2.4 Tax System in Nepal: Current Structure and Implementation (Value Added Tax, Income Tax, Excise Duty, Customs Duty, Local Taxes and Other Taxes)

Tax System

The overall operational and management framework for tax administration, including identification, collection, accounting, reporting, and fiscal responsibility, is known as the tax system. It is an integrated operational framework formed by existing tax-related policies, rules, institutions, and activities. The tax system is built from the interactive existence of tax management methods, procedures, tools, and institutional arrangements. In line with Nepal's federal structure, coordination between levels and agencies in the tax system is essential for taxation, effective revenue mobilization, leakage control, and proper tax utilization at all three levels.

Nepal's Tax Policy

The tax policy adopted by Nepal, which ensures the effectiveness of tax administration and public confidence in tax utilization, is as follows:

Tax Policies in Budget 2080/81

Transforming the import-based revenue structure into one based on direct taxes and domestic production.
Promoting entrepreneurship, attracting investments, and protecting and promoting domestic industries.
Ensuring theoretical stability in tax policy to improve industrial and business environments.
Discouraging informal and illegal transactions, bringing all taxable activities into the tax net, protecting and expanding the tax base.
Making the revenue system technology-friendly, automated, transparent, and taxpayer-friendly to increase voluntary tax participation and compliance.
Controlling revenue leakage through legal reforms and effective coordination.

Other Tax Policies

Minimizing tax rates, expanding the scope, and strengthening collection.
Fair, simple, convenient, transparent, technology-based, and taxpayer-friendly tax administration.
Self-assessment system and voluntary tax participation.
Strengthening and expanding the existing electronic revenue payment system.
Based on modern accounting systems.
Progressive tax system.
Tax Day (Mangsir 1) and honoring outstanding taxpayers.
Tax exemptions, zero rates, concessions, and double taxation avoidance agreements for investment-friendly environments.
Taxpayer education and tax awareness.
Using excise duty to broaden the base of internal revenue.
Operating value-added tax to broaden the revenue base and as a basis for direct taxes.
Developing a reliable and predictable tax system.
Protecting national and international tax bases.
Adopting invoice issuance through electronic means and excise stamps with barcodes and tracking systems.
Reforms in revenue administration's structural and systemic aspects in line with the federal system.
Enhancing capacity in revenue collection, efficiency, tax base identification, and expansion at provincial and local levels.
Developing an integrated taxpayer information management system.
Professionalism, honesty, transparency, cleanliness, and integrity (taxpayers and tax administration).
Accurate declaration, classification, and valuation of goods at customs.
Customs inspection system based on technology and risk management.
Developing the tax system as a catalyst for productive industries.
Reviewing income tax and customs duty rates in line with international contexts and commitments.
Revising non-tax revenue rates to be cost-effective and expanding areas.

(Added for enhancement: As of 2025, Nepal is exploring a multi-rate VAT system to better align with international standards and address varying economic sectors, potentially introducing lower rates for essentials and higher for luxuries to promote equity and efficiency.)

Current Revenue Structure in Nepal

Guided by Nepal's Constitution, periodic plans, policies-programs, annual budgets, economic acts, sectoral policies-rules.
Jurisdiction of revenue sources defined between federal levels.
Intergovernmental Fiscal Management Act, 2074 clarifies the basis for revenue collection and distribution.
Natural Resources and Fiscal Commission (constitutional commission) to determine revenue distribution shares.
Determined to collect the most revenue for the federal level.
About 90% of total revenue is tax revenue; among tax revenue, 70% is from indirect taxes like VAT, customs duty, excise.
About 30% of tax revenue from direct taxes, with about 80% from income tax, 10% from land tax, and 5/5% from vehicle and other taxes.
Strategy of minimizing tax rates, expanding scope, and strengthening collection.
Adopting self-assessment, tax concessions, taxpayer education programs to make the tax system taxpayer-friendly.
Using electronic systems like VCTS, ASYCUDA (NECAS), RMIS, SuTRA Revenue Module for technology-friendly revenue administration.
Adopting a progressive tax system.
Investment-friendly environment emerging with the end of political transition and conflict.

Single Tax Administration

Single tax administration refers to the administrative arrangement where only one level of government has a role in administering taxes listed in the exclusive rights of both provincial and local levels. According to the Intergovernmental Fiscal Management Act, 2074, taxes under single tax administration are as follows:

Vehicle Tax: Province determines and collects the rate.
Land Registration Fee: Province determines the rate, rural/municipalities collect.
Entertainment Tax: Province determines the rate, rural/municipalities collect.
Advertisement Tax: Rural/municipalities determine and collect both.

Reasons for Revenue Leakage in Nepal

Revenue leakage occurs when revenue does not enter the tax net, taxes are underpaid or unpaid in violation of laws, or goods are smuggled evading customs. Reasons for revenue leakage in Nepal include:

Open borders and weak border security causing customs evasion.
Lack of long-term revenue policy.
Lack of tax-paying culture and national pride among taxpayers.
Lack of public confidence in tax utilization.
Lack of inter-agency and inter-level coordination.
Non-full compliance with revenue-related acts and rules.
Low priority on revenue leakage control and minimal punishment for evaders.
Lack of capable tax administration.
Lack of uniformity in law interpretation.
Poverty, illiteracy, lack of awareness.
High tax rates and narrow scope.

Taxpayer Education

Taxpayer education aims to inform taxpayers about the country's tax system, basic tax matters, and their obligations, rights, and responsibilities. Through taxpayer education, citizens' understanding and perception of taxes become positive, motivating voluntary tax participation and compliance. It also builds common understanding between taxpayers and tax administration, ensuring successful implementation of tax laws and developing a clean, transparent, and accountable tax system.

Necessity and Importance of Taxpayer Education

Informing taxpayers about basic tax aspects, utility of taxes, tax laws, and tax system.
Changing the common perception of taxes as a hassle or burden.
Providing accurate information on taxpayers' obligations, rights, and responsibilities.
Increasing voluntary tax participation.
Reducing administrative costs for tax assessment, collection, monitoring.
Providing information on possible corruption and irregularities in tax administration to establish a clean and transparent system.
Timely informing taxpayers about periodic reforms and changes in the tax system.
Bringing informal economic transactions into the tax net.
Facilitating small and medium enterprises in tax compliance to expand and sustain business.
Clarifying complex provisions in tax laws to facilitate investors.
Informing about legal actions for tax evasion to minimize evasion.

Review of Nepal's Existing Tax System

Strengths

Guided by Nepal's Constitution, periodic plans, policies-programs, annual budgets, economic acts, sectoral policies-rules.
Constitutional provision for jurisdiction and distribution of revenue sources between federal levels.
Provision for Natural Resources and Fiscal Commission (constitutional commission) to determine revenue shares.
Adopting self-assessment, voluntary participation, taxpayer-friendly administration, transforming import-based system to domestic production-based, minimizing rates, expanding scope, strengthening collection, tax concessions, taxpayer education, progressive tax system.
Legal provisions like Intergovernmental Fiscal Management Act, 2074; Economic Procedures and Fiscal Responsibility Act, 2076; National Natural Resources and Fiscal Commission Act, 2074; Local Government Operation Act, 2074; Customs Act, 2064; Income Tax Act, 2058; Excise Act, 2058; Value Added Tax Act, 2052; economic acts, rules, directives, procedures of all three levels, revenue heading classification and interpretation (GFSM 2014).
Institutions like Public Accounts Committee, Auditor General, Natural Resources and Fiscal Commission, Ministry of Finance, Comptroller General's Office, Inland Revenue Department and offices, Customs Department and offices, Revenue Tribunal, Revenue Investigation Department and offices, offices related to revenue administration.
Using electronic systems like VCTS, ASYCUDA (NECAS), RMIS, SuTRA Revenue Module for technology-friendly revenue administration.

