Detailed Guide to Income Tax Act of Nepal 2058 (2002): Rules, Rates, Exemptions

The Income Tax Act of Nepal, enacted in 2058 B.S. (2002 A.D.), is a key legislative framework that governs the assessment, collection, and administration of income tax in the country. This Act replaced the former Income Tax Act of 2031 B.S., introducing a more comprehensive and modern approach to taxation. Its primary objective is to generate government revenue in a fair and efficient manner, ensure compliance, and promote transparency and accountability in the tax system.

The Act outlines provisions related to taxable income, tax rates, exemptions, deductions, tax credits, and the responsibilities of taxpayers. It covers individuals, companies, partnerships, and other entities, and categorizes income into three main sources: employment, business, and investment. Additionally, it includes regulations for withholding taxes, advance payments, tax audits, penalties for non-compliance, and appeals procedures.

A notable feature of the Income Tax Act is its progressive tax rate structure, which aims to ensure equity by taxing higher income at higher rates. It also promotes voluntary compliance through self-assessment systems and electronic filing mechanisms. By fostering a structured and predictable tax environment, the Income Tax Act plays a vital role in Nepal’s economic development and fiscal policy implementation.

Key legal provision of Income Tax Act , 2058.

Tax to be leived

In each income year, tax shall be imposed on the following categories of persons and collected as per the provisions of this Act:

1. Any individual or entity that earns taxable income during the income year,
2. Foreign permanent establishments of non-resident individuals operating within Nepal that transfer income from any income year,
3. Persons who receive income that is subject to final withholding tax during the income year.

Assessable Income

Assessable income refers to the income that is subject to tax under the Act. It includes:

• Income earned by resident individuals from employment, business, or investment during the income year, regardless of whether the income is sourced within or outside Nepal.
• Income earned by non-resident individuals from employment, business, or investment that originates from sources within Nepal.

Computation of income from business:

Business income refers to the profits and benefits earned by a person from business activities during any income year. While calculating this income, the following amounts must be included:

• Service charges received,
• Revenue from the sale of stock-in-trade,
• Net profit from business assets or liabilities (as per Chapter 8),
• Gains from selling depreciable business property,
• Gifts received related to the business,
• Compensation for accepting restrictions on business operations,
• Business-related income that may otherwise fall under investment income,
• Any other amounts specified under Chapter 6, Chapter 7, or Sections 56 and 60.

However, deductions allowed under Sections 10, 54, and 69, as well as income subject to final tax withholding, are excluded from the computation of business income.

Computation of income earned from employment:

Employment income refers to the total remuneration an individual receives from employment during an income year. This includes:

• Wages and benefits such as salary, overtime pay, bonuses, gifts, commissions, and other facilities,
• Allowances including dearness, subsistence, entertainment, and transport allowances,
• Reimbursements or settlements of personal expenses,
• Payments for agreeing to employment terms or for termination, retirement, or loss of employment,
• Retirement benefits, including contributions to retirement funds by the employer,
• Any other employment-related payments and amounts specified under Chapters 6 or 7.

However, the following are excluded from employment income:

• Deductions under Section 10 and income with final tax withheld,
• Meals and tiffin provided at the workplace under equal terms for all employees,
• Reimbursements for expenses that serve the employer’s business purpose or qualify as investment income exemptions,
• Minor payments too small or difficult to track as prescribed.

Computation of income earned from investment:

Investment income consists of profits and benefits earned by a person from investments during an income year. The following amounts are included when calculating investment income:

• Dividends, interest, payments for natural resources, rent, royalties, profits from investment insurance, and retirement fund profits (if the fund is unapproved), as well as retirement payments from approved funds.
• Net profits from the sale of non-business taxable investment assets, calculated according to Chapter 8.
• Excess income received from disposing of depreciable investment property beyond its remaining value.
• Gifts related to investments.
• Retirement payments and contributions made to retirement funds related to the investment.
• Compensation received for accepting restrictions on investments.
• Other amounts specified under Chapters 6, 7, or Section 56.

However, the following are excluded from investment income computation:

• Amounts deductible under Sections 10, 54, and 69, and income subject to final tax withholding.
• Amounts already counted as income from employment or business.

Exemptible Amounts under the Income Tax Act of Nepal:

These exemptions support social, governmental, and development objectives while avoiding double taxation and encouraging public welfare.

