Business Tax Planning

Concept Note

On

Income Tax

Submitted By:

Sumi Malla

Ace Instituteof Management

MBA V, Section A

Submitted To:
Mr. Prajwol Sayami

Business Tax Planning Ace

Instituteof Management

17th September, 2023

Introduction

A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or
legal entity) by a government organization in order to finance government activities like infrastructure
and public services. Taxes are generally classified into direct taxes and indirect taxes.

• Direct taxes are levied directly on the income or wealth of the taxpayer, such as income tax,
wealth tax, and inheritance tax.
• Indirect taxes are levied on goods and services consumed by the taxpayer, such as sales tax,
value-added tax (VAT), and excise tax.

Taxes are an important source of revenue for governments. They are used to fund a wide range of public
services, such as education, healthcare, infrastructure, and national defense. Taxes can also be used to
promote economic growth and social justice.

Advantages of tax:

• They provide revenue for governments to fund public services. Taxes are used to fund a wide
range of public services, such as education, healthcare, infrastructure, and national defense.
• They can promote economic growth. Taxes can be used to encourage businesses to invest and
create jobs. For example, governments can offer tax breaks to businesses that create new jobs
or invest in new technologies.
• They can reduce income inequality. Taxes can be used to redistribute wealth from the rich to
the poor. For example, governments can impose higher taxes on high-income earners and use
the revenue to fund programs that benefit low-income earners, such as food stamps and
Medicaid.

Cannons of Taxation

The cannons of taxation are:

Canon of equity: Taxes should be distributed fairly among taxpayers. This means that taxpayers with
higher incomes should pay a higher percentage of their income in taxes than taxpayers with lower
incomes.

Canon of certainty: Taxes should be certain in terms of their amount and due date. This means that
taxpayers should know how much tax they owe and when they owe it.

Canon of convenience: Taxes should be convenient for taxpayers to pay. This means that taxes should
be collected in a way that is easy and efficient for taxpayers.

Canon of economy: Taxes should be collected in a way that minimizes administrative costs. This means
that the government should spend as little money as possible collecting taxes.
Income tax

Income tax in Nepal is a direct tax levied on the income of individuals and businesses. It is one of the
most important sources of revenue for the Government of Nepal. Income taxes are used to fund public
services, such as education, healthcare, and infrastructure. Income tax in Nepal is defined as a tax on the
taxable income of a person. Taxable income is calculated by subtracting certain deductions and
exemptions from the total income.

The tax system in Nepal encompasses various categories of taxpayers and income sources. The following
persons are subject to taxation in each income year and are required to pay tax in accordance with the
Income Tax Act:

• Person with Taxable Income: Individuals or entities that earn taxable income in any income year
are liable to pay tax. This includes income earned from various sources, such as employment,
business, investments, and other activities.
• Non-Resident Person's Foreign Permanent Establishment in Nepal: If a non-resident entity
operates a foreign permanent establishment located in Nepal and generates income, this
income is subject to taxation. The tax liability is determined based on provisions outlined in Sub-
sections (3) and (4) of Section 68 of the Income Tax Act.
• Person Receiving Final Tax Withholding: Individuals or entities that receive income subject to
final tax withholding in any income year are also subject to taxation. Final tax withholding is a
mechanism where tax is deducted at the source, and the recipient is liable for any additional tax
if applicable.

Purpose of Income Tax in Nepal

The primary purposes of income tax in Nepal are:

a. Revenue Generation: Income tax serves as a primary source of revenue for the government, financing
public services, infrastructure development, and other essential functions.

b. Income Redistribution: The tax system in Nepal aims to promote income equality by taxing higher
incomes at higher rates, thereby redistributing wealth and reducing income disparities.

c. Encouraging Investment: Certain tax incentives and deductions are provided to encourage investment
in key sectors, fostering economic growth.

d. Compliance and Enforcement: Income tax laws are designed to encourage compliance and discourage
tax evasion and avoidance through penalties, audits, and enforcement mechanisms.
Key Features of Income Tax in Nepal

a. Progressive Taxation: Nepal employs a progressive income tax system, where higher incomes are
subject to higher tax rates. The tax rates vary based on income slabs.

b. Taxable Income: Taxable income is determined after applying various deductions, exemptions, and
credits as provided by the Income Tax Act of Nepal.

c. Filing and Reporting: Taxpayers in Nepal are required to file annual tax returns, accurately reporting
their income sources and deductions. The government encourages e-filing for efficiency.

d. Deductions and Exemptions: The tax law allows for several deductions and exemptions to reduce the
overall tax burden on individuals and entities.

e. Tax Authority: The Inland Revenue Department (IRD) is responsible for administering income tax laws
and ensuring compliance.