Weaknesses

Despite constitutional, legal, institutional, programmatic, systemic arrangements for tax system effectiveness in Nepal, the following weaknesses exist:

Decreasing revenue mobilization capacity at federal, provincial, and local levels (mid-term budget review).
Increasing financial dependency at provincial and local levels.
Disputes due to lack of clarity on revenue rights (e.g., house rent tax).
High informal economy.
Difficulty in administering Digital Service Tax.
Inability to ensure proper utilization of tax revenue.
Inadequate protection and expansion of tax base leading to suboptimal revenue mobilization (budget revenue targets not met).
Non-scientific tax projections.
Lack of effective monitoring system.
Arbitrary changes in tax rates and policies discouraging business environment.
Weak inter-level and inter-agency coordination failing to control revenue leakage.

Practical Suggestions to Make Tax System People-Friendly

Stability in tax policy is essential to make the tax system people-friendly. Nepal's tax system can be made people-friendly through the following measures:

Transforming the import-based revenue structure into one based on direct taxes and domestic production.
Promoting entrepreneurship, attracting investments, and protecting and promoting domestic industries.
Ensuring theoretical stability in tax policy to improve industrial and business environments.
Discouraging informal and illegal transactions, bringing all taxable activities into the tax net, protecting and expanding the tax base.
Making the revenue system technology-friendly, automated, transparent, and taxpayer-friendly to increase voluntary tax participation and compliance.
Controlling revenue leakage through legal reforms and effective coordination.
Interconnecting agency information systems to make them automated.
Arranging invoice issuance through electronic systems.
Linking large taxpayers to central invoice monitoring systems.
Timely reforms in revenue policy for protection and promotion of domestic industries.
Reviewing existing tax exemptions based on impact for investment-friendly tax policy.
Establishing effective coordination, cooperation, and communication systems between inter-levels and inter-agencies.
Timely review of non-tax revenue rates.
Formulating and implementing umbrella law for non-tax administration.
Making tax assessment electronic-based in line with international practices.
Linking Permanent Account Number with national ID for tax base expansion.
Making monitoring and regulation effective.

Strengths and Weaknesses of Direct and Indirect Taxes

Direct Taxes

Direct taxes are where the legal taxpayer and actual taxpayer are the same. The tax burden cannot be shifted to a third party. They are progressive. Examples: income tax, property tax, land tax, remuneration tax, vehicle tax.

Strengths	Weaknesses
Progressive.	Taxpayers feel the burden.
Economical.	Cumbersome and inconvenient.
Flexible.	Possibility of evasion.
Certainty.	May discourage tax-paying willingness.
Ownership in tax behavior.	Less public involvement.
Good for social justice.	Reduces savings.
Easy to administer.	Difficult to increase investments.

Indirect Taxes

Indirect taxes can be shifted to another person. They are regressive. The final burden is partially or fully on another person. Legal and actual taxpayers differ. Examples: excise, VAT, customs duty.

Strengths	Weaknesses
Convenient to pay.	Regressive.
No extra burden felt.	Cannot maintain social justice.
Low evasion possibility.	Lack of ownership among taxpayers.
High participation.	Costly in collection.
Higher contribution to revenue in countries like Nepal.	Uncertainty.
	Ignores taxpayers' paying capacity.
	Unequal wealth distribution.

Differences Between Direct and Indirect Taxes

Direct Tax	Basis	Indirect Tax
Tax imposed and final burden on the same party.	Definition	Tax imposed on one, final burden on another.
Legal and actual taxpayer same.	Taxpayer	Legal and actual taxpayer different.
Burden not transferable.	Burden	Burden transferable.
Supports social justice.	Justice	Weak in social justice perspective.
Progressive.	Progressive	Less progressive.
Higher evasion possibility.	Evasion	Lower evasion possibility.
Ownership and sense of belonging among taxpayers.	Sense	Less ownership and sense of belonging.
Flexible.	Flexible	Less flexible.
Easy to administer.	Administration	Difficult to administer in countries like Nepal.
Less contribution to Nepal's revenue.	Contribution	Higher contribution to Nepal's revenue.

Value Added Tax (VAT)

Value Added Tax is a tax on the value added at each stage from production to consumption of goods or services. It is an improved form of sales tax based on goods and services. An indirect tax where the payer and final bearer differ. Collected by businesses but ultimately paid by the public or final consumers. Legal and actual taxpayers differ.

Objectives/Necessity/Importance/Characteristics of VAT

Expanding the tax scope (tax base).
Increasing tax participation.
Arranging investable funds.
Making tax consumption-based.
Promoting export trade.
Controlling tax evasion and leakage.
Collecting more tax from those who can afford (higher consumption).
Protecting domestic industries and production.
No tax burden felt by taxpayers (indirect).
Strengthening tax system (efficient, flexible, transparent, international level).
Continuous revenue source.
Non-cascading effect and catch-up effect.
Based on self-assessment (democratic).
Taxpayer-friendly.
Accounting-based tax system.
Administering previous sales tax, entertainment tax, contract tax, and hotel tax through one mechanism.

Principles of VAT

Production Principle
Taxing VAT in the country where goods and services are produced, not on imports. Collecting tax at production point for domestic consumption and exports. Advocated by countries with export trade and trade profits.
Destination Principle
Collecting tax at consumption regardless of production location. Exempting exports and protecting domestic production. Adopted by Nepal and most countries worldwide.

Methods to Determine VAT

Addition Method
Calculating total value added by adding amounts distributed to production factors (capital, labor, land, organization). Multiplying the calculated value added by VAT rate to determine tax.
Subtraction Method
Calculating value added by subtracting purchase price from sales price of goods and services. Multiplying the value added by VAT rate to determine tax.
Tax Deduction Method
Determining payable tax by subtracting tax paid on purchases from tax collected on sales. Adopted by Nepal from the beginning. If sales tax exceeds purchase tax, pay tax; if less, deduct in next tax period.

Reasons VAT is Considered Modern Tax

VAT implementation marked the start of tax system modernization worldwide. First implemented in France in 1954, Nepal adopted it from Mangsir 1, 2054. Unique features making it modern:

Non-cascading effect: Tax on value added, not price, avoiding tax on tax and price increase due to tax.
Self-policing and catch-up effect: Reporting both purchases and sales easily identifies evasion and weaknesses.
Updated transaction details: Monthly or specified period tax returns require updated purchase and sales accounts.
Displacement of multiple taxes: Replacing many traditional taxes makes administration easier. In Nepal, it displaced hotel tax, sales tax, entertainment tax, and contract tax.
Can be implemented with self-assessment and multi-rates.
Based on consumption and destination principles.
Increases tax compliance and participation among taxpayers.
Indirect, no burden felt by taxpayers.
Low evasion possibility.

