Chapter-11 Special Provisions on Banking and Insurance Business

59. Banking business

(1) In computing the income or loss made by any person carrying on a banking business from that business in any income year, it shall be separately computed as if the banking business were a business distinct from any other business carried on by that person.

(1a) Amount up to five percent of the amount of loan due to be recovered and amount managed for non-banking property, kept in the risk bearing fund by the person operating banking business or operating a hire-purchase business after obtaining approval from Nepal Rastra Bank, shall be deducted as expenses, subject to the standards prescribed by the Nepal Rastra Bank.

Entities conducting banking business must choose either to establish a loan loss reserve and claim an expense, or to write off actual bad loans. Where such a loan loss reserve exists, any amount charged to P&L as a bad debt shall not be additionally allowed, and amounts capitalised from that reserve or distributed as profits or dividends shall be included in income in the year of distribution.

Example 19.2.1: Suppose New Bank Ltd.'s total outstanding loans and loan loss reserve balance at the end of FY 2057/58 were Rs. 1,50,00,000 and Rs. 6,30,000 respectively. Of these, Rs. 4,50,000 had been allowed for income tax purposes (up to FY 2057/58, a maximum of 3% of total loans was allowable). At the end of FY 2058/59, the bank's total outstanding loans were Rs. 2,55,00,000 and the loan loss reserve balance was Rs. 14,00,000. Under Section 59(1a), the bank may claim the following expense for the loan loss reserve in FY 2058/59:

Example 19.2.2: Continuing from Example 19.2.1, suppose New Bank Ltd.'s total outstanding loans and loan loss reserve balance at the end of FY 2059/60 were Rs. 2,40,00,000 and Rs. 14,50,000 respectively. Under Section 59(1a), the loan loss reserve position for FY 2059/60 is as follows:

Note: Although only Rs. 50,000 was charged to P&L in FY 2059/60, since the total allowable under Section 59(1a) is only Rs. 12,00,000 and Rs. 12,75,000 was already claimed in the prior year (Rs. 75,000 in excess of the new limit), Rs. 75,000 must be included in income for FY 2059/60.

Example 19.2.3: Suppose New Bank Ltd.'s total outstanding loans, non-banking assets, and loan loss reserve at the end of FY 2070/71 were Rs. 2,30,00,000, Rs. 20,00,000 and Rs. 14,00,000 respectively. At the end of FY 2071/72, these figures were Rs. 2,40,00,000, Rs. 20,00,000 and Rs. 14,50,000 respectively. The loan loss reserve position for FY 2071/72 under Section 59(1a) is as follows:

Note: Although only Rs. 50,000 was charged to P&L in FY 2071/72, an additional Rs. 1,50,000 is allowable within the ceiling, and the bank may claim this additional amount as an expense.

(1b) Amount up to five percent of the amount of loan due to be recovered kept in the risk bearing fund by a cooperative organization shall be deducted as expenses.

(1c) If a risk-bearing fund has been maintained in accordance with Sub-sections (1a) and (1b), then any amount written off from profit as irrecoverable debt shall not be allowed as a deduction, and if, the amount in such fund is capitalized or distributed as profit or dividend, then the amount so distributed shall be included in the income of the year in which it is distributed.

Banks and financial institutions may write off debt claims within the standards prescribed by Nepal Rastra Bank (Regulation 9 of the Income Tax Regulations, 2059). However, a bank or financial institution claiming expenses under Section 59(1a) for a loan loss reserve may not also claim write-off expenses under Section 25(2)(a). However, if upon writing off a loan, the loan loss reserve balance is reduced by an amount equal to the write-off and that reduction is recognised as income from the reserve, the write-off shall not be treated as a separate write-off for expense purposes.

