Taxation and Auditing

A direct tax is a tax imposed on a person's income or wealth, where the legal burden of paying falls on the same person who bears it, so it cannot be shifted to someone else. Example: income tax on salary, business income or investment income.

A presumptive taxpayer pays tax as a fixed amount determined by location (here Birgunj Metropolitan City) and turnover slab, instead of on actual profit, and need not maintain full accounts for income computation. The tax is based on the turnover slab, regardless of the profit actually earned.

Ms. Dahal's turnover is Rs 3,000,000, which exceeds the maximum ceiling of the presumptive scheme (Rs 2,000,000 for goods), so she is not eligible for the lump sum tax and is taxed under the normal rules. Her taxable income of Rs 300,000 lies within the first slab of Rs 500,000 taxed at 1% (social security tax):

$\text{Tax} = 1\% \times 300{,}000 = \text{Rs } 3{,}000$

A presumptive taxpayer is a small business owner who, instead of keeping full accounts and computing tax on actual income, pays a fixed tax according to the location of the business (Income Tax Act, 2058).

• Place of business: Lalitpur Metropolitan City, so the metropolitan rate applies.
• Turnover is Rs 2,600,000, which is above Rs 2 million but within the small-business ceiling for presumptive tax.
• Once the option is adopted, the tax is the fixed amount for the location and does not depend on the profit shown.

Comparison: tax on the taxable income of Rs 300,000 by the normal method would be $300{,}000 \times 1\% =$ Rs 3,000.

Tax liability as presumptive taxpayer for a metropolitan city = Rs 7,500 (fixed amount; the actual taxable income of Rs 300,000 is ignored).

A presumptive taxpayer is a small business owner who pays a fixed tax by location instead of computing tax on actual profit (Income Tax Act, 2058).

• Place of business: Kathmandu Metropolitan City, so the metropolitan rate applies.
• Turnover is Rs 2.5 million, above Rs 2 million but within the small-business ceiling for presumptive tax.
• The tax is a fixed amount and does not depend on the profit shown.

Comparison: tax on the taxable income of Rs 300,000 by the normal method would be $300{,}000 \times 1\% =$ Rs 3,000.

Tax liability as presumptive taxpayer for a metropolitan city = Rs 7,500 (fixed amount; actual taxable income is ignored).

A Permanent Account Number (PAN) is a unique number given by the Inland Revenue Department to a taxpayer for identification in all tax-related transactions, such as filing returns, paying tax, issuing invoices and opening bank accounts. Once issued, it remains with the person for life.

Two objectives of auditing:

1. To express an independent opinion on whether the financial statements give a true and fair view of the financial position and results of the entity.
2. To detect and prevent errors and frauds in the accounting records.

Under the Income Tax Act, 2058, the sources of income are:

1. Business income: profit from trade, industry, profession or vocation.
2. Employment income: salary, wages, pension, allowances and benefits from employment.
3. Investment income: dividend, interest, rent, royalty, natural resource payments, and gains from non-business chargeable assets.
4. Other income: windfall gains, gifts and other incomes received in connection with business or employment.

Section 19 of the Income Tax Act, 2058 allows a deduction for the wear and tear of depreciable assets used in business or investment (not land, trading stock or personal assets).

1. Pooling of assets. Depreciable assets are put into blocks (pools) and depreciation is computed on the pool, not on each asset.

Intangible assets (Block E) are written off on a straight-line basis over their useful life.

2. Depreciation base of a block at year-end:

$\text{Opening WDV} + \text{additions (cost incl. improvements)} - \text{disposal proceeds}$

Additions made and put to use in the last three months of the year (Baisakh to Ashadh) are taken at two-thirds of cost for computing depreciation.

3. Computation.

$\text{Depreciation} = \text{base} \times \text{block rate}$

Closing WDV = base (before the two-thirds adjustment) - depreciation, and this becomes the opening WDV for the next year.

4. Disposal. Proceeds are deducted from the block. If the block value becomes negative, the excess is a gain (business income). If all assets of the block are disposed of and a balance remains, that balance is a deductible loss.

5. Repairs and maintenance. Allowed up to 7% of the block's depreciation base; the excess is added to the block's WDV (capitalised) and depreciated.

6. Additional benefits. Certain industries (special industries and those in specified areas) get additional depreciation, and the Act also restricts depreciation on assets not used for income generation.

7. Intangible assets. Cost is amortised on a straight-line basis over the useful life of the asset, and the amortisation is deducted each year.

Depreciation reduces taxable income, encourages investment and gives a uniform, simple method of cost recovery.

Ms. Thapa received 12 months' salary plus a Dashain allowance equal to one month's salary, i.e. 13 months' pay.

Gross salary = net received + retirement fund + TDS $= 570{,}000 + 60{,}000 + 20{,}000 =$ Rs 650,000

$\text{Monthly salary} = \frac{650{,}000}{13} = \text{Rs } 50{,}000$

(Dashain allowance = Rs 50,000.)

Tax for a couple (family) status, first slab Rs 600,000 at 1%:

$590{,}000 \times 1\% = \text{Rs } 5{,}900$

Tax liability = Rs 5,900. Since TDS of Rs 20,000 has already been deducted, Rs 14,100 is refundable.