(Added for enhancement: As of 2025, Nepal is conducting studies on introducing a multi-rate VAT system, potentially ranging from 5% for essentials to 18% for luxuries, to enhance equity and align with global practices like those in India and the EU.)

Development of VAT Administration in Nepal

VAT Act issued in 2052, VAT Regulations in 2053.
VAT implemented from Mangsir 1, 2054.
Administered by Value Added Tax Department initially, by Inland Revenue Department from 2058.
Single rate of 13% from 2061/62, replacing 10%.
Import VAT collected by customs offices.
Government agencies deduct VAT on contract or tender payments.
Provisions for tax exemptions, zero rates, tax refunds.
Inland Revenue Department handles registration/cancellation, tax collection, assessment and investigation, refunds, arrears collection, irregularities settlement.
Revenue Investigation Department investigates revenue evasion.
Tax Day celebrated from Mangsir 1, 2069, honoring outstanding taxpayers.

Areas and Topics for Reform in VAT Administration

Law Reform: Amend laws to apply multi-rates without exemptions, taxing all transactions progressively.
System Reform: Conduct function & system audits to make online systems simple and user-friendly.
Threshold Review: Increase registration threshold in line with Income Tax Act's turnover limit.
Institutional Strengthening: Enhance resources and capacity of Inland Revenue Department, offices, and staff.
Administrative Strengthening: Make registration, cancellation, tax assessment, investigation agile, quick, quality, informative, taxpayer-friendly.
Effective Regulation: Bring all taxable transactions into tax net through intensive market monitoring, transaction tracking, agency coordination, information sharing.
Tax Returns: Provide taxpayer education, awareness, capacity building, training for timely accurate returns; implement penalty/reward system to reduce zero and credit returns.
Exports/Imports: Prevent under/over invoicing through effective border management and customs development, control illegal smuggling.
Arrears: Run campaigns for VAT dispute settlement and arrears collection.
Tax Exemptions and Refunds: Make tax exemptions, concessions, refunds objective, result-oriented, limited.

Transaction Threshold in VAT

The turnover limit requiring registration and transaction under VAT.

Goods transaction: Up to NPR 5 million annually.
Service transaction: Up to NPR 2 million.
Mixed goods and services: Up to NPR 2 million.
Those within limit need not register, cannot collect tax.
Display notice that registration not required if within limit.
Threshold removed for hardware, sanitary, furniture, furnishing, automobiles, motor parts, electronics, educational consulting, massage therapy, etc.
Imports up to NPR 10,000 at a time.
If required to register but not, tax officer orders registration within 30 days with reasons.

Any person with taxable transaction can voluntarily register even if below threshold.

Difference Between Tax Exemption and Zero Rate in VAT

Tax exemption: Goods/services not subject to VAT, no registration required. Zero rate: No VAT but registration required, comply with tax laws like taxable persons.

Tax Exemption	Zero Rate
Taxpayer not in VAT scope.	Taxpayer in VAT scope.
No registration.	Registration required.
Cannot collect or pay tax.	No collection on sales but can deduct on purchases/imports.
For social justice and administrative simplicity on basic goods/services.	For investment promotion and export encouragement.
Schedule 1 of VAT Act, 2052 lists exempt goods/services.	Schedule 2 of VAT Act, 2052 lists zero-rate goods/services.

Provisions for Tax Exemption and Zero Rate in VAT Act, 2052

Tax Exemption in VAT

Exempt goods or services:

Basic agricultural products.
Basic necessities.
Animals and their products.
Agricultural materials.
Medicine, treatment, and similar health services.
Education, books, newspapers, printed materials, etc., as per Schedule 1 of VAT Act, 2052.

Zero Rate Goods and Services in VAT

Exports outside Nepal or goods/services.
Goods with destination outside Nepal in international flights.
Imports by diplomatic privilege persons or missions.
Raw materials sold to industries in special economic zones.
Electric vehicles and solar batteries produced domestically.
Scooters for disabled persons.
Sculpture, architecture, handicrafts, and raw materials produced by cottage and small entrepreneurs domestically.
Machinery, tools for hydropower projects, etc., as per Schedule 2 of VAT Act, 2052.

The provision for zero rate in Nepal protects domestic industries and production while promoting immediate needs for goods and services. Clear legal provisions for VAT exemptions exist.

Additional Information

Zero Rate

Keeping goods/services in tax scope but tax-free.
Treating zero-rate transactions like taxable ones.
Supplier does not collect tax on sales but can deduct on purchases.

Reasons for Zero Rate

Bringing all into tax net.
Promoting investments.
Promoting exports (exempting exported goods/services).
Special treatment (e.g., scooters for disabled).
Providing diplomatic privileges.

Provisions for Tax Deduction and Refund in VAT

Tax deduction is the provision where a registered person can deduct tax paid or payable on imports or acquisitions related to taxable transactions from collected tax. Types of tax deductions in VAT:

Full tax deduction.
Partial tax deduction.
Proportional tax deduction.
Tax deduction on stock inventory.
Tax deduction on damaged goods.

Conditions for Tax Deduction

Goods or services directly related to taxable business.
Tax invoice received for domestic purchases.
Import documents certifying tax paid on imports.

Tax Deduction Method

Deduct tax paid on purchases/imports from tax collected on sales; submit remaining with tax return to tax office each period.
If purchase tax exceeds sales tax, deduct excess in next period.
If excess remains for four consecutive periods, apply for lump-sum refund to tax officer (format in Schedule-10).

Tax Deduction on Damaged Goods

Apply to tax officer with evidence for deduction on damaged goods:

Within 30 days for fire, theft, accident, breakage, destructive activities.
Within specified time for expired goods.

If verified, tax officer allows deduction. For insured goods, self-deduct up to compensation received.

Other Tax Deduction Provisions

For deducted goods in stock: If used in taxable transactions or in stock, deduction allowed; otherwise, treat as sold at market price and pay tax.
For both taxable and exempt goods/services: Deduct only tax on purchases/imports directly related to taxable goods/services.
If direct relation not established for mixed transactions: Deduct tax on purchases/imports in proportion to taxable sales from total sales.

Refund Process

Tax officer investigates submitted evidence promptly and refunds within specified days from registration date.
For refunds over NPR 20,000, deposit in bank account.
For diplomatic missions/diplomats: Refund tax paid on purchases from registered firms/companies (refund shops) within three days per specified procedure.
Automated refunds through electronic means.

Additional Information

Goods/Services Not Eligible for Tax Deduction

Beverages.
Alcohol or alcoholic beverages like liquor, beer.
Petrol for vehicles.
Entertainment expenses.

Conditions for Tax Officer to Assess Tax in VAT

If tax return not submitted within deadline.
If incomplete or erroneous tax return submitted.
If false tax return submitted.
If tax amount understated or incorrect, with basis for belief.
If under-invoicing in sales price, with basis for belief.
If registration required but not, and transaction done.
If invoice not issued on sales.
If unregistered person collects tax.

Tax officer can assess based on one or all of:

Transaction evidence.
Tax assessment report submitted by tax officer.
Tax submitted by others in similar transactions.
Burden of proof on tax officer for assessment.
Assess within four years from return submission date; if not, submitted return automatically valid.
If false accounts, invoices, documents, forgery, department can reassess anytime.
Tax officer gives 15 days to submit defense.

