Chapter-7 Quantification, Allocation and Characterization of Amounts

27. Quantification of amounts

(1) Any payment shall be quantified equal to the following amount:-

"Payment" means the following transactions:

(1) Transfer of money or property of one person to another person's name, or transfer of a liability of another person to that person's name;

(2) Creation of property by one person that vests in another person's ownership after its creation, or assumption by one person of the liability of another person;

(3) Provision of services by one person to another person;

(4) Use or availability for use of a property owned by one person to another person.

Under the Act, payment is treated as an accrual-basis expense and income. The concept of "payment" plays an important role in computing a person's income and claiming expense deductions. The word "payment" in practice encompasses every means by which one person can benefit another.

(a) In the case of a payment made by transferring property by any person to another person, the amount equal to the market value of the transferred property,

Under this section, the official transaction value for the purposes of the Act is not the value stated in the agreement between the parties or the book value, but the market value determined at the time of transfer, and such market value must be included in income. If such a transaction is related to employment income, it must be included in employment income; if related to business, in business income; and if related to investment, in investment income.

Example 7.2.1: See Example 6.2.8

Example 7.2.2: Suppose Nepal Oil Corporation has a provision to provide 50 litres of petrol per month to its employees as a benefit, and the market value of such petrol is Rs. 80 per litre. In computing the employment income of the employee, Rs. 48,000 per annum (80 x 50 = Rs. 4,000 per month) must also be included in employment income.

Example 7.2.3: Suppose a noodle factory has a provision to give a colour television to any dealer who sells a specified quantity annually. If a dealer who has sold the specified quantity and met the target receives a television (asset) with a market value of Rs. 20,000, that dealer must include Rs. 20,000 in their business income.

Example 7.2.4: Suppose the Board of Directors of ABC Travel Agency Pvt. Ltd., in recognition of the Managing Director Mr. Hariprakash Shrestha's honesty toward the organization, decided to transfer a Jeep to him. In this situation, since the payment in recognition of his honesty was made through the transfer of an asset, the amount equal to the market value of that Jeep must be included in his remuneration income. Market value means not the Written Down Value shown in the asset accounts, but the value determined based on how much the Jeep would fetch if sold on the open market.

Example 7.2.5: Suppose an electricity distribution entity has a provision to give employees a waiver of charges up to a certain number of units per month as a benefit, or a telephone company has a provision to give employees a waiver of charges up to a certain number of calls per month as a benefit, or other similar waivers are made available to employees. In such cases, those entities must compute the amount of such waivers at market value, and the amount so computed must be included in the employment income of the workers or employees using the benefit.

(b) The amount to be determined as prescribed for the payment made for the provision of the following matters, or the amounts to be determined pursuant to clause (e) where there is no provision for determining the amount:-

(1) A motor vehicle used or made available for use for personal purposes of the recipient of payment in full or in part, or

Rule 13(1): For a motor vehicle used or made available for use by any person for personal purposes, in full or in part, for any beneficiary including an employee or worker, the amount shall be determined as follows for any income year pursuant to Sub-clause (1) of clause (b) of Sub-section (1) of Section 27 of the Act:

(a) in cases where it is provided to an employee or worker or any other person receiving remuneration on a monthly basis, the amount to be set by zero point five percent (0.5%) of the salary being drawn by such person;

(b) in cases other than those mentioned in clause (a), the amount to be set by one percent of the prevailing market value of the motor vehicle per annum.

Explanation: For the purposes of this Rule, 'motor vehicle' means a motorcycle, car, jeep and other motor vehicle of similar kind.

Example 7.2.6: Suppose an employee is provided a car for both personal and official use by their employer. The market value of the car is Rs. 20,00,000. The employee receives their monthly remuneration as follows:

Since the vehicle is provided for official use as well, the basic salary drawn must be determined to calculate the Perquisite value.

Amount at 0.5% rate: (1,85,930 x 0.5/100) = Rs. 929.65. Rs. 929 is treated as a payment received for the use of a vehicle and is included in the employee's employment income. Fractions of a paisa are not counted in such quantification.

Example 7.2.7: Suppose Mr. Harisharan was appointed as a consultant at ABC Travel Agency Pvt. Ltd. for a lump sum fee of Rs. 50,000 to conduct a program. The entity made a car available to him for three months for both personal use and to assist in performing the specified work. The market value of the car is Rs. 20,00,000. In computing his business income, in addition to the Rs. 50,000 received in cash from that entity, he must also include Rs. 5,000 (1 percent of Rs. 20,00,000 for 3 months=20,00,000*1%*3/4) in income.

(2) A building made available for the recipient of payment.

