in other words, if our law is not up to the international standard, the foreign investor would not be interested to invest in Nepal. Our tax law also needs to at in par with tax law systems of other countries if we are to compete in international market.

If we are to improve our national economy, improvement in tax law and system is very necessary which our government seems to have understood that. The law has several good aspects. As mentioned above, it has tended to expand tax base and at the same time to bring various type of tax income into tax net. It has adopted capital gain as taxable income where as it has also accepted the capital loss which can be calculated in assessing the taxable income. We must appreciate the government and the department of tax for giving so much effort in bringing such comprehensive and exhaustive tax law which does not only help government to raise income tax for public expenditure, it also helps to establish modern income tax system in Nepal.

Most of the taxpayers are complaining of excessive discretionary power given to tax office and their trend of imposing excessive tax on taxpayers without any good cause and ground. They also claim of delay in getting judicial remedy from the court. Some of them still claim that present Bill provides such discretionary powers to tax office which shall have same evil that tax payer wanted to get rid of.

The problem of tax assessment and reassessment is not the weakness in law. When administering the tax system, no one can expect of system of mechanical rather it should be of justifiable and practical. The tax system can only work successfully and end result can be achieved where there is a atmosphere of trust and faith between taxpayer and the department. Blame of misuse of power and instinct of corruption should not be considered from one side only. If there is a charge of corruption, the blame must be imposed both on taxpayer and tax officer. So it is very important that a system of harmony and understanding is developed which will help eradicate corruption in tax regime.

The new bill has also tried to bring a balance by punishing both the taxpayer and tax office are involved in tax fraud or tax planning with an intention to avoid tax payment to the government.

We must support this bill, which has many goods aspect. It has also some shortfalls which need to be rectified before it passes through the parliament. The language needs to be improved, the tax officers who are responsible for implementing this bill, need to be trained the legal regime should be enhanced to handle complex tax issues, judges handling tax cases must be trained. Since the law is very advanced and modern, the taxpayer lawyer must also improve and expand their legal knowledge to fully understand the present income tax bill. Laws are not static. They must always move with the need of society. If we have any flaws in the bill, it can always be improved and amended with the help of court and legislature. Let us support the view, let this new bill be passed so that we can have advance and comprehensive tax law which is the need of time.

(Mr. Pandit is practicing attorney in Kathmandu in the field of corporation, banking , insurance and international business transaction)

By Surendra Bhusan Shrestha

The Income Tax Bill, 2058 has become a hot issue for all concerned as it is in the process to be passed after a long time. At the time of writing this article, it is on the consideration in Finance Committee of Lower House. The previous Income Tax Act, 2031 as amended by its provisions of Finance Bill, was designed with very few provisions which could have hardly given solution to most of the tax matters and the major bulk of tax issues had always remained unresolved in the books of a taxpayer and minds of tax-consultants.

The new Tax Bill has tried to bring a harmony in the whole system by providing a solution for diversity of matters with an equitable notion within the Act. In general, people, specially the layman, will find it quite difficult to understand and exercise the new Bill as it has added various new provisions and new concepts in a very complicated and sophisticated language. To make it easier for taxpayers as well as tax authorities and tax professionals to understand the ambiguities in the language must be eradicated and the clear explanatory sections shall be added onto it.

The proposed tax bill is a very good gesture towards bringing new avenues of investment as it has tried to define all rates and all provisions in one Act. It has smoothened the process of decision making for prospective foreign investors as they need not go through a bunch of Acts to find the position of their investment and the tax liability.

It will be a very good leap forward in this age of globalization to put into practice a concept of equity in the matters of Income Tax as the new Bill has tried to do so by providing for taxation on retirement funds. This new concept of taxation on retirement benefits is introduced with the objective that similar type of income for all kinds of people is kept into same tax bracket be it businessman or employee.