Recovery of Tax Provisions

Deduct from refundable amount to taxpayer.
Seize movable and immovable assets.
Seal, auction through sealed bid or public auction, all or part of assets at once or in parts.
Deduct from taxpayer's amounts in banks or financial institutions.
Deduct from amounts payable to taxpayer by government or government-owned organizations or local levels.
Claim amounts payable to taxpayer by third parties.
Freeze taxpayer's imports, exports, other transactions.
Restrict travel outside Nepal.

Additional Information

Penalty for VAT Evasion

Not issuing VAT invoice: NPR 10,000 per instance for taxpayer, NPR 1,000 for buyer.
Issuing false invoice: 50% of invoice value penalty, up to 6 months imprisonment.
Transporting goods over NPR 10,000 without invoice: NPR 10,000 per instance.
Other VAT offenses: Punishment by authorized officer and body.

Problems in VAT System

Customs clearance not realistic affecting VAT collection.
Low/no invoicing causing tax evasion.
Arbitrary exemptions not bringing into scope.
Increasing non-filers not submitting returns.
Increasing credit returns increasing refund demands.
Large amounts misappropriated through fake invoices.
Risk-based assessment not time-bound, quality, capable, effective.
Tax arrears not collected timely.
Not bringing all transactions into tax net with multi-rates.
No practice of taking/giving bills leading to revenue leakage.
Inadequate and ineffective taxpayer education.
Self-assessment not effective.
Monitoring-evaluation not effective.
Revenue investigation not as expected agile and effective.
Electronic payment system not as effective and accessible.
Lack of cleanliness, commitment, efficiency, effectiveness in tax administration.
Lack of awareness, honesty, national pride among taxpayers.

Ways to Make VAT Effective

Broaden and simplify VAT system.
Update acts and rules timely.
Minimize exempt goods/services, specialize.
Run campaigns for taxpayer education, awareness, alertness.
Deploy empowered monitoring teams, monitor teams too.
Cancel registration, impose penalties for non-timely return submitters.
Initiate study on multi-rate VAT.
Make giving/taking bills effective through incentives, compliance promotion.
Enhance monitoring-evaluation, tax assessment, penalty systems to control leakage.
Lower threshold to include all transactions and potential businesses.
Control under-invoicing through incentives.
Identify and stop fraud in exemptions and refunds.
Make taxpayer education effective, reach all.
Enhance self-assessment through incentives.
Enhance effectiveness in monitoring-evaluation and tax assessment.
Make revenue investigation scientific, agile, effective.
Broaden electronic payment system, include all transactions.
Reform administration to enhance cleanliness, commitment, efficiency, effectiveness.
Develop awareness, honesty, national pride among taxpayers through education.

Form of Adopted VAT System in Nepal

Integrated previous sales tax, hotel tax, contract tax, entertainment tax into VAT.
Single rate of 13% adopted.
Tax calculation based on deduction method, tax only on value added.
Clear classification of transactions as taxable (turnover threshold), exempt (Schedule-1), zero rate (Schedule-2).
Adopting destination principle (collect on consumption and imports, exempt exports).
Under federal divisible fund, collect in federal level, distribute 70%, 15%, 15% to federal, provincial, local (Intergovernmental Fiscal Management Act, 2074).
Further organized by acts, rules (VAT Act, 2052 and Regulations, 2053).
Specialized administrative mechanisms like Inland Revenue Department, offices, Revenue Investigation Department.
Mandatory registration for goods/services transactions under VAT.
No transaction or invoice issuance without VAT registration.
Methods and accounts to keep determined by acts, rules.
Tax deduction and refund provisions.
Reciprocal zero rate for exports, diplomatic transactions.
Encouraging self-assessment and taxpayer voluntary participation.
Clear legal provisions for regulation and reward-punishment systems.

Excise Duty

"Tax on production is excise duty"

Indirect tax on domestically produced and imported goods and services is excise duty. Tax on health and environment affecting and luxury goods or production. Excise duty on domestic goods applies at customs point for imports.

Excise duty applies to goods and services. In Nepal, legal provision for services but not implemented in practice. Per Economic Ordinance 070, excise on 56 goods in Nepal. Though legal and institutional arrangements for excise, proper implementation not achieved.

Areas for Reform in Excise Administration

Stability in excise rates and areas.
Strengthening excise administration.
Broadening internal revenue base.
Controlling revenue leakage.
Transforming physical control system to self-release system.
Organizing tax system.
Updating excise-related policies and laws timely.
Protecting domestic industries through excise.
Bringing new manpower in excise administration.
Implementing automated control system.

In conclusion, excise use inevitable for Nepal's decreasing revenue gap. Necessary to expand excise scope and rates with systematic mobilization and stability.

Contribution of Customs Reform to Trade Facilitation

Making import-export process economical, efficient, effective, international-friendly to reduce trade costs and make economy competitive with external economy is customs reform. Customs reform covers multiple areas. Passenger clearance, revenue collection and reporting, integrity promotion, manpower development, infrastructure development, IT quality enhancement, etc. These areas are interrelated and further support trade facilitation. Contributions of customs reform to trade facilitation:

Formulating and implementing customs-related provisions of WTO Trade Facilitation Agreement, Revised Kyoto Convention standards, other international standards-compliant customs laws.
Using modern IT to remove import-export related obstacles.
Studying time for goods release from customs to implement quick clearance system.
Reducing number of documents for import-export.
Ending direct contact between business and staff for faceless and paperless office concept.
Developing customs inspection based on risk management for international level.
Developing adequate physical infrastructure at customs for service quality enhancement.
Reforming customs valuation, goods declaration, classification for accurate revenue collection and minimizing leakage.
Coordinating with border agencies, local bodies, stakeholders through meetings and interactions for trade facilitation.
Timely reforming customs procedures during disasters like earthquakes, COVID-19 for safe and quick goods and passenger clearance.

Core objective of customs reform is trade facilitation. Customs reform supports trade facilitation through above activities.

Post-Clearance Audit

Verifying reliability of information provided during customs clearance by customs administration is post-clearance audit. Examining exporter/importer's purchase, sale, export/import related accounts, records, or other documents, bank records, computer systems, etc., related to business. Important to detect ignorance of law, carelessness or intentional violation, prevent revenue loss. Post-clearance audit done to ascertain:

Accurate goods declaration or not.
Goods as per declaration or not.
Customs value realistic or not.
Goods classification sub-heading correct or not.
Duty paid as per prevailing law during export/import or not.
Goods imported with full/partial customs exemption used for purpose or not, imported by concerned person or not.
Uniformity in size, shape, unit in invoice, purchase account, sales invoice for goods imported under permit, invoice, other import documents.

Benefits of Post-Clearance Audit

Controls revenue leakage.
Analyzes leakage nature.
Identifies reliable importers.
Easy to identify revenue risk areas.
Supports customs administration in measuring importer's law compliance level.
Reduces time and cost in customs inspection, facilitates inspection.
Improves customs administration, makes more professional.
Minimizes unhealthy competition in business environment.
Punishes wrongdoers, increases law compliance.
Supports reducing informal economy.
Promotes transparency and accountability.

