Nepal’s Taxation Transition: Finding the Ideal Tax Template

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Nepal’s Taxation Transition: Finding the Ideal Tax Template

There seems to be confusion at the heart of the country’s tax system. At the very least, it has been problematic with many sectors calling for the tax regime to be reformed. 


During his recent trip to the United States to participate in the annual meeting of The World Bank, Minister for Finance Dr Yuba Raj Khatiwada presented Nepal as the most competitive country in South Asia in terms of corporate income tax. “We have the most competitive institutional income tax rates in the region. Investors should take advantage of this,” he told US businessmen who participated in an investment seminar, held on the sidelines of the World Bank meet, organised jointly by the Embassy of Nepal and the International Finance Corporation, the private sector arm of the World Bank Group. 

Dr Khatiwada’s statement is true as the government levies a 20 percent corporate tax for industries in the manufacturing sector and 25 percent for other types of businesses, the lowest among the South Asian nations. In neighbouring India, the flat rate of corporate income tax is 25 percent at present which was 30 percent until last year. Similarly, the corporate tax structure in Bangladesh is 25 percent for publicly listed and 35 percent for non-listed business entities. In the meantime, it stands at 31 percent and 28 percent in Pakistan and Sri Lanka respectively. Besides, customs duties for imports average at 11 percent in Nepal. “Customs duties for almost three-fourths of goods and commodities are less than 10 percent,” Dr Khatiwada tells NewBiz.  

However, this does not show the overall picture of taxation in Nepal. From tax rates to the utilisation of the money collected as taxes, a number significant issues exist. For entrepreneurs, the taxation related problems are even more difficult and exhausting. “Corporate income tax in Nepal is competitive. But businesses here are levied taxes at every step,” expresses Hari Bhakta Sharma, president of the Confederation of Nepalese Industries (CNI), a prominent private sector body.  “The overall tax burden is very high for industrialists. From the import of equipment and machineries to setting up the plants, they are levied high taxes,” he adds.  Sharma mentions Nepal as the country with the highest tax burden in the South Asia region. According to him, the tax burden attributes to the high operational costs for businesses here. He is of the view that capital formation hasn’t been possible as the government mops up the various taxes the capital the industrialists have. “Entrepreneurs do not receive government services according to the tax they have been paying,” he says. 

Kamalesh Kumar Agrawal, vice-chairman of Nepal Chamber of Commerce (NCC) shares views similar to Sharma.  “The government should not discourage entrepreneurs by levying exorbitantly high rates on general tax headings,” said Agrawal in a programme organised by NCC on August 23 in the capital to discuss the tax related problems.  “This has created difficulty for both the business community and the general public alike,” he noted. 

In the first federal budget of Nepal presented by the finance minister on May 29, the government hiked excise duties on some items such as alcohol, raised customs duties on items including passenger vehicles and unprocessed lentils and scrapped previously arranged customs tariff waivers on the import of agricultural commodities such as oil seeds.  The government also repealed the provision of a VAT rebate on items such as vegetable ghee, cooking oil, flour, sugar, mobile phone sets, textile and dairy products. According to Dr Khatiwada the repeal came because the tax rebate lacked clarity of purpose and was unclear in its benefits to the taxpayer. “Also, there was not any clear accounting of the paid amount and rebated amount of such taxes,” he says. 
But entrepreneurs disagree.

Speaking to NewBiz in June, Shekhar Golchha, vice-president of the Federation of Nepalese Chambers of Commerce and Industry (FNCCI), had said that the VAT rebate was introduced so that it would enable manufacturers and traders to supply certain essential items in the market at affordable price points as they receive some amounts of money in refunds.

“The justification for this is that the removal of this arrangement has resulted in the immediate market price increment of some daily essentials including edible oil, ghee, dairy products, certain types of food grains, noodles, biscuits and consumer electronics like mobile phones,” mentioned Golchha. 

Government’s Dependency on Taxpayers’ Money
In Nepal, tax collection has been the major source of income for the government to finance its activities. For instance, out of the total government revenue of Rs 612.59 billion in FY2016/17, tax revenue amounted to Rs 553.86 billion.

In FY2017/18, it was Rs 657.75 billion out of the revenue totaling Rs 728.35 billion. Tax revenue has been projected to reach Rs 838.34 billion in the current fiscal year. 

On the other hand, the non-tax revenue has a fairly smaller part to play when it comes to the government’s revenue, though it is also increasing. In FY2016/17 and FY2017/18, non-tax revenue totaled Rs 55.31 billion and Rs 657.75 billion respectively. It is estimated to reach Rs 107.21 billion by the end of the current fiscal year. Proper utilisation of taxpayers’ money has remained a big problem that needs to be addressed. Official data clearly shows a large chunk of the revenue goes to the recurrent expenditure of the government. In FY2016/17, the recurrent expenditure, which is comprised of government employee compensation, use of goods and services, interest and services, subsidies, social security and other expenses, amounted to Rs 518.61 billion increasing to Rs 699.58 billion in FY2017/18. It is estimated to reach Rs 1,159.44 billion in the current fiscal year. 