How is Law made?

The process of law making in Nepal are as follows:

1. Drafting of the bill: The concerned ministry drafts a bill on a particular topic. The bill is drafted in
consultation with experts and stakeholders.

2. Review by the Law Ministry: The draft bill is sent to the Law Ministry for review. The Law Ministry
ensures that the bill is compatible with the constitution and other laws of Nepal.

3. Presentation of the bill to the HoR: The minister of the concerned ministry presents the bill to the
HoR. The HoR debates the bill and makes any necessary amendments.

4. Passage of the bill by the HoR: If the bill is passed by the HoR, it is sent to the National Assembly. The
National Assembly also debates the bill and makes any necessary amendments.

5. Passage of the bill by the National Assembly: If the bill is passed by the National Assembly, it is sent to
the President for assent.
6. Assent by the President: If the President assents to the bill, it becomes law. If the President does not
assent to the bill, it is sent back to the HoR for reconsideration.

Inclusions

• Accommodation: The value of accommodation provided to an employee is included in their

income at a rate of 2% of the salary.
• Vehicle: The value of any vehicle provided to an employee is included in their income at a rate of
0.5% of the vehicle's cost.
• Subsidized Loan - Differential Interest: If an employee receives a subsidized loan with differential
interest rates, the difference between the market interest rate and the subsidized rate is
included in their income.
• Drivers, Kitchen Staff, Guards, Gardeners: Any benefits provided to employees in these
categories are also included in their income.
• Service Charge: Any income received as a service charge directly related to the business is
included in the computation of business income.
• Amount from Stock-in-Trade: Income obtained from the disposal of stock-in-trade, such as
goods or merchandise, is considered as part of business income.
• Net Profit from Business Assets or Liabilities: The net profit or loss derived from business assets
or liabilities is calculated in accordance with Chapter-8 of the tax code and included in the
business income.
• Balancing Charge (Depreciable Property): The amount derived from the disposal of depreciable
property used in the business, also known as the balancing charge, is included.
• Gifts: Any gifts received in relation to the business are considered part of business income.
• Restriction Acceptance: Amounts received for accepting restrictions related to the operation of
the business are included.
• Business-Related Amounts from Investments: Even if an amount is typically considered as
income from investments, if it is directly related to the business, it is included in business
income.
Exclusions:
1. Final Withholding Tax: Income subject to final withholding tax is excluded from taxation under
the regular income tax system.
2. Meals and Uniforms for Official Purposes: The value of meals and uniforms provided to
employees for official purposes is excluded.
3. Reimbursement of Expenses: Reimbursements of expenses incurred by employees in the course
of their employment are not included in their taxable income.
4. Small Expenses: Expenses up to NPR 500 are exempt from taxation.
5. Reasonable Travel Allowance/ Daily Allowance (TA/DA): Reasonable TA/DA expenses are
excluded from taxable income.
6. Section 10 Deductions: Amounts that are eligible for deductions under Section 10 of the tax
code are not included in business income.
7. Section 54 (Dividends - Final Withholding): Distribution of profits by resident entities, excluding
companies and partnerships, and redistribution of distributed profits are exempt from tax.
8. Section 69 (Foreign Controlled Entity): Income from foreign-controlled entities may be excluded
under specific conditions:
• Resident person holds more than 50% of the shares.
• Resident person has the right to more than 50% of the income.
• Resident person has the right to appoint the majority of the Board of Directors.
• Resident person indirectly holds more than 50% of the shares.
• Up to 4 resident people hold more than 50% of a foreign company.