Post-clearance audit is effective means for trade facilitation and control. Necessary to enhance to minimize revenue leakage.

Process for Arrears Recovery in Nepal

Amount not paid timely per tax return or additional tax assessed from assessment/investigation, not submitted within deadline per law is tax arrears. Includes income tax arrears, VAT arrears, excise arrears. Process based on prevailing legal provisions in Nepal:

a) Preliminary Process

Initially inform non-paying arrears taxpayer to submit arrears tax. Includes:

Correspondence via post and email detailing arrears.
Publishing notice on office notice board and website.
Collection visits.
Officially informing taxpayer or representative about arrears, having them pay.
Seeking commitment for arrears payment.

b) Final Legal Process

If arrears not paid from preliminary process, recover through legal actions as needed:

Write to freeze import-export and purchase-sale transactions.
Search and freeze assets, claim on such assets, auction.
Auction stock inventory.
Deduct from taxpayer's amounts in banks/financial institutions.
Deduct from amounts payable to taxpayer by government or government-owned organizations or local levels.
Recover tax from receiver (per Income Tax Act section 108).
Recover tax from person to pay amount.
Recover from agent for non-resident.
Make jointly or separately responsible for joint venture.
File case in district court.

If taxpayer does not pay tax liability timely, revenue not received timely, additional financial burden from interest and fees causes stress. Increases financial risk. Thus, tax offices and taxpayers must be sensitive for arrears recovery.

Income Tax

Tax on returns from use of capital, labor, or both. An important direct tax. Oldest tax in tax system history. Tax on income, profit, remuneration. Income tax started in Britain in 13th century. Imposed for revenue collection and fair income distribution for social justice (progressive tax principle).

Objectives of Income Tax Act 2058

Taxing all sources of income.
Taxing all income-earning transactions.
Making income tax revenue productive.
Developing taxpayer-friendly tax system.
Making tax administration more effective and accountable.
Developing accounting-based tax system.
Emphasizing self-assessment system.
Taxing equal income equally.

Characteristics of Nepal's Current Income Tax System

Based on self-assessment system.
Risk-based tax assessment.
Accounting-based tax determination.
Complex and modern tax law.
Employment, investment, business, incidental gains as income sources.
Provision to deduct expenses related to business and investment income.
Depreciable assets classified into 5 groups, group-based depreciation deduction.
Exemptions for specified transactions.
Presumptive tax provision.
Tax on capital gains and dividends.
International tax administration provision.
Double taxation avoidance agreement provisions.
Income adjustment provision.
Three-installment tax (pay as you earn) principle.
Source deduction provision.

Income in Income Tax Act 2058

Income from Business

Any person's profit and gain from business in any income year is that person's business income for that year.

Amounts to include in profit and gain calculation:

Service fees.
Amounts from trading stock disposal.
Net gain from business assets and liabilities disposal.
Gifts received in business.
Amounts received for accepting restrictions in business.
Amounts of investment income nature but directly related to business.
Other amounts to be included in income.

Deductible Expenses

Per sections 13-19 respectively:

General deduction.
Interest expense.
Trading stock cost expense.
Repair and improvement expense.
Pollution control expense.
Research and development expense.
Depreciation expense.

Income from Employment

Any natural person's remuneration from employment in any income year is that person's employment income for that year.

Include in employment remuneration calculation:

Wages, salary, leave amounts, overtime, fees, commission, awards, bonuses, other facilities.
Cost of living allowance, rent, entertainment, transport amounts.
Reimbursement or settlement of personal expenses.
Payments for agreeing to employment terms.
Payments for employment termination, loss, or compulsory retirement.
Retirement payments and retirement contributions.
Other payments related to employment.

Income from Investment

Dividends, interest, natural resource payments, rent, royalty, investment insurance gains, gains from unapproved retirement fund interests, payments from approved retirement fund.
Net gain from non-business taxable asset disposal in investment.
If income from depreciable asset disposal in investment exceeds expenses for group, excess amount.
Gifts received in investment.
Retirement payments and retirement fund deposits including contributions in investment.
Amounts received for accepting restrictions in investment.
Other specified amounts.

Deductible Expenses for Investment Income

General expense deduction.
Interest expense.
Repair and improvement expense.
Depreciation expense.
Other specified expenses.

Principles of Income Tax

(a) Integrated and Source-Based Principle

(k) Integrated Tax Assessment Arrangement

Assessing income tax by adding income from all sources for any person. Same tax rate for all sources. Not much in practice except some developed countries with capable administration.

(kh) Source-Based Arrangement

Identifying income from various sources separately and assessing tax differently. Can assess if information on any source available, no need for all. Different rates for different sources. Most countries assess income tax source-based.

(aa) Origin and Global Principle

Origin Principle

Taxing in country where capital invested or income earned. Right to tax production or income within territory. Adopted by developing nations.

Benefits:

Helps capital-importing countries increase tax.
No tax on citizens' foreign earnings.

Disadvantages:

Increases tax planning possibility.
Encourages tax evasion.
Less justice principle.
Less capital investment possibility in developing countries with high rates.
Small tax base.

Global Principle

Taxing resident's income from any country in own country. Developed capital-exporting countries like USA, OECD countries advocate, but most developing countries follow origin-based.

Benefits:

Broad tax base.
Tax collection on poor countries' citizens' foreign earnings.
Higher possibility of domestic investment.
Helps establish coordination.
Less tax planning possibility.

Disadvantages:

Narrows tax scope for income-earning supporting nation.
Benefits developed capital-exporting but less for developing.
Possibility of economic colonization by developed in developing.

Resident and Non-Resident Principle

Classifying any person as resident or non-resident for taxation.
Defined by country's law to distinguish resident/non-resident.
Countries like USA, Australia, Canada, Philippines consider based on nationality.
Some countries consider natural persons with permanent residence or specified period stay as resident.
Different treatment for natural persons and companies to distinguish resident/non-resident.

Resident Person in Nepal (per Income Tax Act, 2058): Any Natural Person

Normal residence in Nepal.
Present in Nepal for 183 days or more in uninterrupted 365 days.
Deployed abroad by Nepal government anytime in income year.

Tax Exemption Provisions

Generally, tax on any income, but exemptions on some incomes considering social, economic, other factors. Tax exemption arrangement provides full tax waiver or tax concessions. Income Tax Act, 2058 or annual economic acts can provide exemptions.

Reasons for Tax Exemptions and Facilities

Promoting exports.
Accelerating industrial development.
Reducing trade deficit by promoting trade and business.
Creating and increasing employment.
Creating investment-friendly environment.
Increasing investments by increasing savings.
Administrative simplicity and efficiency.
Maintaining social, economic justice.
Supporting priority sector development.
Bringing weak classes/areas into mainstream economic development.

Tax Exempt Sources per Nepal's Income Tax Act 2058

Personal Tax Exemptions

Tax exemptions per bilateral/multilateral treaties between Nepal government and foreign country or international organization.
Amounts received by natural person in foreign government service.
Amounts received by non-Nepali citizen in foreign government service or immediate family from foreign government fund.
Amounts received by non-Nepali citizen appointed in Nepal government service on non-taxable condition.
Allowances given by Nepal government to widows, elderly, or disabled persons.
Amounts received as will, inheritance, or scholarship excluding amounts included in income calculation from employment, business, or investment.
Pension received by Nepali citizen retired from foreign army or police from foreign government fund.