Moreover, the concept of Capital Gain Tax is also being streamlined in the new Bill. This is being introduced at present to bring in the tax liability only on Short Term Capital Assets. The Bill has defined non-business chargeable assets to exclude :

i) a private residence of an individual that has been owned continuously for three years or more; and lived in by the individual continuously or intermittently for a total of three years or more;

ii) a private residence of an individual disposed for less than Rs. 10 million and

iii) the property disposed off in methods other than the sale within the three generation.

The new Income Tax Bill has clearly spelt out the definition of Resident and Non-resident and concept of global system of tax. The Resident has been defined to include a person who is present in Nepal for more than 182 days in any period of 365 consecutive days of which 183 days fall within the income year. Thus the income earned by a resident in foreign country is also taxable in Nepal.

According to the new Income Tax Bill, it is considered that the taxable income is generated from three heads:

a) Business b) Employment and
c) Investment

Business has been connoted to include Profession and Investment to include Rent Income.

It is clearly provided in the Bill that no costs of a domestic or personal matter is allowed to be deducted in calculating a person’s taxable income for an income year from any business, employment or investment.

It has spelt out that final withholding payments include

dividends paid by a resident company;

a) rent for the lease of land or a building and associated fittings and fixtures, having a source in Nepal, and that is received by an individual other than in conducting a business;

b) gains from investment insurance;

c) interest paid by a Bank or Financial Institution where a resident Bank or Financial Institution pays interest to an individual with respect to a deposit held with the Bank or Institution and the payment has a source in Nepal and is not received by the individual in the course of conducting a business; and

d) payments made to non-resident persons that are subject to withholding tax in respect to withholding by employers, withholding from investment returns and service fees, and withholding from contract payments.

Companies are required to maintain its account in accrual basis for tax purposes. Though it is so provided, the commercial banks are required to follow a form of hybrid accounting from the financial year 2058/59 according to Nepal Rastra Bank’s new directive. It has to follow the cash basis of accounting on calculation of income and accrual basis of accounting on expenses. It may give the burden to Commercial Banks having high exposure of loans in providing tax liability in unrealized income as such banks might have a big gap on Accounting Profit and Tax Profit. On the other hand, though the Bill has provided for the settlement of bad debts, it is unclear towards deducting provision for loan loss against the Income of the commercial bank in deriving Net Income. The literal interpretation of Draft Bill as such does not give scope to entertain the deduction of provision for loan loss under Nepal Rastra Bank’s guidelines in deriving Net Income for Income Tax purpose. But the Income Tax Authority has established a fact of accepting Nepal Rastra Bank’s guidelines for tax purpose verbally. Let’s hope for the amendment in the Tax Bill to spell out on this matter or, if not, at least the provision in the Income Tax Rules to throw light on this matter in a positive manner.

Depreciation system is also mechanized with a concept of pool system. There are five different pools of assets having different rates. The addition/purchase and disposal/sale on each pool of assets need to be separately shown.

There are some discretionary powers provided by the Bill in the hands of the Tax Officers which will be harmful to the tax payers only if it is utilized otherwise. Most honest to say, the Tax Planners are always bound to make a balance of interest on both sides.

It can be conceived according to the speech of Income Tax Authority that the previous Act could not really practice a concept of Self-Tax Assessment though it was so provided for. The Income Tax Authority has given justification to the previous shortcomings by installing the scope of Amended Assessments only in new Income Tax Bill. We hope the dreams of planners will be realized in its implementation process.

It is in public and social interest to generate more tax revenue by strictly administering such a system that tries to eliminate or lessen the tax avoidance to a maximum extent. But in the name of lessening tax avoidance, it should not fade away the responsibility of the Government as spelt out in the Economic Plan. The question arises as to whether or not the social responsibility of the Government of reducing poverty and attaining optimal distribution of wealth (reducing the concentration of wealth in few business units and individuals) will be supplemented by the new Income Tax Bill in the days to come. Whether or not the Income Tax Bill seeks to support in achieving considerable growth in economic activities such that the under-poverty population can be downsized from 38% to 30% within the Tenth Plan period is also another important matter of concern.