The following incomes are exempt from tax:

• Amounts exempted under bilateral or multilateral treaties between Nepal and foreign countries or international organizations.
• Income earned by individuals employed in foreign government services, provided they are residents or non-residents solely due to this employment and the payments come from that foreign government’s fund.
• Income received by non-Nepalese citizens working for the Government of Nepal under tax exemption terms.
• Allowances provided by the Government of Nepal, provincial, or local governments as social security.
• Gifts, inheritances, and scholarships, except those required to be included under specific sections.
• Donations or contributions received by tax-exempt organizations without expectation of return.
• Pensions received by Nepalese citizens retired from foreign military or police services from the foreign government’s fund.
• Income earned by Nepal’s government bodies (central, provincial, local).
• Earnings of Nepal Rastra Bank aligned with its objectives.
• Income earned by water and sanitation consumer organizations registered under the Water Resources Act.
• Income earned by mutual funds approved by the Nepal Securities Board according to their objectives.
• Earnings by educational institutions with government agreements to operate non-profit or not distribute profits.

Professional Exemptions and Facilities:

1. Agricultural Business:

Income earned by registered firms, companies, partnerships, or corporate bodies engaged in agricultural business is exempt from tax on 50% of their earnings. Agricultural income from land (as defined under the Land Act) outside of registered agricultural business is also exempt.

2. Cooperative Organizations:

Cooperatives and savings and credit cooperatives registered under the Cooperatives Act and engaged in forest- or agriculture-based industries (e.g., sericulture, dairy, poultry, fishery, tea/coffee farming, etc.) are exempt from tax. Dividends distributed by such cooperatives are also tax-exempt. Interest income up to NPR 25,000 from deposits in microfinance institutions, rural development banks, postal savings, and cooperatives is exempt.

3. Special Industries and Information Technology:

Special industries and IT industries enjoy various tax exemptions based on employment generation and location, including:

• Tax reductions from 10% to 30% depending on employment numbers.
• Additional exemptions if employing women, Dalits, or disabled persons.
• Tax holidays for industries in remote, undeveloped, and least developed areas.
• Full or partial exemptions for large investments or capacity expansions.

4. Industries in Special Economic Zones:

Full tax exemptions for 5-10 years and partial exemptions afterward, including on dividends and income from foreign technology or management fees.

5. Natural Resources and Mineral Exploration:

Income tax exemptions for up to seven years plus partial exemptions thereafter.

6. Technology and Software Industries:

50% tax exemption for software development, data processing, cybercafes, and related tech parks.

7. Electricity and Renewable Energy:

Full tax exemptions for the first 10-15 years with partial exemptions afterward for hydropower, solar, wind, and bioenergy projects.

8. Export Income:

Partial tax exemptions ranging from 20% to 50% depending on the entity and tax rates, with additional benefits for production-based exports.

9. Infrastructure and Transport:

Tax exemptions up to 50% for operation of trams, trolley buses, ropeways, railways, roads, bridges, and airports.

10. Other Specific Industries and Enterprises:

• Tax exemptions for industries producing brandy, cider, wine, vaccines, oxygen gas, sanitary pads, etc.
• Micro-enterprises enjoy full tax exemption for 7 years, with additional years if woman-owned.
• Special provisions for tourism, airlines, startups, and environmentally-friendly industries.

11. Multiple Exemptions:

Where multiple exemptions apply, taxpayers must choose one.

12. Old Property Clause:

Tax exemptions may be denied if the property was previously used for similar business or industry purposes.

Donations and Gifts to Tax-Exempt Organizations:

A taxpayer may deduct donations or gifts made to organizations approved by the Department for tax exemption purposes when calculating their taxable income. However, the deductible amount in any income year cannot exceed NPR 100,000 or 5% of the person’s adjusted taxable income for that year, whichever is lower. In special cases, the Government of Nepal can, through official notification, allow full or partial deduction of amounts donated for specific purposes as specified in the notification.

Deductible Amounts:

1. General Deduction:

A person may deduct expenses incurred in the income year that are directly related to earning income from business or investment.

2. Interest Deduction:

Interest paid on debt liabilities created to generate business or investment income can be deducted. For resident entities controlled by tax-exempt organizations, interest deductions are limited to the interest income received and 50% of the adjustable taxable income. Any excess interest can be carried forward to future years.

3. Allowances for Stock-in-Trade:

Deduction is allowed for the cost of goods sold, calculated by adding opening stock and purchases and subtracting closing stock, with closing stock valued at the lesser of cost or market value. Cost can be computed using methods like FIFO or average cost.

4. Repair and Maintenance Expenses:

Expenses on repair and maintenance of depreciable property used in income generation are deductible, but limited to 7% of the depreciation base amount, except for airplane testing costs which have no limit. Excess expenses can be added to depreciation base for the next year.

5. Pollution Control Expenses:

Expenses incurred for pollution control can be deducted up to 50% of adjustable taxable income. Excess amounts can be capitalized and depreciated in the following year.