Incomes Received by Exempt Organizations

Donations, gifts.
Returns expecting or not, other contributions directly related to organization's work.
Amounts earned by Nepal Rastra Bank per its objectives.
Organization can deduct 5% of adjusted taxable income or NPR 100,000 whichever less from donations to tax-exempt organizations, but no exemption if exempt organizations do profitable activities.

Agricultural Business Exemptions

Income from agricultural business registered as firm, company, partnership, organized institution exempt, and agricultural income except from land per Land Act 2021 section 12 kh and ng for agricultural industry and industrial work on specified condition and limit land.

Cooperative Business Exemptions

Income and distributed dividends of cooperatives registered and operated per Cooperative Act for agriculture or forest produce-based silk, fruits, animal/poultry/fish farming, dairy, tea, coffee, herbs cultivation, production, processing, grass farming, leased forest, agroforestry, etc., vegetable storage cold storage, agriculture-related seeds, pesticides, fertilizers, agricultural tools trading cooperatives, rural community-based savings and credit cooperatives and unions exempt.

Source Deduction

Provision to deduct tax from payment of income at time of payment, pay remaining. Also called advance deduction. Based on pay as you earn principle for taxpayer's income earning. Payments like investment income, dividends, remuneration, service fees, contracts with deduction at payment time, pay remaining. Source deduction classified as final deduction and adjustable deduction.

Importance of Source Deduction

Government receives tax regularly.
Easy for taxpayers to pay tax when earned.
Administrative simplicity.
No need for some taxpayers to submit income returns.
No evasion possibility.
No burden to taxpayers due to adjustment facility in some cases.
Transparency in tax system.

Self-Assessment System

Method where taxpayer self-assesses own tax in any income year. Taxpayer submits own tax to administration. Makes taxpayer responsible for tax assessment. Replaced previous just assessment process. Considered democratic tax assessment. Provision for self-assessment in eighth amendment 2059 of Income Tax Act 2031. Implemented in practice from FY 051/52.

Characteristics of Self-Assessment System

Taxpayer can self-assess applicable tax.
Modern process and system for tax management.
Makes taxpayer responsible.
Supports developing taxpayer-friendly administration.
Transparency in tax management.
No private authority exercise by administration.
Tool to minimize and control tax evasion.
Develops taxpayer's role and involvement in society, country development.

Double Taxation Avoidance Agreement

Agreement between two countries to avoid tax in both. Authority to Nepal government to agree with any country's government for no double tax per Income Tax Act 2058. Also called financial fraud preventive agreement. Agreement where person earning income in foreign pays tax only once, not in own country again. Nepal has double taxation avoidance agreements with 11 countries. Nepal follows UN Model and OECD Model interpretations for agreements.

Main Topics in Double Taxation Avoidance Agreements

Resident person and permanent establishment concept.
Dividend tax.
Rate source country can levy on interest & royalty payments.
Recognition of tax concessions for industrial promotion.
Avoiding double tax through tax adjustment.
Solving related taxpayer issues through competent authorities meetings.
Exchange of tax information.
Mutual cooperation in tax administration.
Special provisions for specific persons or transactions.

Effects of Agreements

Mutual exchange of taxpayer information per agreement.
Treating non-residents like residents.
Foreign tax adjustment per specified method.
Providing industrial facilities.
Solving dissatisfaction with officers directly.
Cooperating in arrears recovery.
Avoiding double tax effects.
Preventing tax evasion, neutrality in tax system.
Removing discrimination between taxpayers.
Increasing international transactions, attracting foreign investment.

Problems in Income Tax

Taxpayers not entering tax net.
Increasing arrears in submitting income returns.
Increasing assessed tax arrears and assessment arrears.
Under-invoicing problem persisting.
Tax administration not reaching all areas.
No stability in policy matters.
Income Tax Act not simplified and understandable to all.
Waiving arrears timely reducing tax-paying tendency.
Employee morale not high.
No implementation of punishment for law violators.
Changes in fees and interest rates bringing instability.
No objective review of tax rates.
No emphasis on implementing dividend tax, capital gains tax.
No tax on profitable activities by exempt organizations.
Repair and improvement expense limit not scientific.
Resident definition not clarified.
Income tax administration traditional.
Organized sector family-based business operation though accounting-based.
Double accounting tendency persisting, unable to discourage evaders.
Expense deduction limit issues.
Assessments based on agreements not real ground, compromise.
Increasing irregularities amount, no effectiveness in collecting due irregularities, problem in responsibility and accountability of taxpayers and administration.

Solutions Suggestions

Continue market surveys, monitoring, research.
Seize to auction assets for arrears collection.
Make IT effective in offices.
Monitor advance deductions.
Emphasize taxpayer education.
Preliminary scrutiny of all income returns.
Special scrutiny of special taxpayers.
Quick settlement of case files.
Issue notices timely for tax payment.
Effectively implement act provisions.
Make tax administration capable and research-based.
Necessary action on non-return submitters.
Intensity in revenue irregularities settlement.

Excise Duty

Indirect tax on specified domestically produced and imported goods and services is excise duty. Tax on health, environment affecting, luxury goods or production. Excise on domestic goods at customs point for imports.

Applies to goods and services. Legal provision for services in Nepal but not implemented. Excise on 56 goods per Economic Ordinance 070. Though legal and institutional arrangements, proper implementation not achieved.

Factory Price in Excise

Price taken by factory to wholesaler for excise goods.

Per Excise Act 2058, factory price means price determined by adding production or production and sales distribution costs and establishment profit only, without adding excise or other taxes.

Factory price for excise administration means base price for levying excise.

Expenses Included in Factory Price Determination

Raw materials.
Auxiliary raw materials.
License fees.
Customs duties.
Insurance amount and transportation.
Labor expenses (salary, wages, facilities).
Production expenses.
Office and administration expenses.
Sales cost and advertisement expenses.
Sales agent commission expenses.
Warehouse expenses.
Packing expenses.
Profit amount.

Physical Control in Excise Administration

Production, release, import, export of excise goods under excise officer or designated employee's control is physical control system. (Excise Act 2058)

Physical control system adopted for production and sales of sensitive excise revenue goods like liquor, cigarettes, beer.

Excise inspectors of first and second class from Inland Revenue Office for physical control.

Excise Directive issued by Inland Revenue Department to organize physical control.

Expected to help in controlling excise revenue leakage and increasing collection.

Self-Release System in Excise Administration

Production and sales of excise goods except liquor and cigarettes without direct excise officer control, factory paying excise per rules to sell goods.

Self-release system for production, release, import, export of excise goods except based on physical control. (Excise Act 2058)

In self-release system, factory and operations from designated representative only, no work from others except designated representative, apply for designated representative to Inland Revenue Office, apply for representative designation and get approval.

Keep accounts certified by office representative in self-release system.

In self-release system, pay excise, VAT, other revenue in advance before goods release.

Inland Revenue Department issued Self-Release System Directive, 2063 to organize self-release system.