Rule 13(2): For a building used or made available for use by any person for personal purposes, in full or in part, for any beneficiary including an employee or worker, the amount shall be determined as follows for any income year pursuant to Sub-clause (2) of Clause (b) of Sub-section (1) of Section 27 of the Act:

(a) in cases where the person providing the building provides it to an employee or worker or any other person receiving remuneration on a monthly basis, the amount to be set by two percent of the salary being drawn by such person;

(b) in cases where the person providing the building rents it and provides it to a person other than that mentioned in Clause (a), the amount to be set by twenty-five percent of the amount paid for the rent;

(c) in cases where the person providing the building provides a building for which rent is not to be paid to a person other than that mentioned in Clause (a), the amount to be set by twenty-five percent of the prevailing house rent.

Rule 14: In certifying any payment pursuant to Section 27 of the Act or making conversion into Nepalese rupees pursuant to Section 28 of the Act, denomination of paisa exceeding the rupee shall not be counted.

Example 7.2.8: Suppose the employee in Example 7.2.6, in addition to salary and allowances, is also provided with a building with an annual rent value of Rs. 60,000. Since that person is an employee of the company, an amount of Rs. 3,718.60 (1,85,930 x 2/100) computed at 2 percent of the basic salary drawn must be included in employment income as the building benefit value. Although the valuation of the building benefit is Rs. 3,718.60, in accordance with Rule 14 of the Income Tax Regulations, 2059, since fractions of a paisa are not counted, only Rs. 3,718 must be included in income. If the employer has made cash or equivalent available to the worker or employee specifically for accommodation purposes, the full amount made available must be included in that person's income as accommodation.

Example 7.2.9: Suppose Nepal Bank Limited has a guest house in Bhairahawa. One flat of that guest house was made available to the bank's Director Mr. Bhajeshwar Mahat for one year. Suppose the prevailing monthly rent for a similar flat in the same area is Rs. 5,000. In this situation, the Director Mr. Bhajeshwar Mahat must include Rs. 1,250 (5,000 x 25/100) per month in his income and compute income accordingly.

Where accommodation is provided to office cleaners, messengers or office assistants working at the office for security reasons, such accommodation is not a benefit to the person but rather for the security of the office (for the employer's business purpose). In such a case, the amount equal to 2 percent of salary for the accommodation provided need not be included in that person's employment income.

Example 7.2.10: Suppose Deepak, an employee earning a monthly salary of Rs. 25,000, is provided accommodation by the office. He pays Rs. 200 per month to the office for the accommodation provided. Since the accommodation is provided to him as a benefit, in accordance with the regulations, the amount equal to 2 percent of the basic salary drawn, i.e., Rs. 500 per month, must be included in his employment income.

(c) The amount which remains by deducting the contributions of the recipient of payment from the expenditure made by the person making payment for the provision of the following:-

(1) The services of a caretaker of the house, cook, driver, gardener or other domestic assistant,

Where an entity provides services of a house caretaker, cook, vehicle driver, gardener or other domestic helper to its employee in accordance with its regulations, the amount remaining after deducting the benefit recipient's contribution must be included in computing that person's employment income.

Example 7.2.13: Suppose Bikash Bank Limited provided a helper to work at the home of its Chief Executive Officer (CEO). The helper is an employee of Bikash Bank Limited with a monthly salary of Rs. 5,000, and the institution designated his working area as the CEO's home. The service agreement at the time of the CEO's appointment provides for a deduction of Rs. 1,000 per month from the CEO's salary for providing one helper. In this situation, the bank pays Rs. 5,000 as remuneration to the helper. Since the contribution of the CEO (the person receiving the service) is Rs. 1,000, the remaining amount of Rs. 4,000 per month (5,000 - 1,000) must be included in computing the CEO's employment income.

(2) Any food, beverage or entertainment, or

Example 7.2.14: Suppose Hotel Kathmandu Regency has a provision under its employee service regulations whereby officer-level employees working there and up to 2 family members can eat a buffet dinner for Rs. 200 per person. If other persons can eat the same buffet at Rs. 700 per person, then after deducting the employee's contribution of Rs. 200 from the employer's expense of Rs. 700, the remaining Rs. 500 must be included in the employment income of the person using the benefit.

(3) Services like water, electricity, telephone installed in the residence of the recipient.

Example 7.2.15: Suppose Nepal Khusi Company Ltd. pays water charges of Rs. 1,000 per month, electricity charges of Rs. 2,000 per month and telephone charges of Rs. 3,000 per month installed at the personal residence of its Chief Executive Officer. The total of Rs. 6,000 per month paid by the entity for the above-mentioned facilities made available at the CEO's residence must be included in computing the CEO's employment income.