Example 19.2.4: Suppose New Bank Ltd.'s total outstanding loans and loans required to be written off per Nepal Rastra Bank directives at the end of FY 2080/81 are as follows:

1. Total outstanding loans before write-off: Rs. 1,00,00,00,000

2. Loans to be written off: Rs. 6,00,00,000

3. Outstanding loans after write-off: Rs. 94,00,00,000

The bank's loan write-off is within Nepal Rastra Bank's prescribed standards, and the bank has not availed the loan loss reserve facility under Section 59(1a). In this case, the bank may claim the written-off loan amount of Rs. 6 Crores as an expense deduction under this provision.

Example 19.2.5: Suppose New Bank Ltd. has been claiming the loan loss reserve facility under Section 59(1a). At the end of FY 2080/81:

Since the bank has chosen the Section 59(1a) loan loss reserve option, it cannot directly charge write-off amounts to P&L under Section 25(2). When writing off loans mandatorily required by Nepal Rastra Bank, the write-off amount must be debited against the loan loss reserve and a corresponding income entry made in the reserve. Analysis:

Because the total of write-off (Rs. 1,00,00,000) and remaining reserve (Rs. 4,10,00,000) = Rs. 5,10,00,000 exceeds the 5% ceiling of Rs. 5,00,00,000, the excess Rs. 10,00,000 cannot be claimed as a deductible expense.

Explanation: For the purposes of this Section, "banking business" means the banking transaction carried out by banks and financial institutions having obtained approval to carry out banking transactions pursuant to the law in force.

Key Definitions for Banking Business:

(a) "Banking business" means banking transactions conducted by banks and financial institutions that have obtained approval to conduct banking transactions under the prevailing law. Under prevailing law, banking transactions may only be conducted after obtaining approval from Nepal Rastra Bank. Under Section 59(1) of the Act, when computing the income or loss from banking business of any person conducting banking business in any income year, banking business shall be treated as a separate business from any other business operated by such person, and shall be computed separately.

(b) "Financial institution" means, under Section 2(G) of the Nepal Rastra Bank Act, 2058, a financial institution established under prevailing law for the purpose of providing loans for agriculture, cooperatives, industry, or any other specific economic purpose, or for collecting deposits from the general public. The term also includes institutions that the Government of Nepal has notified in the Nepal Gazette as financial institutions.

(c) "Financial transaction" or "banking business" means, as stated in Section 49 of the Banks and Financial Institutions Act, 2073, primarily the acceptance of deposits payable on demand or at a specified time, with or without interest, in accordance with prevailing practice, the repayment of such deposits, and activities such as providing loans and making investments.

Banking business (Sec 59): computed as a SEPARATE business. Loan-loss / risk reserve - a bank may deduct up to 5% of (outstanding loans to be recovered + non-banking assets) held in the reserve, per NRB standards (59(1a)); a cooperative up to 5% of outstanding loans only, non-banking assets excluded (59(1b)).

A bank must CHOOSE either the reserve deduction OR actual bad-loan write-off (Sec 25(2)(a)) - it cannot claim both on the same loans.

Amounts later capitalised from the reserve or distributed as profit/dividend are included in income in the distribution year (59(1c))

60. General insurance business

(1) In computing the income or loss made by any person carrying on a general insurance business from that business in any income year, it shall be separately computed as if the insurance business were a business distinct from any other business carried on by that person.

(2) In computing the income of any person carrying on the general insurance business in any income year, it shall be done as follows:-

(a) In income, in addition to any other amounts required to be included pursuant to this Act, the following amounts, as well, shall be included:-

(1) Amounts for premium of insurance including premium for reinsurance received by that person from that business in that year, and

(2) Amounts received in that year from payments referred to in sub-clause (1) of clause (b) for any contract of reinsurance, security, guarantee or compensation.

(b) In expenses, in addition to the amounts that can be deducted pursuant to this Act, the following amounts, as well, may be deducted:-

(1) Payments made by that person as an insurer in operating that business in that year, and

(2) Premiums included pursuant to sub-clause (1) of clause (a) in computing the income earned from that business in that year or last year and returned to the insured in that year.