Under the Income Tax Act, 2058 (Sec. 94), a taxpayer who expects to have a tax liability must pay it in advance in installments during the income year (installment, or advance tax, method). The Act is of 2058 BS, not 2015.

Provisions

• The taxpayer estimates his tax liability for the year (the estimate is revised if income changes) and files an estimated return.
• The estimated tax is paid in three installments, with tax deducted at source (TDS) during the period counted against it:

• Tax paid in installments is credited against the final assessed tax.
• Interest is charged if installments are paid short or late.
• Persons whose income is only salary, or whose income is wholly subject to final withholding, need not pay installments.

Example

Estimated annual tax Rs 500,000 and TDS Rs 50,000 by Poush end:

• By Poush end, cumulative tax = $40\% \times 500{,}000 = 200{,}000$. Less TDS 50,000, so pay Rs 150,000.
• By Chaitra end, cumulative tax = $70\% \times 500{,}000 = 350{,}000$. Less amounts already paid, so pay a further Rs 150,000 (assuming no further TDS).
• By Ashadh end, cumulative tax = Rs 500,000. Pay the balance of Rs 150,000.

Mrs. Sharma received 13 months' pay (12 months plus one month's Dashain allowance).

Gross salary = $680{,}000 + 72{,}000 + 28{,}000 =$ Rs 780,000

$\text{Monthly salary} = \frac{780{,}000}{13} = \text{Rs } 60{,}000$

(Dashain allowance = Rs 60,000.)

Tax for a couple (family):

Tax liability = Rs 16,800. TDS already deducted is Rs 28,000, so Rs 11,200 is refundable.

Under the Income Tax Act, 2058 (Sec. 94), a taxpayer who expects to have a tax liability must pay it in advance in installments during the income year (installment, or advance tax, method).

Provisions

• The taxpayer estimates his tax liability for the year and files an estimated return; the estimate is revised if income changes.
• The estimated tax is paid in three installments, and tax deducted at source (TDS) is counted against it:

• Tax paid in installments is credited against the final assessed tax.
• Interest is charged if installments are short or late.
• Persons whose income is only salary or is wholly subject to final withholding need not pay installments.

Example

Estimated annual tax Rs 400,000 and TDS Rs 40,000 by Poush end:

• By Poush end, cumulative tax = $40\% \times 400{,}000 = 160{,}000$. Less TDS 40,000, so pay Rs 120,000.
• By Chaitra end, cumulative tax = $70\% \times 400{,}000 = 280{,}000$. Less amounts already paid (160,000), so pay a further Rs 120,000.
• By Ashadh end, cumulative tax = Rs 400,000. Pay the balance of Rs 120,000.

The Canon of Certainty (Adam Smith) states that the tax a person is required to pay should be certain and not arbitrary. The amount, time and manner of payment must be clear to the taxpayer and to every other person, so that the taxpayer can plan and the tax official cannot demand an unfair amount.

Residential status: Mr. Clinton arrived on 1 Chaitra and stayed until the end of Ashad, a period of about four months (roughly 120 days) in the income year. This is less than 183 days, and he does not satisfy the 365-days-in-two-years test, so he is a non-resident individual.

Tax liability: A non-resident person is taxed only on Nepalese-source income, at a flat rate of 25% for an individual.

$\text{Tax} = 25\% \times 1{,}000{,}000 = \text{Rs } 250{,}000$

Employment income of Mr. Sujal:

• Salary: Rs 50,000 × 12 = Rs 600,000.
• Apartment facility: residence provided by the government to its employee is not taxed as a benefit (it is excluded from employment income).

Total employment income = Rs 600,000.

Cost of trading goods (cost of goods sold):

Capital gain on the non-chargeable assets

Tax liability: Gain on shares by a natural person is taxed at 10% (as the shares were not held for long term and are not listed):

$\text{Tax} = 10\% \times 1{,}300{,}000 = \text{Rs } 130{,}000$

Vouching is the examination of documentary evidence (invoices, receipts, vouchers, bank statements, contracts, minutes) that supports the entries in the books of account. It means verifying that a transaction actually took place, was authorised, is correctly recorded, and relates to the business and the period.

Why vouching is the essence of auditing

1. Basis of the audit: The auditor's opinion on the true and fair view depends on the books being correct, and the correctness of entries can be judged only by checking the evidence behind them.
2. Verifies authenticity: It confirms that recorded transactions are genuine and not fictitious.
3. Checks authorisation: It shows that each payment was properly sanctioned by competent authority.
4. Detects errors and fraud: Missing, altered or duplicated vouchers reveal misappropriation, window dressing or manipulation.
5. Checks classification and period: It ensures the amounts are in the right accounts (capital or revenue) and recorded in the proper period.
6. Tests the internal control: The condition and handling of vouchers shows whether the controls work.
7. Provides audit evidence: Vouchers are the main written evidence that supports the audit report.

Therefore, vouching forms the foundation on which all other audit procedures, including verification of assets and liabilities and the preparation of the report, are built. It is rightly said that "vouching is the essence of auditing."