6. Research and Development Expenses:

R&D expenses for business improvement are deductible up to 50% of adjustable taxable income, with excess capitalized and depreciated later.

7. Depreciation Deduction:

Depreciation on depreciable properties used in business or investment is deductible as per the schedule. Special provisions apply for obsolete equipment replacement and property transferred to the government in public infrastructure projects.

8. Loss from Business or Investment

Losses from business or investments not deducted in the current year can be carried forward up to seven years (or twelve years for specific public infrastructure and petroleum projects). Losses from foreign sources or non-taxable income must be matched against the same type of income. Special rules apply for losses related to long-term contracts, including permission for loss carrybacks.

9. General Conditions:

• If income from a business or investment is fully exempted, losses from that income cannot be carried forward.
• Taxpayers with multiple businesses/investments may allocate losses across them as desired.

This framework allows taxpayers to reduce taxable income by deducting relevant expenses, interest, losses, and allowances under specified limits and methods.

Deductible Amounts:

General Deduction:

A person may deduct expenses incurred in the income year that are directly related to earning income from business or investment.

Interest Deduction:

Interest paid on debt liabilities created to generate business or investment income can be deducted. For resident entities controlled by tax-exempt organizations, interest deductions are limited to the interest income received and 50% of the adjustable taxable income. Any excess interest can be carried forward to future years.

Allowances for Stock-in-Trade:

Deduction is allowed for the cost of goods sold, calculated by adding opening stock and purchases and subtracting closing stock, with closing stock valued at the lesser of cost or market value. Cost can be computed using methods like FIFO or average cost.

Repair and Maintenance Expenses:

Expenses on repair and maintenance of depreciable property used in income generation are deductible, but limited to 7% of the depreciation base amount, except for airplane testing costs which have no limit. Excess expenses can be added to depreciation base for the next year.

Pollution Control Expenses:

Expenses incurred for pollution control can be deducted up to 50% of adjustable taxable income. Excess amounts can be capitalized and depreciated in the following year.

Research and Development Expenses:

R&D expenses for business improvement are deductible up to 50% of adjustable taxable income, with excess capitalized and depreciated later.

Depreciation Deduction:

Depreciation on depreciable properties used in business or investment is deductible as per the schedule. Special provisions apply for obsolete equipment replacement and property transferred to the government in public infrastructure projects.

Loss from Business or Investment:

Losses from business or investments not deducted in the current year can be carried forward up to seven years (or twelve years for specific public infrastructure and petroleum projects). Losses from foreign sources or non-taxable income must be matched against the same type of income. Special rules apply for losses related to long-term contracts, including permission for loss carrybacks.

Expenses Not Allowed for Deduction:

Non-deductible Expenses:

For computing taxable income from business, employment, or investment, the following expenses cannot be deducted:

• Personal or domestic expenses (e.g., private living costs, personal travel, clothing except work-specific clothes, personal education unless directly related to business without a degree/diploma).
• Taxes payable under this Act, fines, or penalties paid for violating laws or regulations (except taxes paid to provincial or local governments).
• Expenses incurred to earn income exempted under the law or income already subject to final tax deduction.
• Payments to employees or workers without a Permanent Account Number (PAN), except small frequent wages up to NPR 3,000.
• Expenses for invoices over NPR 2,000 without PAN mentioned (except for natural persons selling agricultural or household goods).
• Profit distribution or similar payments by any entity.

Restrictions on Cash Payments:

For persons with annual turnover exceeding NPR 20 lakh, cash payments over NPR 50,000 are not deductible unless made:

• To the Government of Nepal, constitutional bodies, government-owned corporations, or banks/financial institutions.
• To farmers or primary agro-product producers/processors.
• For retirement contributions or payments.
• In places without banking services (within 10 km).
• On days banking services are closed or where cash payment is mandatory.
• When deposited into the recipient’s bank account.

Capital Expenses and Foreign Income Tax:

Capital expenses and foreign income taxes are generally not deductible.

The Income Tax Act, 2058 (2002), is a foundational law that structures Nepal’s tax system to ensure fair revenue collection, compliance, and transparency. It defines taxable income from employment, business, and investment, specifying allowable deductions like business expenses, interest, depreciation, and losses, while limiting non-deductible expenses such as personal costs, fines, and undocumented payments. The Act promotes social and economic goals through exemptions for agriculture, cooperatives, special industries, and infrastructure projects. By establishing clear rules on income computation, deductions, and exemptions, it creates a balanced, predictable tax environment that supports Nepal’s fiscal policy and economic development.