(3) Sum of the following amounts kept in the risk bearing fund:-

(a) Amount up to fifty percent of the net insurance premium shown in the profit and loss account of any year, and

(b) Amount up to one hundred and fifteen percent of the remaining amount for payment of claim at the end of any year.

Provided that the amount received as deduction in expenses in any year pursuant to this sub-clause shall be included in income in computing the income of insurance business in the forthcoming income year.

The income of persons conducting general insurance business includes: premiums received from insured persons (Premium Received), premiums received for accepting reinsurance (Reinsurance Accepted), commission received for ceding reinsurance (Reinsurance Ceded), and recoveries received from reinsurance arrangements where the insurer has made payments. The specific deductions for general insurance include claims payments made by the insurer, premiums returned to insured persons, commission paid for ceding reinsurance, agent commission, the Unexpired Risk Reserve (50% of net insurance premium), and the Reserve for Unsettled Claims (115% of outstanding claim amounts at year-end).

General insurance policies are normally one year in duration. Since companies issue insurance policies throughout the year, the company's potential liability does not expire simultaneously with the financial year end. Accordingly, under insurance law, 50% of net insurance premiums collected in that financial year (after deducting reinsurance) must be transferred to the unexpired risk reserve. However, the amount so transferred must be included in income in the following year.

Where a general insurance company has received a claim by year-end but the loss survey or other required documentation is still pending acceptance, the company must add 15% to the received claim amount and place it in reserve. This 15% additional provision is to make provision for claims that have occurred and are insurable events but have not yet been intimated. The amount claimed as an expense in this year must be computed as income in the following year.

Example 19.3.1: Suppose Nepal Insurance Company Ltd.'s insurance account data for FY 2079/80 and FY 2080/81 is as follows:

Income computation for Nepal Insurance Company Ltd. for FY 2080/81:

Note: The amounts placed in the risk reserve fund that were claimed as expenses- Reserve for Unsettled Claims Rs. 34,500 and Unexpired Risk Reserve Rs. 2,00,000, must be included in income for FY 2081/82.

Explanation: For the purposes of this Section, "registered general insurance business" means an insurance business registered in Nepal under the law in force and carrying on general insurance transactions.

Key Definitions for General Insurance Business (Section 19.3.1):

(a) General insurance is all insurance other than investment insurance. Examples include motor vehicle insurance, fire insurance, health insurance, and travel insurance. Premiums paid for general insurance may be deductible as a business expense, and claim amounts received may be includible in income depending on the circumstances. General insurance premiums for health and medical treatment purposes may qualify for the medical tax credit under Section 51 of the Act.

(b) "Registered general insurance business" means, as per the explanation in Section 60 of the Act, an insurance business registered in Nepal under the prevailing law and conducting general insurance transactions. To operate an insurance business in Nepal, approval must be obtained from the Insurance Authority under the Insurance Act.

(c) "Insurer" means an entity that has obtained approval to operate insurance or reinsurance business under the prevailing law. Since prevailing insurance legislation (Insurance Act, 2079) requires that only organised institutions may apply for a licence to conduct insurance business, a natural person cannot be an insurer.

(d) "Insured" means the natural person or institution that has taken out insurance.

General insurance business (Sec 60): computed as a SEPARATE business. INCOME = premiums (incl. reinsurance accepted) + reinsurance commission/recoveries + prior-year reserves released. EXPENSES = claims paid + premiums returned + reinsurance & agent commission + management + depreciation + risk-bearing reserves:

(a) Unexpired Risk Reserve = up to 50% of net premium,

(b) Reserve for Unsettled Claims = up to 115% of outstanding year-end claims. Reserves deducted this year are added back to income the following year (revolving)

61. Investment insurance business

(1) In computing the income or loss made by any person carrying on an investment insurance business from that business in any income year, it shall be separately computed as if the investment insurance business were a business distinct from any other business carried on by that person.