Self-tax assessment is a system under the Income Tax Act, 2058 in which the taxpayer himself computes his taxable income and tax liability, files the return, and pays the tax on the basis of that computation, instead of waiting for the tax office to assess it. The Inland Revenue Department generally accepts the return as filed, subject to later audit or amendment.

Benefits

1. Saves time and cost: Tax officers need not assess every return, which reduces administrative work and cost.
2. Voluntary compliance: It builds trust between the tax administration and the taxpayer and encourages honest reporting.
3. Quick settlement: Tax is determined and paid at once, with less delay and fewer disputes.
4. Better planning: Taxpayers know their liability and can plan their finances.
5. Focus on high-risk cases: The department can concentrate audit on suspicious returns.
6. Awareness and responsibility: Taxpayers become better informed about tax laws and keep better records.
7. Reduced corruption: Less contact between officers and taxpayers lowers harassment and malpractice.

Tax deduction at source (TDS) is a method of collecting tax in which the person making a payment (the payer) deducts the tax at the prescribed rate from the payment before paying it to the recipient, and deposits that tax with the Inland Revenue Department. The recipient receives the net amount and gets credit for the tax deducted when his final liability is computed. It is also called withholding tax (Sections 87 and 88 of the Income Tax Act, 2058).

Types: (i) final withholding, where the tax deducted discharges the liability (e.g., 5% on bank interest and dividends received by a natural person); (ii) non-final (advance) withholding, which is adjusted against the final tax (e.g., 15% on royalties, 10% on rent, 1.5% on contract payments).

Example: A company pays Rs 100,000 rent to a landlord. It deducts 10% TDS:

$\text{TDS} = 10\% \times 100{,}000 = \text{Rs } 10{,}000$

It pays the landlord Rs 90,000 and deposits Rs 10,000 with the tax office. The landlord claims the Rs 10,000 as credit against his income tax.

Advantages: Revenue is collected at the time of income, evasion is reduced, the government receives revenue regularly, and the taxpayer pays tax in small instalments.

Treatment of the adjustments

• Year 6: The profit was struck after deducting Rs 50,000 as donation to a tax-exempt entity. A donation is not a business expense and is allowed only as a deduction from total income, limited to the lower of 5% of adjusted taxable income or Rs 100,000. Adjusted income before donation is Rs 0 (loss 50,000 + donation 50,000), so the allowed donation is nil. The loss of Rs 50,000 is therefore reduced to Rs nil.
• Year 9: The profit was calculated before deducting pollution control cost of Rs 200,000, which is an allowable expense. Adjusted profit = 700,000 - 200,000 = Rs 500,000.

Set-off of losses (carried forward for 7 years and set off against income on a first-in, first-out basis)

Taxable income = Rs 375,000 (all in year 9; the other years have nil taxable income).

(a) Net assessable income from profession

Household expenses, the personal half of water and electricity, and the life insurance premium (a personal item) are not allowed as business expenses.

(b) Statement of taxable income

Bank interest (net Rs 28,500) and dividend (Rs 17,500) are subject to final withholding tax and so are excluded.

$\text{Tax} = 1\% \times 327{,}000 = \text{Rs } 3{,}270$

Assume VAT at 13%, and that VAT is charged on the selling price at each level.

Importer level

Retailer level

(a) Cost price for the final consumer = 163,750 + 21,287.50 = Rs 185,037.50

(b) VAT collected by the government at each level

• Importer: output VAT 16,380 - input VAT 0 = Rs 16,380
• Retailer: output VAT 21,287.50 - input VAT 16,380 = Rs 4,907.50
• Total VAT = Rs 21,287.50 (13% of the final price of Rs 163,750).

Group "D" assets are depreciated at 15% on the pool's written down value. Assets purchased in the last quarter (Baisakh to Ashad) get depreciation at two-thirds of the rate. Disposal proceeds are deducted from the pool.

Depreciation base

(a) Allowable depreciation

$15\% \times 1{,}300{,}000 = 195{,}000$

$15\% \times \tfrac{2}{3} \times 900{,}000 = 90{,}000$

Total depreciation = Rs 285,000

Repairs of Rs 130,000 are allowed in full because they are within 7% of the closing depreciation base (7% of 2,200,000 = 154,000), so nothing is added to the pool.

(b) Opening WDV for the next year

$\text{WDV} = (1{,}300{,}000 + 900{,}000) - 285{,}000 = \text{Rs } 1{,}915{,}000$

Business loss is dealt with mainly by Section 20 (and related sections) of the Income Tax Act, 2058.

1. Computation of loss: If allowable business expenses exceed business income for the year, the excess is a business loss. It is computed by the same rules as business income, after adding back disallowed items.

2. Set-off in the same year: A loss from one business source is first set off against the income from other business sources and other heads of income of the same person in the same year (loss from a business cannot be set off against income that is exempt or taxed under a final withholding).

3. Carry forward: Any loss not absorbed is carried forward and set off against income of the following years. The period of carry forward is 7 years, extended to 12 years for certain businesses (for example electricity generation, transmission and distribution, infrastructure and other specified industries).