Example 7.2.16: Suppose any employer has a provision to make available to its workers or employees up to a specified or unspecified number of units of electricity per month, or up to a specified number of phone calls per month, as a benefit. In such cases, those entities must include the amount paid by the employer for such benefits in computing the employment income of the workers or employees using the benefit. Since a telephone installed at the residence of the person receiving the telephone benefit is used for both personal and official purposes, only the charges for calls made for personal use need be included in income.

(d) If the interest paid by any person who has to receive payment in any income year for a loan is less than the amount of interest to be paid as per the prevailing interest rate, the amount to the extent of such a difference, and

"Prevailing interest rate" means the interest rate available in the market for the particular type of loan extended. For this purpose, the taxpayer themselves has the responsibility to declare the interest rate and demonstrate compliance with it. The interest benefit including concessional interest or interest-free loans provided by the employer to employees must also be included in income.

Example 7.2.17: Suppose a person has been provided with a loan of Rs. 1,00,000 at an annual interest rate of 4 percent, and the prevailing interest rate is 8 percent. The difference of 4 percent, resulting in Rs. 4,000, constitutes an interest subsidy received by that employee and must be computed and included in employment income.

(e) In respect of a payment other than the payment referred to in clauses (a), (b), (c) and (d), if a third person receives payment instead of the recipient of payment, the amount equal to the value of the benefit derivable generally.

Example 7.2.18: Suppose Hariprasad, an employee at Bold Kid Pvt. Ltd., has a son studying at a school called Kinder World. The Pvt. Ltd. directly pays the school Rs. 10,000 per month for the school fee. Such payment is treated as an indirect benefit provided to the employee by the employer, and must be included in the income of Hariprasad when determining his employment income. Here, the Pvt. Ltd. is paying Hariprasad's liability, thereby indirectly benefiting him. Even though the third party Kinder World received the payment, since Hariprasad received the benefit, that amount is treated as his income.

Quantification of payments / perquisite valuation (Sec 27, Rule 13):

(a) payment in property = market value (not book value);

(b) VEHICLE for personal use = employee/monthly-paid person: 0.5% of basic salary (salary + grade), others: 1% per annum of vehicle market value. BUILDING/accommodation = employee: 2% of basic salary; rented building to a non-employee: 25% of rent paid; own building to a non-employee: 25% of prevailing rent;

(c) domestic help, food/entertainment, utilities (water/electricity/phone) = employer's cost minus the recipient's contribution;

(d) concessional or interest-free loan = difference from the prevailing interest rate; (e) indirect/third-party payment = value of the benefit.

Cash given for vehicle/accommodation = full amount taxed.

Rule 14: fractions of a paisa are ignored

(2) The time when a payment is earned, received, made, borne or otherwise worked out for tax purposes in respect of clauses (a) and (e) of sub-section (1) shall be the time when the quantification of amounts has been made.

In accordance with Section 27(2) of the Act, the time at which a payment is accrued, received, given, borne, or otherwise accounted for for tax purposes is deemed to be the time of quantification of such amounts, i.e., payment is treated as made or received on that date.

Example 7.2.19: Suppose Nepal Bank Ltd. appointed ABC Consultancy Pvt. Ltd. as a tax consultant effective from 1st Shrawan 2080 pursuant to an agreement dated 2079.10.28. Under that agreement, the bank has a provision to pay Rs. 1,00,000 per year to the company. As per the agreement, at the time of signing on date 2079.10.28, an advance of Rs. 40,000 was received. Since ABC Consultancy is a company and must account on the Accrual Basis, and the consultancy fee is deemed to accrue only in income year 2080/81, the Rs. 40,000 received as an advance is not treated as accrued in income year 2079/80 and must be accounted for as a liability until it accrues.

Example 7.2.20: Suppose Mr. Harish is an employee of Bikash Bank. In accordance with the bank's regulations, a vehicle has been arranged for both his personal and official use. Suppose his monthly salary is Rs. 40,000. In this situation, the benefit of Rs. 200 per month for using a vehicle is treated as a payment received. That amount is treated as received when the salary payment is made.

Example 7.2.21: Suppose ABC Company's balance sheet for financial year 2080/81 shows Rs. 4 lakhs payable to B&W. On 10th Shrawan 2081, pursuant to a decision of B&W's Board of Directors, the Rs. 4 lakhs owed to B&W was waived due to ABC Company's poor financial condition. ABC Co. must account for the waived Rs. 4 lakhs as income at the same time, i.e., on 10th Shrawan 2081.

Example 7.2.22: Suppose Ram owes Rs. 5 lakhs to Harish & Co. Pursuant to an understanding between Shiv Shankar and Ram, Shiv Shankar assumed Ram's liability to Harish & Co. on date 2080.03.16. In this situation, since the liability is disposed of on that date, Ram must account for that amount as his income.