Meanwhile, capital expenditure has been growing relatively slowly. In FY2016/17and FY2017/18, such expenditure amounted to Rs 208.74 billion and Rs 238.66 billion, which is expected to reach Rs 313.99 billion in the current fiscal year. Experts highlight the need to tame the high operational expenditure of the government in order to achieve economic competitiveness. “Both the government and private sector have high operational expenses. This is why the competitiveness of our economy is low,” shares Sharma.  

With the country adopting the federal system of governance, the government expenses have swelled and the lack of resources pose a major hindrance when it comes to meeting its recurrent and capital expenditures. Nevertheless, the overdependence of the government on revenue won’t be good for the economic wellbeing of the nation, opine experts.  “Government revenue accounts for 30 percent of Nepal’s GDP. In developed countries, it is 12-14 percent,” says Sharma, adding, “The high share of revenue in the country’s GDP indicates the level of the poverty and economic backwardness of the country in today’s world.”  According to him, the government revenue should be utilised in the socio-economic development of the country which is challenging in our context.  

Federal Challenges in Taxation
The last few months have seen the problems in taxation intensifying after local governments began increasing the existing tax rates and imposing several new taxes. From levying taxes on street vendors, sale of cattle, movement of citizens, re-introduction of the long abolished scrap and octrio taxes, alongside multifold increases in government service fees and surcharges, (which many see as ridiculous and irresponsible of the local bodies), a lengthy list of recently surfaced tax related problems from across the country can be prepared.  

In several areas across the country, members of the business community and general people alike have taken to the streets to protests the tax hikes and imposition of new tariff rates. Birgunj Metropolitan City, for instance, revoked the imposition of taxes on scrap goods, the sale of petroleum and the raised business registration fees after the Birgunj Chamber of Commerce and Industry (BCCI) organised a mass protest. 

The Nepali business fraternity had long feared that the problem of double taxation would spiral out of control after the country started practicing the federal system of governance. This fear has now become a reality. Recently, cement producers in the Argakanchi found themselves in a difficult position when one of the municipalities in the district imposed taxes on every sack of produced cement as well as clinker, in a clear breach of the tax collection jurisdiction implemented by the Ministry of Federal Affairs and General Administration (MoFAGA). As per the guidelines, local bodies are entitled to levy tax on business transactions only once a year in their jurisdictions. 

These examples show how local governments are imposing haphazard taxes without considering how they will affect the business environment and consumers. On the other hand, they also show a lack of orientation or understanding of tax laws. 

 “There has to be a clear demarcation in terms of taxation areas between all three tiers of the government. It is the responsibility of the federal government to formulate laws for making it clear the taxation areas of the federal units,” says Dr Prakash Chandra Lohani, former minister for finance. 

“It is clearly mentioned in the constitution that citizens don’t have to pay double taxes. Local governments in many areas are levying taxes on the movement of citizens from one place to another. The cases related to double taxation have arisen significantly after the implementation of the three tiers of government. A state of confusion prevails among the citizens due to the haphazard taxes being levied by the local governments,” says Vidyadhar Mallik, former minister for health.

According to Mallik, who also served as the secretary of finance and director general of Inland Revenue Department, this situation arised primarily because the laws are yet to be enacted to define the role and responsibilities of the government of all three levels in tax collection. The delay in the formulation and enactment of the laws indicates that this situation of confusion over taxation won’t go away for some time. 

Way Forward
The government’s inability to form the National Natural Resources and Fiscal Commission (NNRFC) has led to the federal units being at loggerheads over taxation. NNRFC was supposed to be formed sometime after the promulgation of the new constitution in 2015. There has been a consistent delay in forming the body which has been deemed very important in order to establish fiscal federalism in a country like Nepal which has just started its journey into the federal system of governance. Currently, the Ministry of Finance has been taking an administrative role in the NNRFC as the body hasn’t been fully formed yet.  

Dr Lohani suggests looking into the practices of other federal countries so that NNRFC can function effectively in the future.  “In India, the Finance Commission has been successfully distributing the net proceeds of the taxes and tax devolutions between the central and state governments for many decades,” he says, adding, “And, in the United States, states themselves are responsible for taxation and finding ways to resolve the related issues.”  

Mallik suggests that it will be pragmatic for the local governments to have full authority for collecting taxes and royalties from real estate, construction and natural resources.

As a very young federal democracy, there are some factors for Nepal to consider in terms of taxation to mitigate the challenges posed by fiscal federalism.  Some economists have claimed that the reliance on indirect taxes makes devolution of fiscal decision making to the provinces and local bodies difficult. According to a World Bank report, centralised tax collection and decentralised service delivery in Nepal has led to the highest vertical fiscal gap among countries with a federal system. The government, to reduce this fiscal gap, announced during the budget speech that it expects to provide a grant of Rs 114.24 billion for provincial and local government from the revenue generated from VAT and excise duties.

So far, adopting the federal system has been like sailing into uncharted waters for Nepal. New thinking is required to overcome the challenges that are likely to come ahead. Now, the tax system of the country has to be reformed in such a way that entrepreneurs and the general public don’t have to face problems. From making the tax system friendlier to taxpayers by the optimal use of ICT, proper utilisation of taxpayers’ money to transforming the tax regime into one of the essential components to improve the business environment in the country, there are many things that need to be done so that Nepal can boldly face the 21st century’s economic challenges. 

Indirect Taxes in Nepal : Challenges and Trends

Problems in New Tax Arrangements and Taxation Reform

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