Finance Act 2081: Key Amendments and Their Impact in Nepal

The Finance Act 2081, enacted in 2024, ushers in a new phase of economic reforms aimed at achieving the vision of a “happy and prosperous Nepal.” This Act, presented on 28th May 2024 (Jestha 15, 2081 BS) by the Honorable Finance Minister, focuses on creating an investment-friendly environment, improving tax administration, and reducing tax evasion. It introduces major amendments that could significantly impact businesses, individuals, and the broader economic landscape of Nepal. This article will analyze these key changes under the Finance Act 2081 and their potential effects.

Finance Act 2081 Analysis

1. Digital Permanent Establishment (PE)

A major development under the Finance Act 2081 is the introduction of Digital Permanent Establishment (PE). The Act adds Section 2, sub-section (5) to the Income Tax Act, 2058, expanding the definition of digital PE. The provision targets foreign companies with a significant digital presence in Nepal or those conducting digital transactions within the country for at least 90 days in the last 12 months. This change aligns Nepal’s tax system with global efforts to tax digital services, following the decline of traditional physical economies.

Previously, digital services tax (DST) only targeted Business-to-Consumer (B2C) transactions. The introduction of digital PE extends the tax net to both B2B and B2C digital transactions, ensuring that non-resident digital service providers will be taxed under the new PE framework. The Finance Act 2081 aims to provide a clear mechanism for taxing non-resident digital services providers and mitigate revenue losses due to digital transactions.

However, the implementation of this change remains uncertain. Non-resident companies may face challenges in complying with Nepal’s tax regulations, especially concerning cross-border expenses and international trade dynamics. This shift also raises questions about the enforcement of such laws and their potential for creating conflicts due to unclear guidelines.

2. Tax on Change in Control

Section 57 of the Income Tax Act, 2058, has been amended in the Finance Act 2081 to provide tax relief in the event of change in control due to capital increases in startups, venture capital, and private equity funds. This provision was added to encourage investment in Nepali businesses, particularly in emerging sectors.

The amendment specifies that tax will not be imposed if there is an increase in capital without changing the proportion of ownership among existing shareholders. This move is expected to stimulate startup investments and provide relief to small businesses and startups seeking venture capital funding.

However, complexities might arise in its practical application, especially in cases where existing and new shareholders are treated differently, leading to inconsistencies in tax application.

3. Contribution-Based Retirement Payment

In the Finance Act 2081, a new section has been added that defines Contribution-Based Retirement Payment, which involves employee and employer contributions to an approved retirement fund. This measure strengthens the country’s pension and retirement savings system. Furthermore, tax deductions for contributions to the Social Security Fund and the Citizen Investment Trust have been extended, benefiting employees and workers who invest in retirement funds.

4. Advance Tax Deduction at Customs Points

The Finance Act 2081 also introduces a provision for advance tax deductions at customs points on various imported goods, including live animals, meat, dairy products, and other essential goods. This change aims to streamline tax collection but may result in unfair tax burdens if the advance tax cannot be offset against the income tax for the year.

This amendment raises concerns about the practicality and fairness of the new taxation system, as importers could face double taxation without sufficient mechanisms for tax credits.

5. Prize Money and Windfall Gain Tax

A new amendment in the Income Tax Act, introduced under the Finance Act 2081, targets prize money exceeding NPR 500,000 with a windfall gain tax. While this change aims to ensure that large winnings contribute to national revenue, there are concerns about fairness, especially for athletes and artists who make significant contributions to Nepal’s reputation.

6. Tax Assessment on Undisclosed Assets

The Finance Act 2081 also introduces a provision requiring the taxation of undisclosed assets or black money. If a person declares previously undisclosed income, the government will investigate and apply the highest applicable income tax rate if no violations of the Income Tax Act are found. This provision aims to reduce tax evasion and enhance financial transparency.

7. VAT Exemption on Domestic Trade of Potatoes, Onions, and Apples

The Finance Act 2081 has removed the VAT on domestic trade of certain agricultural products, including potatoes, onions, and apples, aligning with constitutional rights to equality and dignity. This decision is expected to provide relief to low-income groups and farmers involved in the production and trade of these essential commodities.

8. Advance Tax Withholding and Other Amendments

The Finance Act 2081 also revises the withholding tax provisions, including reducing the advance tax withholding rate on foreign currency loans from 10% to 5%. This reduction is aimed at improving Nepal’s foreign investment climate by making it easier and more attractive for international businesses to operate in Nepal.

Other key amendments under this Act include stricter rules for VAT and digital invoicing, as well as the introduction of green taxes on petroleum and coal imports, in line with international environmental commitments.

Conclusion: The Road Ahead for Nepal’s Economy

The Finance Act 2081 brings crucial changes to Nepal’s economic and tax landscape, particularly in the areas of digital taxation, investment incentives, and tax administration reforms. While these amendments show promise in fostering a more dynamic and investment-friendly environment, challenges remain in terms of implementation and clarity.

The introduction of digital permanent establishments and tax changes for startups and foreign investors is expected to encourage economic growth, but policymakers must address the ambiguities surrounding tax enforcement, especially in the context of digital service providers.

As Nepal continues to modernize its tax system and integrate with the global economy, it is crucial that the government provides clear guidelines to ensure fair tax practices, encourage investment, and improve compliance.

Disclaimer

S & S Jurists, one of Nepal’s leading law firms in the corporate sector, publishes articles on its website for informational purposes. This information should not be taken as legal advice, advertisement, personal communication, solicitation, or inducement. The firm and its team members shall not be liable for any consequences arising from the information provided here. If you need further legal advice on the subject matter, please contact us at: [email protected]

Citations

• Bimal Prasad Bhattarai (Case No. 076-WO-0492); Ved Lavati (Case No. 075-WO-0512) involving, and Ram Vriksha Mandal (Case No. 075-WO-0613).
• Finance Act, 2081 – Nepal Gazette, July 16, 2024.
• OECD (Organisation for Economic Co-operation and Development), BEPS 2.0 Framework, 2023.