4. Order of set-off: Losses are set off in the order in which they were incurred, the earliest loss first (first-in, first-out). Current-year losses are set off before carried-forward losses.

5. No carry back: A loss cannot be carried back to earlier years.

6. Restrictions

• A loss on an exempt activity or from a source exempt from tax cannot be carried forward.
• A loss of the foreign-sourced business cannot be set off against Nepalese-source income (it may only be set off against foreign-source income).
• Losses of an entity changing ownership by more than 50% cannot be carried forward unless the same business continues (anti-avoidance rule).
• Business loss and investment loss cannot be set off against windfall gains, and losses from the sale of a non-business asset are dealt with under the capital gain rules.

7. Loss from agriculture and special cases: A loss from agriculture can be set off against any business income of the person; special periods apply to long-term contracts and to industries receiving incentives.

8. Records: The loss must be claimed and reported in the return, supported by audited accounts or proper records. The Inland Revenue Department may verify losses when they are claimed.

These provisions help businesses to spread losses over time, encourage investment, and make taxation fair on average income.

Under the Income Tax Act, 2058, the income of a person is taxed on the basis of the sources (heads) of income listed in Section 3. Income is calculated separately for each source, and is then aggregated to give total income.

1. Business income (Section 7): Profit from carrying on a business, trade, profession, vocation, or industry, including gains on sale of trading stock and business assets, commission, fees, service charges, interest connected to the business, amounts received for accepting restrictions on business, and the like.

2. Employment income (Section 8): Salary, wages, pension, allowances, bonus, overtime, leave pay, commission and other benefits received from employment, including non-cash benefits such as housing, vehicles, free education, and contributions of employers to retirement or insurance funds.

3. Investment income (Section 9): Income from property and investments, such as:

• dividends, interest and discount,
• natural resource payments and royalties,
• rent from land, buildings and other assets,
• gains from investment insurance, premiums and the like,
• gains from the sale of non-business chargeable assets (capital gains) and any other income, for example amounts received for accepting a restriction on investment.

4. Other incomes (Sections 3 and 10 and related): Windfall gains (lottery, prizes, etc.), gifts received in connection with business or employment, and other unclassified income.

Based on location: Income may arise within Nepal (Nepalese-source) or from outside (foreign-source). A resident is taxed on worldwide income, while a non-resident is taxed on Nepalese-source income only.

Exempt incomes: Certain incomes, such as income of the Government, specified agricultural income, and some allowances for official duty, are exempt.

Assumptions: Mr. Basnet is a resident, single individual; the tax slabs of the relevant year (1% up to Rs 500,000, 10% on the next Rs 200,000, 20% on the next Rs 300,000, 30% on the next Rs 1,000,000). Items taxed by final withholding (dividend, bank interest, gain from investment insurance and government securities, windfall gain) are excluded. Net receipts are grossed up for non-final TDS (royalty and natural resources 15%, rent 10%).

(a) Net assessable income from investment

Excluded: dividend 95,000, bank interest 95,000, investment insurance gain 190,000, government securities gain 20,000 and windfall gain 15,000 (final withholding; lottery ticket cost Rs 1,500 is therefore not allowed), office rent Rs 40,000 and house insurance Rs 12,000 (not incurred for earning this income).

(b) Statement of total taxable income

(c) Tax liability

TDS already deducted (royalty 12,000, rent 40,000, natural resources 45,000 = 97,000) is credited, leaving Rs 22,650 payable.

Assumptions: Dr. Shrestha retired on 1 Chaitra, so he received salary for 8 months and pension for 4 months; he is a resident single individual. Non-final TDS items (natural resources, part-time salary and meeting allowance at 15%) are grossed up.

(a) Assessable income from employment

Not included: tiffin and meal given equally to all staff, emergency medical expenses of Rs 480, and the travelling and daily allowance for the official seminar. No values are given for the car and housing facilities, so none can be added.

(b) Statement of taxable income

Not allowed: political party donation, transportation and household expenses (personal). Medical expense is a tax credit, and advance tax is a payment of tax.

(c) Tax liability

After crediting advance tax of Rs 10,000 and TDS of Rs 46,500 (natural resources 15,000, part-time salary 30,000, meeting allowance 1,500), the balance payable is Rs 88,650.

Assumptions: Mr. Bharat is a resident individual (single). Tax slabs: 1% up to Rs 500,000. Income tax deducted on net items is grossed up for non-final items (natural resources 15%); dividend and bank interest are subject to final withholding.

(a) Net assessable income from business

This includes agricultural income of Rs 30,000, and the amount received for accepting the business restriction (Rs 40,000) and the customs duty refund (Rs 15,000). Pollution control cost, repairs, hospitality, bonus and audit fees are allowed as business expenses.

(b) Net assessable income from investment

(c) Statement of total taxable income

(d) Tax liability

$\text{Tax} = 1\% \times 493{,}366 = 4{,}934$

Less: 50% rebate on the tax on agricultural income ($1\% \times 30{,}000 = 300$, so rebate = 150).

Tax liability = Rs 4,784.

Tax already paid (advance tax Rs 7,500 and TDS on natural resources Rs 15,000) exceeds this, so a refund (or carry forward) of Rs 17,716 arises.