Deductions

1. Contribution to Approved Funds: Deductions are allowed for contributions made to:
• Provident Fund
• Citizens Investment Trust
• Social Security Fund
• Insurance Premiums: Deductions are allowed for insurance premiums paid for:
 2. Life Insurance (up to NPR 40,000)
• Health Insurance (provided by Resident Insurance Companies, up to NPR 20,000)
• Housing Insurance (provided by Resident Insurance Companies, up to NPR 5,000)
3. Section 12-Donation Deduction: Deduction for donations and gifts given to organizations
entitled to tax exemption.
4. Section 13 Preliminary expenses: Preliminary expenses can be claimed as a deduction in the
very first income year of a business operation, but not in subsequent years.
5. Section 14 - Interest Deduction: Deduction for interest paid for business purposes or purchasing
assets used in the income year.
6. Section 15 – Cost of Sales: Cost of Sales (COS), also known as the Cost of Goods Sold (COGS),
refers to the direct expenses incurred by a business to produce the goods or services it sells
during a specific period. COS is a crucial component in calculating a company's gross profit and
understanding its profitability.
7. Section 16 - Repair and Maintenance Expenses: Deduction for expenses incurred in repairing
and maintaining depreciable property used to earn income.
8. Section 17 - Pollution Control Expenses: Deduction for expenses related to controlling pollution
or conserving the environment.
9. Section 18 - Research & Development Expenses: Deduction for expenses related to research
and development to improve business processes.
10. Section 20- Set Off and Carry Forward: Losses incurred in one year can be deducted in
subsequent years subject to certain conditions:
• Losses from other businesses in the same year.
• Losses from the same business not deducted in the last seven years.
11. Section 19-Depreciation:
Depreciation is a crucial concept in income tax that allows businesses to account for the wear
and tear of assets used in their operations over time. It is a tax deduction that recognizes the
reduction in the value of assets and helps businesses accurately reflect their expenses and
taxable income. This concept note outlines the requirements, methods, and rates for applying
depreciation in the context of income tax, focusing on Nepal's tax regulations.

Requirements for Applying Depreciation:

In Nepal, depreciation can be claimed if the following conditions are met:

 • Asset Used in Earning Income: Depreciation can be claimed for assets that have been used to
generate income from business activities.
• Ownership: The asset must be owned by the taxpayer claiming depreciation.
• Depreciable Asset: The asset must fall into one of the specified blocks of depreciable assets,
which include buildings, machinery, vehicles, furniture, and intangible assets.

Blocks of Depreciable Assets

Depreciable assets are grouped into blocks for the purpose of calculating depreciation. In Nepal, these
blocks are categorized as follows:

Block A Building, structures, and any construction of a permanent nature.

Block B Computers, statistical equipment, furniture & fixtures, and office equipment.
Block C Automobiles, buses, and minibuses.
Block D Block D: Construction and earth-moving equipment and any depreciable asset not
included in Blocks A, B, or C.

Block E Intangible assets other than those mentioned in Block D.

Rates of Depreciation

Depreciation rates vary depending on the type of asset and the block it falls into. Nepal has three types
of depreciation rates:

1. Normal Rate:
These rates apply to most assets, and they are as follows:

Block A 5%
Block B 25%
Block C 20%
Block D 15%
Block E (100/Life)%
 2. Accelerated Rate:
These rates apply to specific industries or entities as mentioned in Section 17 of the Industrial
Business Act 2076, power generation and transmission, public infrastructure construction, and
taxable cooperative institutions. The rates are higher to encourage investment in these areas:

Block A 6.67%
Block B 33.33%
Block C 26.67%
Block D 20%

3. Terminal Depreciation:

When assets within a pool are disposed of, the remaining value after deducting the sale proceeds
from the depreciation base is allowed as a deduction. If the remaining amount is less than NPR
2,000, it can be claimed as depreciation.

Tax Rates for Individuals

The tax rates for individuals in Nepal are progressive and vary based on income levels. As of the
information provided, the tax rates are as follows:

First 500,000 1% or 0%
Next 200,000 10%
Next 300,000 20%
Next 1000,000 30%
Balance 36%

Tax Rates for Couples

For married couples, the tax rates are similar but with different income thresholds:

First 600,000 1% or 0%
Next 200,000 10%
Next 300,000 20%
Next 900,000 30%
Balance 36%

Other Tax Provisions

• Remote Area Allowance: Employees working in remote areas may receive a remote area
allowance, which is tax-exempt and can be as high as NPR 50,000.
Allowance
A 50,000
B 40,000
C 30,000
D 20,000
E 10,000

• Diplomatic Mission of the Government of Nepal: Employees working in diplomatic

missions of the Government of Nepal may receive a 75% deduction on foreign
allowances.
• Disability: Individuals with disabilities may receive a 50% additional deduction on the
first income slab.
• Pension: Pension income is eligible for a 25% additional deduction on the first income
slab or the actual pension amount, whichever is lower.
• Women's Rebate: Women with salaried income may be eligible for a 10% tax rebate.
• 50% Exemption on Core Business Income: Under certain conditions, businesses engaged
in specific sectors may be eligible for a 50% tax exemption on income earned from their
core business activities for a specific income year.