The question arises as to whether or not the social responsibility of the Government of reducing poverty and attaining optimal distribution of wealth (reducing concentration of wealth in few business units and individuals) will be supplemented by the new Income Tax Bill in the days to come.

It is in public and social interest to generate more tax revenue by strictly administering such a system that tries to eliminate or lessen the tax avoidance to a maximum extent.

The establishment of diplomatic relation between Nepal and China in 1955 formalised the centuries-old contacts and traditional friendship including trade relation. The Sino-Nepalese relations have expanded to the economic and trade fields starting from the Nepal-Tibet (Bhot) trade history. The close trade relation with Tibet still today is very ancient. Historically, entrepot trade between India and Tibet in Nepal played a vital role. This position was ended when there was the consolidation of British power in India and extension of its influence over Tibet.

The establishment of China’s authority and influence in Tibet in 1950 had an adverse effect in Nepal. Since 1950, the trade between Nepal and China including Tibet has undergone significant changes. But till now, though container truck had been arrived from Lhasa in the context of opening Nepal-China road traffic, it has not been regularlised even to-year. Chinese port of Canton is 2800 Kilometre away from Nepal. So, Nepal is compelled to use the Calcutta port for reducing transit cost in relation to trade with third countries. Until 1947, South Asia was an integrated part under British Empire except Nepal and Bhutan. Nepal, a landlocked country, has a special provision for her trade with India. India’s transit facilities have been used for her trade with the rest of the world. Currently, Nepal and China have been conducting trade under the agreement of Nov, 22,1981. China carried out Peoples’ Democratic reforms in the year 1947 whereas the political change in Nepal took place in 1951. However, Nepal-China relation received a boost after the establishment of diplomatic relation in 1955. There have been several high level visits between both countries. Since then, efforts to consolidate the traditional ties between these two countries at the state level were also made time and again. During the seventh century A.D, Anshuvarma, a Lichhavi King of Nepal, made a successful attempt to establish a friendly and cordial relations with Tibet. These relations further flourished during the Malla period in Nepal. The main source of national economy of Nepal during the Malla period was the trade with Tibet. After the unification of Nepal, Shah dynasty has always given much priority to consolidate ties with the northern neighbour and expand the trade volume.

The exchange of visits by the leaders and high ranking officials of both the countries provided opportunities to extend and find areas of mutual cooperation during the Panchayat system and present multy-party system in Nepal. After restoring the Multi-party system in the country high level visits have been exchanged from neighbouring countries. The official sources say that Nepal’s trade with Tibet has greater potentiality. Thus, in order to develop the overland trade, both the countries have agreed to use Kathmandu-Lhasa road which has not been regularlised for road traffic purpose . Apart from growing Nepal-China trade volume, the Chinese assistance in Nepal’s development is worth noting as it has been providing assistance to Nepal in different sectors. The industrial sector is one sector, which has been supported by the Chinese assistance from the very beginning. Large-scale industries in different products had been some examples of Chinese assistance in the industrial sector of Nepal.

(Dr. Regmi is associated with Trade Promotion Centre).

Top Ten Taxpayers in 2057/058

(Exclusive of Govt. institutions)

Source: Inland Revenue Dept.

Tuborg Opinion Poll

1. Do you think that the proposed Income Tax Bill presented in the parliament for approval is good for enchancing national revenue?

2. Are the fears raised by the business community on Income Tax Bill genuine?

3. Do you think that all people who earns more than 55,000 in a year pay income tax?

4. Do you think that the tax officials are competent enough to deal with taxpayers?

5. Are income tax collectors honest?

6. Is it justified for a person to pay huge taxes to the national coffer if the government in return does not take care of the taxpayers?

7. Are Nepalese people in general aware of the tax system of the land?

8. Have you found any harassment while paying taxes?

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