(e) Explanation is given against each adjustment above: income taxes, fines, reserves and personal expenses are not business expenses; VAT is a pass-through; stock errors are corrected to arrive at the true profit; investment and finally taxed items are separated from business income; and intangible assets and cars are depreciated under the Act.

A Permanent Account Number (PAN) is a unique identification number issued by the Inland Revenue Department to every person liable to pay tax or required to be registered. It is used for filing returns, paying taxes, issuing invoices, claiming VAT refunds, opening bank accounts and in major business transactions, and it remains valid for life.

Output VAT is the value added tax charged and collected by a VAT-registered person on the taxable goods or services that he sells. It is a liability to the government, from which input VAT is deducted to find the net VAT payable.

Example: A trader sells goods for Rs 100,000 and charges 13% VAT.

$\text{Output VAT} = 13\% \times 100{,}000 = \text{Rs } 13{,}000$

A tax audit is an examination of the books of account, records and returns of a taxpayer by the tax authority or by an authorised auditor, to check whether the income, deductions, VAT and withholding tax have been correctly declared and the tax law followed.

Example: The Inland Revenue Department selects a company's income tax return and examines its sales invoices, purchase bills, VAT returns and expense records to find under-reported sales or wrongly claimed expenses.

Residential status: Ramesh came on 1 Magh 2080 and stayed until the end of Baisakh 2081, which is about four months (roughly 120 days) in the income year. This is less than 183 days, so he is a non-resident individual.

Taxable income: As a non-resident, only Nepalese-source income is taxable. The consultancy fee of Rs 200,000 is earned in Nepal, so taxable income = Rs 200,000.

Tax liability: A non-resident individual is taxed at a flat 25%.

$\text{Tax} = 25\% \times 200{,}000 = \text{Rs } 50{,}000$

When an employer lends to an employee at less than the prevailing (market) rate, the interest saved is a taxable employment benefit (interest subsidy).

• Loan: Rs 3,000,000
• Interest saved per year: $10\% - 8\% = 2\%$
• Loan outstanding from 1st Marga to the end of Ashadh = 8 months

$\text{Subsidy} = 3{,}000{,}000 \times 2\% \times \frac{8}{12} = \text{Rs } 40{,}000$

Rs 40,000 is included in the employment income of Mr. Dahal.

Capital gain on shares:

$\text{Capital gain} = 1{,}200{,}000 - 500{,}000 = \text{Rs } 700{,}000$

Mr. Pandey is a natural person who held the shares for more than 365 days (two years), so capital gains tax is charged at 5%.

$\text{Tax} = 700{,}000 \times 5\% = \text{Rs } 35{,}000$

Capital gain = Rs 700,000; tax liability = Rs 35,000 (a final tax on the gain).

Section 10 of the Income Tax Act, 2058 lists incomes that are exempt from tax. The main ones are:

1. Income of the government: income of the Government of Nepal, provincial and local governments (and bodies fully owned by them as specified).
2. Tax-exempt organisations: income of religious, charitable and public welfare institutions (approved as tax-exempt organisations), other than income from business.
3. Development trusts: income of funds and trusts such as the Pashupati Area Development Trust, Lumbini Development Trust and similar bodies named in the Act.
4. Retirement and social security funds: income of approved retirement funds, the Employees Provident Fund, Citizen Investment Trust and the Social Security Fund.
5. Diplomats and foreign aid: income of foreign diplomats and their staff under reciprocity, and income of foreign agencies and persons from grants and aid covered by agreements.
6. Scholarships: scholarships, stipends and similar educational awards.
7. Compensation received: compensation for death, injury or loss of personal property, and certain pensions, gratuities and benefits paid to the family.
8. Other: income exempted by treaty or by notification of the government, and certain agricultural and cooperative incomes specified in the Act.

These incomes are excluded when computing total assessable income.

Meaning. Final withholding payments are certain payments from which the payer deducts tax at the prescribed rate at the time of payment, and that deduction is the final tax on that income. The recipient need not include the income in his return or pay any further tax on it (Sec. 92 of the Income Tax Act, 2058).

Five final withholding incomes (examples)

1. Dividends paid by a company to a resident, taxed at 5%.
2. Interest on bank and financial institution deposits received by a natural person, taxed at 5%.
3. Winnings from lottery, prizes and other windfall gains, taxed at 25%.
4. Retirement payments such as lump-sum gratuity or pension, taxed at 5%.
5. Payments of Nepal-source income (royalty, service fees, etc.) to a non-resident without a permanent establishment in Nepal, taxed at 15%.

(Other examples are insurance gains and certain payments to non-residents such as shipping or airline income.)

Adjustments

• Year 1: the donation of Rs 300,000 to a public hospital was charged. The allowable donation is the lower of 5% of adjusted taxable income or Rs 100,000. Adjusted taxable income $= -200{,}000 + 300{,}000 = 100{,}000$, so the allowable donation is $5\% \times 100{,}000 = 5{,}000$. Taxable income of year 1 is $100{,}000 - 5{,}000 = 95{,}000$ (no loss remains).
• Year 4: pollution control cost is an allowable deduction, so no adjustment is needed.
• Year 5: interest of Rs 50,000 must still be deducted, so profit is $200{,}000 - 50{,}000 = 150{,}000$.