Excise Officer Can Assess Excise

If excise return not submitted within deadline.
If incomplete or erroneous excise return submitted.
If false excise return submitted.
If excise amount understated or incorrect, with belief basis.
If under-invoicing in sales price, with belief basis.
If production yield not met when specified for excise goods.
If alcohol content in released liquor and chulai material differs by more than 1%.
If excise evaded.
If unlicensed person deals in excise goods.

Excise officer gives 15 days to submit defense for assessment.

Department can monitor assessment, if error, director general can order reassessment.

Excise Officer's Rights

Inspect goods, places, documents, accounts, records related to excise liability.
Search, seize places within jurisdiction or related to offense under act.
Request information from person preparing records, books, accounts, documents or entering details during duty.
Seize or take away any documents, books, records in transaction places or related places.
Audit excise at transaction places, offices, other suitable places.
Request information on excise goods or services transactions from banks, financial institutions, any person.

Duty of banks, financial institutions, concerned person to provide requested information.

Problems in Excise Administration

Excise given less priority compared to other taxes.
Said for controlling health, environment affecting, luxury transactions but scope broadening.
Principle to levy excise only on domestic production but levying on imports too, unable to differentiate from other taxes.
Development of self-release based excise assessment reducing possibility to accurately evaluate and control excise transactions.
No comprehensive study for objective, realistic excise rates.
Lack of labs, equipment, technical manpower for excise assessment.
No adoption of new technology in excise management.
Lack of capacity and professionalism of excise officers making assessment not objective.
No taxpayer agreement on assessment, going to cases affecting excise arrears collection.

Solution Measures

Make excise leakage control effective.
Install shield flow meters in liquor factories.
Expand excise base by levying on arms and sawn timber too.
Levy higher on adverse health/environment goods, lower on others.
Make monitoring system effective in excise administration.
Increase and develop manpower, enhance professional capacity.
Maintain quantitative rate for cigarettes and liquor, levy value-based at end.
Control illegal liquor production and distribution.

Customs Duty

Goods-based tax based on foreign trade levied at relevant customs point per country's customs law.

Revenue amount to pay to relevant country's government per law for import-export of goods from one country to another.

Customs duty on goods for export/import per customs.

Overall customs duty on transactions, rate, method, tools is customs duty scope.

In Nepal, export duty and import duty levied and collected per Economic Act, basic customs duty areas:

Import duty.
Agricultural reform fee.
Indian excise refund.
Other customs income.
Export duty.

Method and basis for levying customs duty divided into two: ad valorem percentage, where duty levied on percentage of value. Second quantitative basis, duty on quantity not value, e.g., fabric, petroleum, stone, gravel, sand.

Customs Valuation

Valuation and price determination of export-import goods for customs duty collection.

Objectives

Providing basis for customs duty determination.
Facilitating trade business.
Supporting increased customs revenue collection.
Providing accurate information and statistics on foreign trade.
Protecting and promoting domestic industries.
Making customs administration transparent and client-friendly.
Providing facility to compare goods prices.
Supporting policy making.

Customs Valuation Methods

(k) Traditional Method

Centralized valuation method is traditional customs valuation.

Customs valuation method adopted by Nepal before 2054 is traditional.

Method before GATT Valuation is traditional.

Traditional customs valuation method adopts:

Publishing reference books.
Forming valuation committee.
Publishing customs price list.
Determining and recording customs prices.
Determining price on committee recommendation.
Priority to pre-determined prices.
Determining price from Customs Department GATT Valuation.

(kh) Modern Method

Method after GATT Valuation is modern customs valuation.

Also called decentralized customs valuation.

Nepal adopted GATT Valuation method in 2054 with seventh amendment of Customs Act 2019.

Customs Valuation Methods for Imported Goods

Transaction value method of goods.
Transaction method of identical goods.
Transaction value method of similar goods.
Method deducting expenses and profits from goods sales price.
Calculation method adding sales expenses and profits to goods production cost.
Reasonable method.

Customs Tariff

Structural list of customs duty is customs tariff.

Details of customs duty rates for export-import goods is customs tariff.

Table with customs duty rates is customs tariff.

Harmonized systems for goods classification adopted in most world countries for customs tariff.

Customs duty rates determined based on this Harmonised system.

Current general customs tariff 5, 10, 15, 20, 30, 40 percent and special tariff higher.

Necessity of Customs Tariff

Making customs administration transparent.
Simplifying customs duty determination.
Supporting trade management.
Supporting economic policy and planning.
Making statistics management effective.
Uniformity in customs management.
Protecting domestic industries.
Fair business competition.
Overall country development support.

Computer Technology in Nepal's Customs Administration

Computer technology considered important means to automate and modernize customs administration.

Automated System for Customs Data (ASYCUDA) adopted in over 90 countries, Nepal adopted from 1996.

ASYCUDA world implemented in customs offices in Nepal.

Emphasis on following for effective customs information and statistics management:

LAN, WAN, Data Centre, CCTV installation.
Valuation Database construction.
Computerised management of Harmonized System, etc.

Necessity of Computer Technology in Nepal's Customs Administration

Modernizing customs administration.
Automating customs administration.
Enhancing institutional capacity of customs.
Making customs administration international standard compliant.
Process strengthening in customs.
Uniformity in goods inspection.
Making customs information statistics reliable, automated, quick flow.
Maintaining good governance in customs administration through E-Governance.

Post-Clearance Examination

Whether imported goods after customs office clearance are as per importer's declaration or not, or declaration compliant or not ascertained by director general or customs officer examining importer's purchase, import or sale related accounts, records, other similar documents, bank records, computer systems, etc. related to business.
If goods different from declaration or not per declaration, or under-declared value or quantity, thus less duty collected, customs officer recovers less duty immediately from importer, punishes for under-declared value or quantity.
If classification sub-heading different causing less duty, related customs office recovers less duty immediately from importer, can do up to 4 years from clearance date.

Customs Reform and Modernization Action Plan Work Areas

Scientificizing customs valuation system.
Emphasis on customs operation and modernization.
Simplifying passenger clearance process.
Simplifying customs clearance process.
Selection based on risk management for inspection.
Developing infrastructure in customs area.
Developing customs integrity system.
Human resource development with skill enhancement.

Measures to Control Customs Leakage

Increasing efficiency in customs administration.
Minimizing customs rates gradually.
Emphasizing realistic customs valuation.
Effectively adopting transaction value.
Adopting simplified procedures.
Strict punishment for customs leakers.
Reducing customs exemption practice.
Increasing citizen awareness.
Effective customs system operation.
Reducing customs exemption practice.

Problems Related to Customs Revenue

Biggest problem in customs administration is not showing real transaction value, under-invoicing (Low invoicing) causing non-collection of due customs duty.
Goods classification not realistic in customs clearance process causing large revenue leakage.
Lack of sufficient facility-equipped machines in all customs points making customs inspection not realistic and objective.
Large economic transactions through smuggling due to open borders, not entering customs net.
Complaints of large customs leakage due to collusion between customs administration, customs agents, security inspectors, business persons.
Customs contribution decreasing with rates decreasing per globalization and WTO provisions.
Current customs clearance system based on self-declaration, 1?(/% system adopted to make successful not effective, goods not correctly declared.
Customs contribution mostly import-based, import decrease or substitution negatively affecting overall revenue collection.
Customs administration or customs points actions not clean, transparent, based on real transactions, objective, accountable causing subsequent economic transactions affected, evading income tax, VAT, excise, etc.
Not updating customs-related economic transaction information statistics at central level through computer-based Networking System for all stakeholders.