Key Definitions for Investment Insurance Business:

As per Section 2(am) of the Act, "investment insurance" means any of the following types of insurance:

(1) Insurance taken in respect of the death of the insured person or an associate of the insured person;

(2) Insurance in respect of personal injury or specific disability of the insured person or their associate, provided that the insurance agreement is valid for at least five years, or has no expiry date, and cannot be terminated by the insurer before the expiry of five years except in the specific circumstances mentioned in the agreement;

(3) Insurance involving the payment of a sum or series of sums to the insured in the future;

(4) Reinsurance of insurance under sub-clauses (1), (2) or (3); and

(5) Reinsurance of reinsurance mentioned in sub-clause (4).

Examples of investment insurance include Life Insurance, Endowment Policy, Superannuation, etc. Even if Accidental Insurance or Medical Insurance are related to life-related risks, if the contract duration is less than five years, they are not classified as investment insurance. However, if the contract duration exceeds five years, they fall within the definition of investment insurance.

(2) It shall be as follows in computing the income of any person carrying on the investment insurance business in any income year:-

(a) Except the following amounts, other amounts that can be included pursuant to this Act shall be included:-

(1) Amounts for premium of insurance including premium for reinsurance received by that person in operating that business in that income year, and

(2) Amounts received in that year from payments referred to in sub-clause (1) of clause (b) for any contract of reinsurance, security, guarantee or compensation.

(b) Except the following amounts, other amounts that can be deducted pursuant to this Act shall be deducted:-

(1) Payments made by any person as an insurer in operating that business, and

(2) Premiums referred to in sub-clause (1) of clause (a) returned to the insured.

(3) The amounts referred to in sub-clauses (1) and (2) of clause (a) and sub-clauses (1) and (2) of clause (b) of sub-section (2) shall not be considered as incomes and expenses for the asset or liability of that person.

(4) The investment insurance agreement of the investment insurance business of any person shall not be deemed as the asset and liability of that person.

While premiums received in a general insurance business are treated as income for that business, in the case of life (investment) insurance, the premiums accumulated by policyholders under insurance policies are not treated as income of the entity for income tax purposes. Under Section 61(3), such received premium amounts are also not treated as incomings in respect of the entity's liabilities or assets. Therefore, an entity conducting life insurance business must record premiums received from policyholders as capital (equity) in its accounts.

Similarly, amounts received as compensation under insurance agreements, reinsurance premiums, etc. are also not treated as income of the entity but as capital. Likewise, payments made by the insurer and premiums returned to insured persons are not treated as deductible expense or outgoings in respect of any asset or liability. An entity conducting life insurance business must include other ordinary income - such as interest income, miscellaneous income - in income for income tax purposes, and may claim ordinary expenses such as management expenses, interest expenses, depreciation, agent commission, etc. as deductions.

Example 19.4.1: Suppose Swarnima Life Insurance Company Ltd. is an entity (insurer) conducting life insurance business. For this income year, the entity's data is as follows:

Income Computation:

Payments returned to policyholders are treated as capital refund with gain for tax purposes:

In the above example, the Rs. 10,00,000 received as insurance premium is not treated as income of the insurer, business liability, or asset incomings. The total insurance policy value (Sum Insured) of Rs. 5,00,00,000 is also not treated as the insurer's liability. Under the Act, premiums received from policyholders and payments made by the insurer to policyholders are not treated as incomings or outgoings in respect of assets and liabilities. Therefore, such receipts and payments and any resulting savings or losses are not treated as income or deduction for income tax purposes.

Investment (life) insurance business (Sec 61): computed as a SEPARATE business. Premiums received from policyholders are NOT income - treated as capital/equity, and not as incomings on any asset/liability (61(3)). Only ordinary income (interest, misc, reinsurance-ceded commission) is taxed; ordinary expenses (management, agent commission, depreciation) are deductible. Investment insurance = life/endowment cover for death, or injury/disability with a term of 5 years or more, or future payment of sums. On a policy payout, the GAIN (payout − premiums paid by the policyholder) is taxed at 5% final WHT u/s 88; a loss on surrender = no tax

62. Amount received from insurance

(1) For the purposes of computing the income of any person, the provisions contained in Section 31 shall apply in respect of the amount received by that person from insurance.