Taxable income with loss carry forward (losses are set off against later years)

The business loss of year 2 is carried forward and set off in years 3 and 4 (within the 7-year limit). Taxable income of the 6th year is Rs 300,000.

VAT is 13%. The price paid by the customer includes VAT.

(a) Import price

Retailer's selling price (excl. VAT):

$\frac{339{,}000}{1.13} = 300{,}000$

Retailer's purchase price (excl. VAT) = selling price - profit (10% of selling price) - extra cost $= 300{,}000 - 30{,}000 - 1{,}000 = 269{,}000$.

Importer's selling price to the retailer = 269,000. Importer's cost = $269{,}000 - 26{,}900 - 1{,}000 = 241{,}100$.

Import price of TV = Rs 241,100

(b) VAT at each stage

Total VAT received by the government = Rs 39,000 (equal to VAT on the final price).

Block D depreciation rate is 15%. Assets acquired in the last three months (Baisakh to Ashadh) get depreciation at two-thirds, so the 20th Jestha addition counts at two-thirds of its cost.

Depreciation base

a. Allowable depreciation and repairs

$\text{Depreciation} = 920{,}000 \times 15\% = \text{Rs } 138{,}000$

Repairs and maintenance are allowed up to 7% of the depreciation base: $7\% \times 920{,}000 = 64{,}400$. Actual repairs Rs 60,000 are below the limit, so Rs 60,000 is fully allowed.

b. Value of fixed assets at the end of the year

$\text{Closing WDV} = (600{,}000 + 100{,}000 + 120{,}000 + 180{,}000 - 20{,}000) - 138{,}000 = 980{,}000 - 138{,}000 = \text{Rs } 842{,}000$

Mrs. Barsha keeps cash-basis accounts, so income is taxed when received and expenses are allowed when paid (the outstanding salary is therefore not deducted, and the legal fees of earlier years received this year are taxed this year).

a. Net assessable income from profession

Not included: birthday gifts (personal, not taxable); lottery, dividend and bank interest (final withholding); outstanding salary (cash basis).

b. Statement of taxable income

Meaning. Under a self-assessment system, the taxpayer himself computes the taxable income and tax liability, files the return, and pays the tax without waiting for the tax office's assessment. The tax office accepts the return and checks it later through audit and enquiry (Sec. 98 of the Income Tax Act, 2058, introduced the system in Nepal).

The statement is true because the system succeeds where certain conditions are present, and these are strongest in developed countries.

1. High tax literacy and voluntary compliance. Citizens understand why tax is paid and have a culture of honest reporting, so returns are reliable.
2. Good record keeping. Businesses keep proper accounts, and banking and digital payments leave a trail, so declared income is easy to verify.
3. Strong tax administration. Computerised systems, matching of third-party data (banks, employers) and risk-based audit detect false returns quickly.
4. Effective penalties. Fines, interest and prosecution for under-reporting are certain and enforced, so cheating does not pay.
5. Simple, stable laws. Clear rules and online filing lower compliance cost and mistakes.
6. Trust between taxpayer and tax office. Taxpayers expect fair treatment and reviews are speedy, so they cooperate.

Benefits there: lower administration cost, faster assessment, fewer disputes and higher revenue.

In developing countries such as Nepal, a large informal sector, weak accounting, low tax awareness and limited audit capacity cause under-reporting and evasion, so self-assessment works less well unless these are improved.

Hence self-assessment is most effective in developed countries because their taxpayers, records and administration support it.

Assumptions: Mr. Kamal is a resident individual taxed as single; TDS on natural resource payments, royalty and private-lending interest is 15% (non-final) and on rent 10%, so grossing up is done accordingly. Winnings and insurance gains (final withholding) and bank interest are excluded.

(a) Net assessable income from investment

Not allowed or not included: personal expenses Rs 20,000 and cost of lottery ticket Rs 500 (winnings are final withholding); wind fall gain (net Rs 15,000), insurance gain (net Rs 190,000) and fixed deposit interest (net Rs 20,000) are final withholding incomes.

(b) Statement of total taxable income

(c) Tax liability

TDS already deducted (rent of natural resources 75,000 + royalty 15,000 + other natural resource payment 1,500 + lending interest 30,000 + machinery rent 40,000) = Rs 161,500.

Tax payable now = $203{,}800 - 161{,}500 =$ Rs 42,300.

Assumptions: previous income year is FY 2080/81 and Mr. Rohit is single. He joined on 1st Baishakh 2075, and the grade rises on each Baishakh, crossing the efficiency bar at Rs 60,000. Basic salary was Rs 66,000 for 9 months (Shrawan to Chaitra 2080) and Rs 69,000 for 3 months. Accommodation is taken at 5% and the vehicle facility at 2.5% of basic salary.

(a) Assessable income from employment

Dividend from the bank (net Rs 19,000) is final withholding, so it is excluded. Medical expenses paid by the office are not the employee's own deduction.