Local Revenue

Regular, non-liability direct tax and non-tax amounts received by local government per prevailing law for benefiting from local resource use, wealth increase, business, economic activities.

Objectives of Local Revenue

Managing local public expenditure with sustainable, reliable, credible, regular sources.
Mandatory contribution to local government for benefiting from economic activities.

Objectives of Local Revenue (Continued)

Ensuring local governments have financial autonomy to deliver public services effectively.
Promoting accountability and transparency in local resource utilization.
Encouraging sustainable economic development at the local level.
Reducing dependency on central government grants through self-generated revenue.

Types of Local Taxes

Local taxes in Nepal are levied and collected by local governments (municipalities and rural municipalities) as per the Local Government Operation Act, 2074, and other relevant laws. These include:

Property Tax: Levied on land, buildings, and other immovable properties based on their valuation.
Business Tax: Imposed on businesses operating within the jurisdiction of local governments.
Entertainment Tax: Applied to activities like cinema, concerts, and other recreational events.
Advertisement Tax: Levied on advertisements displayed within the local area.
Vehicle Tax: Collected on vehicles registered or operating within the local jurisdiction (often in coordination with provincial governments).
Rental Tax: Imposed on income from renting properties within the local area.

Implementation Status of Local Taxes

Since the adoption of the federal structure under the Constitution of Nepal 2015, local governments have been granted significant authority to levy and collect taxes. This has strengthened their financial capacity, but several challenges remain:

Effectiveness: Local taxes contribute to local development, but the revenue potential is underutilized due to limited capacity and lack of uniformity in tax policies across local bodies.
Challenges:
- Duplication of taxes between federal, provincial, and local levels, leading to confusion among taxpayers.
- Inadequate technical and administrative capacity at the local level to design and implement effective tax systems.
- Lack of awareness among taxpayers about local tax obligations.
- Disparities in tax rates and collection mechanisms across different local bodies, leading to inefficiencies.
Reform Efforts:
- Introduction of digital platforms for tax collection and management to enhance transparency.
- Training programs for local government officials to improve tax administration skills.
- Public awareness campaigns to educate citizens about the importance of local taxes for community development.

(Added for enhancement: As of 2025, local governments are piloting integrated revenue management systems to streamline tax collection and reduce duplication, with some municipalities adopting blockchain-based platforms for transparent record-keeping.)

Other Taxes

In addition to the major taxes discussed above, Nepal levies several other taxes that contribute to the national revenue pool:

Vehicle Tax: Levied on the ownership and use of vehicles, with rates varying based on vehicle type and engine capacity. Administered primarily at the provincial level.
Tourism Service Fee: Charged on tourism-related activities, such as trekking permits and entry fees to heritage sites.
Capital Gains Tax: Applied to profits earned from the sale of capital assets like real estate or securities.
Road Maintenance and Improvement Tax: Levied on fuel imports to fund infrastructure development.

Implementation Status

Effectiveness: These taxes have a limited scope and contribute a smaller portion to total revenue compared to VAT, income tax, or customs duty. Their implementation is often inconsistent due to weak enforcement mechanisms.
Challenges:

Limited public awareness about these taxes, leading to low compliance.
Complex administrative processes for collection and monitoring.
Potential for evasion, especially in capital gains tax, due to underreporting of asset values.

Reform Efforts:

Strengthening digital tracking systems for vehicle and tourism-related taxes.
Introducing stricter regulations for capital gains tax to curb underreporting.
Coordination with provincial governments to streamline collection processes.

Comparative Analysis of Tax Contributions

To provide a clearer picture of the tax system's structure, the following chart illustrates the contribution of major taxes to Nepal's total revenue (based on data up to 2023, with projections for 2025):

Comparative Analysis of Tax Contributions

The following table illustrates the contribution of major taxes to Nepal's total revenue (based on data up to 2023, with projections for 2025):

Tax Type	Contribution (%)
Value Added Tax (VAT)	40%
Income Tax	25%
Excise Duty	15%
Customs Duty	15%
Local Taxes	3%
Other Taxes	2%

Challenges in Nepal's Tax System

Despite progress, Nepal's tax system faces several systemic challenges that hinder its efficiency and effectiveness:

Large Informal Economy: A significant portion of economic activities remains outside the tax net, reducing revenue potential.
Revenue Leakage: Tax evasion, under-invoicing, and smuggling, particularly at customs points, lead to substantial revenue losses.
Limited Taxpayer Awareness: Many citizens and businesses lack sufficient knowledge about tax obligations, leading to non-compliance.
Administrative Weaknesses: Inadequate technical capacity, lack of coordination among government levels, and outdated systems hamper tax administration.
Policy Instability: Frequent changes in tax policies create uncertainty for businesses and investors.
Dependence on Indirect Taxes: The heavy reliance on indirect taxes like VAT and customs duty places a disproportionate burden on lower-income groups, undermining social equity.

Recommendations for Reform

To address the challenges and enhance the effectiveness of Nepal's tax system, the following recommendations are proposed:

Expand Tax Base: Bring more businesses and individuals into the tax net by simplifying registration processes and offering incentives for voluntary compliance.
Enhance Digitalization: Fully implement digital platforms like ASYCUDA, VCTS, and SuTRA Revenue Module across all tax types to improve transparency and efficiency.
Strengthen Taxpayer Education: Launch nationwide campaigns to educate citizens and businesses about tax obligations and benefits, fostering a culture of compliance.
Improve Coordination: Establish robust mechanisms for coordination between federal, provincial, and local governments to eliminate tax duplication and enhance revenue sharing.
Combat Revenue Leakage: Strengthen border security, implement advanced tracking systems, and impose stricter penalties for tax evasion and smuggling.
Introduce Progressive Tax Policies: Shift focus toward direct taxes like income tax to promote social equity and reduce reliance on regressive indirect taxes.
Stabilize Tax Policies: Ensure long-term policy consistency to build investor confidence and support economic growth.
Capacity Building: Invest in training and resources for tax officials at all levels to enhance administrative efficiency.

(Added for enhancement: Nepal could explore adopting artificial intelligence-based analytics for tax auditing and fraud detection, as piloted in countries like India and Singapore, to further strengthen revenue collection and compliance by 2027.)

Conclusion

Nepal's tax system is a critical pillar of its economic framework, supporting public services and development initiatives. While significant progress has been made in modernizing tax administration, challenges like revenue leakage, limited tax base, and administrative inefficiencies persist. By focusing on digitalization, taxpayer education, and policy stability, Nepal can enhance its tax system's efficiency and equity. The adoption of innovative technologies and progressive tax policies will be key to achieving sustainable economic growth and reducing fiscal dependency in the long term.

References

Constitution of Nepal, 2015.
Intergovernmental Fiscal Management Act, 2074.
Value Added Tax Act, 2052.
Income Tax Act, 2058.
Excise Act, 2058.
Customs Act, 2064.
Local Government Operation Act, 2074.
Economic Ordinance, 2080/81.
Inland Revenue Department, Nepal.
Ministry of Finance, Government of Nepal.