(2) Notwithstanding anything contained in sub-section (1), the following provisions shall apply in respect of the profits made from investment insurance:-

(a) If a resident person makes payment of such amount, tax shall be imposed on the insured through final tax deduction, and

(b) If a non-resident person makes payment of such amount, it shall be computed by including that amount in the income of the insured.

In the case of compensation received from general insurance, unless the election under Section 46 of the Act applies, the characterisation must be made under Section 31: where any person or an associate receives any indemnity (including insurance payments) for income received or receivable, or for loss sustained in business or investment, such indemnity amount shall be included in the income computation from employment, business, or investment, as applicable.

However, compensation for physical injury from a personal accident of a resident natural person need not be included in income, and expenses for treating such injury cannot be claimed as a tax credit under Section 51. The indemnity amount receivable upon the death of a natural person also need not be included in income.

Example 19.5.1: Suppose Tulsi Enterprises has insured its stock for Rs. 50 Lakhs. In FY 2078/79, a fire broke out in the company's warehouse, and goods worth Rs. 30 Lakhs were present at the time of the fire. The company filed a claim with the insurance company in FY 2078/79 itself, but by year-end the insurance company had not yet settled the claim. In this case, the company may claim the damaged stock as an expense deduction in FY 2078/79 under Section 15(1) of the Act. If the insurance company accepts the claim and pays Rs. 25 Lakhs in FY 2079/80, the entire amount must be included in business income for FY 2079/80.

Example 19.5.2: Suppose Pipal Enterprises has insured its furniture and office equipment for Rs. 20 Lakhs. In Ashoj 2078, all furniture and office equipment were completely destroyed by fire. The company's Group 'B' depreciation base in that income year was Rs. 15 Lakhs. The insurance company paid Rs. 18 Lakhs in FY 2079/80. The company purchased Rs. 10 Lakhs of replacement office equipment by end of Poush 2079.

FY 2078/79 treatment: Since all assets in Group 'B' were destroyed by fire, the entire depreciation base (Rs. 15 Lakhs) is deemed to have been disposed of and Rs. 15 Lakhs may be claimed as a deduction under Section 19 of the Act (terminal depreciation).

FY 2079/80 treatment:

Insurance proceeds Rs. 18,00,000 received (included in business income under Sections 31 & 62)

Example 19.5.3: Suppose Diwakar Khaniya took out a life insurance policy with Shubha Life Insurance Company Ltd. (registered in Nepal) for Rs. 5,00,000, and paid total premiums of Rs. 5,50,000. The policy matured on 2081/02/04. As per the insurance agreement, the insurance company paid Rs. 9,50,000 to him.

Computation:

The insurance company must deduct Rs. 20,000 as tax at the time of payment and pay the balance Rs. 9,30,000. This tax withheld is a final withholding under Section 62(2)(a) and Section 92(1)(c), and need not be included in the policyholder's income return.

However, if in the above example Diwakar Khaniya had insured with a non-resident insurer (not registered in Nepal) and received the same amount, the entire gain of Rs. 4,00,000 must be included in investment income. If he paid any foreign tax on that gain, he may claim a foreign tax credit subject to the provisions of the Act.

Explanation: For the purposes of this Section, "profits made from investment insurance" means the excess sums of payment received by any person for investment insurance in respect of that insurance over the premiums paid by that person.

Amount received from insurance (Sec 62): general-insurance proceeds are characterised under Sec 31 (included in the relevant income head, except personal-injury & death compensation to a resident natural person). Investment-insurance PROFIT (payout − premiums paid): if paid by a RESIDENT insurer → 5% final WHT on the insured (u/s 88, 92(1)(g)), not in the return; if paid by a NON-RESIDENT insurer → the full gain is included in the insured's investment income.