(b) Statement of taxable income

Not allowed: personal and household expenses, tuition fees and house insurance premium.

(c) Tax liability

TDS of Rs 30,000 on the part-time income can be credited, leaving about Rs 132,123 payable (after other TDS by the office).

Assumptions: Mr. Bhandari is a single individual. Stock errors are taken as a percentage of the book value (opening stock understated by 10% of Rs 90,000; closing stock overstated by 20% of Rs 55,000).

a. Net assessable income from business

Notes: refund of customs duty (Rs 15,000) is business income; the amount received for accepting restriction, commission, sundry income, recovered bad debts and speculation income are business income. Pollution control cost, repairs, bonus, bad debts and hospitality are allowed (no limits are violated on the data given). Cash payment over Rs 50,000 where banking is available is disallowed.

b. Net assessable income from investment

c. Statement of total taxable income

d. Tax liability

Less: advance tax paid Rs 7,500, so tax payable = Rs 172,083.

Input VAT is the VAT that a VAT-registered person pays on purchases of goods and services (or on imports) used for taxable business activity. It is claimed as a credit against the VAT charged on sales (output VAT).

$\text{VAT payable} = \text{Output VAT} - \text{Input VAT}$

For example, a trader pays Rs 13,000 VAT on purchases and collects Rs 20,000 VAT on sales. He deposits $20{,}000 - 13{,}000 =$ Rs 7,000 to the government. Credit is allowed only with a valid tax invoice and for purchases used in taxable business.

Residential status. Messi arrived on 1st Baishakh 2080 and stayed till the end of the income year (Ashadh end 2080 falls in FY 2079/80), a stay of only about 3 months (92 days). A natural person is resident only if present in Nepal for 183 days or more in the income year (or 183 days in two consecutive years, counting the above); he fails this test, so Messi is a non-resident.

Taxable income. Consultancy fees from ANFA are Nepal-source income:

$10{,}000 \times 130 = \text{Rs } 1{,}300{,}000$

Tax liability. A non-resident natural person is taxed at a flat 25%:

$1{,}300{,}000 \times 25\% = \text{Rs } 325{,}000$

Tax deducted by ANFA at source can be credited against this liability.

Facilities provided by a private employer are added to the salary.

Total amount to be included in employment income of Mr. Thapa = Rs 645,000.

Losses on non-chargeable business assets can be set off only against gains on such assets. The net capital gain of Mr. Laxman is Rs 300,000.

This statement is a popular definition of tax: a tax is a compulsory payment made by a person (or entity) to the government, without any direct return benefit, to meet public expenditure.

Explanation of the features

1. Compulsory. Payment is required by law; refusal leads to penalty, interest or prosecution. It is not a voluntary donation.
2. Contribution to the government. It is paid to the central, provincial or local government and not to private parties.
3. No direct quid pro quo. The payer does not receive a specific service in return for the amount paid, unlike a fee for a particular service.
4. Imposed by law. It is levied by the authority of an Act, for example the Income Tax Act, 2058 or the VAT Act, 2052.
5. For public purposes. The revenue finances roads, health, education, defence and administration, and also helps redistribute income and stabilise the economy.

Thus, a tax is a compulsory, legally imposed contribution from a person to the government for common public needs, with no direct benefit expected in return.

Meaning. Tax Deduction at Source (TDS), also called withholding tax, means the payer deducts tax at the prescribed rate from a payment at the time of paying it and deposits the amount with the Inland Revenue Department. The recipient receives the net amount, and the tax deducted is credited against his final tax liability (or is the final tax, in the case of final withholding payments).

Features

• Deducted by the payer when the payment is made or credited.
• Rates are fixed by the Act (for example salary at slab rates, rent 10%, dividend 5%, service fees 1.5% to 15%).
• Must be deposited within 25 days of the end of the month in which the deduction was made.
• It gives early revenue, reduces evasion and spreads the burden of tax.

Example

A company pays monthly office rent of Rs 100,000 to an individual landlord.

$\text{TDS} = 100{,}000 \times 10\% = \text{Rs } 10{,}000$

The company pays Rs 90,000 to the landlord and deposits Rs 10,000 with the tax office. The landlord claims Rs 10,000 per month as a credit in his annual tax return.

Adjustments

• Year 1: the donation of Rs 20,000 is added back, so the loss is $50{,}000 - 20{,}000 = 30{,}000$. Donation is allowable only up to 5% of adjusted taxable income, which is nil in a loss year, so no donation is allowed.
• Year 3: business income of Rs 20,000 not adjusted reduces the loss to $150{,}000 - 20{,}000 = 130{,}000$.
• Year 6: depreciation of Rs 10,000 not yet deducted gives income of $600{,}000 - 10{,}000 = 590{,}000$.

Loss carry forward

Taxable income of year 6

$590{,}000 - 100{,}000 = \text{Rs } 490{,}000$

Tax liability (taxed as an entity at 25%):

$490{,}000 \times 25\% = \text{Rs } 122{,}500$

Losses can be carried forward up to 7 years, so all losses are available in year 6.

VAT is 13%.

a. Import price

Amount paid by the retailer to the importer, excluding VAT:

$\frac{13{,}673}{1.13} = 12{,}100$

The importer's selling price is Rs 12,100 and profit is 10% of cost plus profit (i.e. of selling price), so cost of importer $= 12{,}100 \times 90\% = 10{,}890$.

$\text{Import price} = 10{,}890 - 1{,}000 = \text{Rs } 9{,}890$

b. Total VAT to the government

Retailer's cost $= 12{,}100 + 900 = 13{,}000$; profit is 15% of selling price, so

$\text{Selling price} = \frac{13{,}000}{0.85} = 15{,}294.12$

Total VAT to the government = Rs 1,988.24.

Block B depreciation rate is 25%. The office equipment purchased on 10th Baishakh falls in the last three months, so it is taken at two-thirds of cost for depreciation.

Depreciation base

a. Allowable depreciation and repairs

$\text{Depreciation} = 1{,}150{,}000 \times 25\% = \text{Rs } 287{,}500$

Repairs limit $= 7\% \times 1{,}150{,}000 = 80{,}500$. Actual repairs are Rs 80,000, so Rs 80,000 is fully allowed.

b. Value of fixed assets at year end

$\text{Closing WDV} = (800{,}000 + 90{,}000 + 180{,}000 + 270{,}000 - 100{,}000) - 287{,}500 = 1{,}240{,}000 - 287{,}500 = \text{Rs } 952{,}500$

Mr. Sital keeps cash-basis accounts, so the outstanding rent of Rs 20,000 is not deducted. The balance b/d, loan and agriculture income are not professional income, and lottery, dividend and bank interest are final withholding incomes. The statement does not foot exactly, so only the figures listed are used.

a. Net assessable income from profession

Personal expenses, insurance premiums and donation are not professional expenses.

b. Statement of taxable income

Agricultural income, lottery, dividend and bank interest are excluded as exempt or final withholding.

A taxpayer who is dissatisfied with an assessment or decision of the Inland Revenue Department (IRD) can challenge it through a three-step process under the Income Tax Act, 2058.

1. Administrative review (Sec. 115)

• The taxpayer files an application with the Director General of the IRD against the assessment or decision of the tax officer.
• It must be filed within 30 days of receiving the notice of assessment.
• The taxpayer must pay the undisputed tax and one-third of the disputed tax amount (or the prescribed deposit) along with the application.
• The Director General decides within 60 days and issues a written decision with reasons.

2. Appeal to the Revenue Tribunal (Sec. 116)

• If the taxpayer or the department is not satisfied with the administrative review decision, or if no decision is given within the time, an appeal can be filed before the Revenue Tribunal.
• The appeal must be filed within 35 days of the decision (or of the expiry of the time limit for the review decision).
• The Tribunal is an independent quasi-judicial body, which hears both parties and gives a decision, which is binding on both parties.

3. Further appeal (Sec. 117)

• An appeal on the Tribunal's decision on a question of law can be made to the Supreme Court within 35 days.

Importance. The system gives natural justice to the taxpayer, reduces litigation in courts, encourages tax officers to be fair, and gives quick, low-cost settlement of tax disputes. A taxpayer who files for review is not required to pay the disputed tax beyond the prescribed portion until the matter is decided.

Assumptions: Mr. Dhurmush is a single resident individual. TDS on natural resource payments and royalty is 15%, on rent 10%. Domestic dividend and bank interest (received by a natural person) are final withholding incomes and are excluded. Joint investment income is shared 50:50. A business loss can be set off against other income.

a. Net assessable income from investment

b. Statement of total taxable income

c. Tax liability

TDS credit ($135{,}000 + 30{,}000 + 20{,}000 = 185{,}000$), so tax payable = Rs 132,500.

Assumptions: previous income year FY 2080/81, Mr. Arpan single. Scale Rs 60,000 rising Rs 2,000 each Baishakh from 2075, so basic salary is Rs 70,000 for 9 months and Rs 72,000 for 3 months. The vehicle facility is taken at 2.5% of basic salary (the official running costs borne by the office are not added). Meal and tiffin given to all employees equally is not taxable.

a. Assessable income from employment

b. Statement of taxable income

Dividend and bank interest are final withholding incomes. Personal medical treatment paid by the office, domestic expenses and house insurance are not deductible.

c. Tax liability

TDS of Rs 1,500 on the meeting allowance (and TDS on salary) is credited against this tax.

Reading the account: Sales Rs 5,000,000; closing stock Rs 350,000; purchases Rs 2,850,000; opening stock Rs 25,000; gross profit Rs 2,275,000; net profit Rs 1,650,000. Insurance of fixed assets Rs 15,000, R&D Rs 50,000 and depreciation Rs 50,000. Gain on non-chargeable assets Rs 20,000. Assumed: single proprietor.

a. Net assessable income from business

Refund of customs duty, gain on foreign exchange and sundry incomes are business income and stay in. Research and development, insurance of fixed assets and membership charges are allowed.

b. Net assessable income from investment

c. Statement of total taxable income

d. Tax liability

Less: advance tax paid Rs 20,000, so tax payable = Rs 251,900.