28. Conversion into money

(1) If the income of any person and the amounts to be included and deducted in assessing that income are quoted in a currency other than Nepalese rupees, such amounts shall be converted into Nepalese rupees.

(2) If the amounts to be included or deducted in computing the income of any person in any income year have been quoted in a currency other than Nepalese rupees, such currency shall be converted into Nepalese rupees as per the exchange rate prevailing at the time when the amount was received, expended, paid, settled or otherwise worked out for tax purposes.

As provided under the Income Tax Act, Nepal Accounting Standard 11 (NAS-21: Effects of Change in Foreign Currency Rates) also provides for transactions in foreign currency to be converted into Nepali rupees (Functional Currency) using the prevailing exchange rate on the date of the transaction. Where a transaction is in foreign currency, the exchange rate of that same day must be used and accounts must be kept in Nepali rupees. When using exchange rates, the selling rate must be used where you are making a payment, and the buying rate must be used where you are to receive payment. Similarly, even where foreign currency payment is made without the need to purchase foreign currency, i.e., where the foreign currency is already available, the buying rate must still be used to convert the amount payable.

Example 7.3.1: Suppose Colgate Nepal Company issued an export bill for US$ 50,000 worth of various types of toothpaste and exported them on date 2080.03.32. On that date, the company recorded the sales in its sales books as US$ 50,000, and using the buying rate specified by Nepal Rastra Bank of NRs. 131.5 per US$, converted the amount and recorded total sales of NRs. 65,75,000 in the Nepali rupee column of the sales book.

It may be difficult for taxpayers to convert every daily transaction in foreign currency into Nepali rupees. In such cases, the taxpayer may also use the average exchange rate specified by the Department for any income year, with the written approval of the Department. For this purpose, "average exchange rate" means the exchange rate specified by the Department applicable to any income year for any person.

The following examples further clarify this provision:

Example 8.5.1: Suppose Ganga Manpower Services Pvt. Ltd. claimed an expense deduction for a commission of US$ 10,000 payable to Overseas International Inc. on date 2080.6.5. After withholding 5 percent tax, the amount payable was US$ 9,500, which was recorded as a liability at the exchange rate prevailing at the time of the transaction of Rs. 133 per US dollar, amounting to Rs. 12,63,500. That company remitted US$ 9,500 to Overseas International Inc. on date 2080.12.3. If the exchange rate at the time of remittance was Rs. 130 per US dollar, the following adjustment to income must be made in income year 2080/81: (1) Payable balance before adjustment: Rs. 12,63,500. (2) Amount at exchange rate on remittance date: Rs. 12,35,000 (US$ 9,500 x 130). (3) Amount to be adjusted (added) to income (exchange gain): Rs. 28,500 (Rs. 12,63,500 - Rs. 12,35,000).

Example 8.5.2: Suppose Ganga Manpower Services Pvt. Ltd. mentioned in Example 8.5.1 above remitted US$ 9,500 to Overseas International Inc. on date 2080.12.3. If the exchange rate on that date was Rs. 134 per US dollar, the following adjustment to income must be made in income year 2080/81: (1) Payable balance before adjustment: Rs. 12,63,500. (2) Amount at exchange rate on remittance date: Rs. 12,73,000 (US$ 9,500 x 134). (3) Amount to be adjusted (additional deduction claimed) (exchange loss): Rs. 9,500 (Rs. 12,73,000 - Rs. 12,63,500).

Example 8.5.3: Suppose Colgate Nepal Company issued an export bill for US$ 50,000 worth of various types of toothpaste and exported them on date 2081.2.30. On that date, the company recorded the sales in its sales book as US$ 50,000, and using the buying rate specified by Nepal Rastra Bank of NRs. 132 per US$, recorded total sales of NRs. 66,00,000 in the Nepali rupee column. When the amount was received on date 2081.8.3, the exchange rate published by Nepal Rastra Bank was NRs. 130 per US$, meaning the company received Rs. 65,00,000 in total. Accordingly, the company must claim Rs. 1,00,000 as an exchange loss expense in income year 2081/82. Similarly, if the buying rate of Nepali rupees against the dollar at the time of receiving US$ 50,000 was Rs. 133, the exchange gain of Rs. 50,000 must be included in the company's income for income year 2081/82. In this example, even if the exchange rate on 2081.3.31, that is, the last day of income year 2080/81, differs from the rate on 2081.2.30, the exchange gain or loss computed based on the exchange rate on that date for the outstanding amount cannot be included in income or claimed as an expense deduction for income tax purposes.

Example 8.5.4: Suppose Colgate Nepal Company opened a Usance LC on date 2081.2.30 to import raw materials worth US$ 50,000, with a provision to make payment within 180 days of the import date. The company imported such goods through the Birgunj Customs Office on date 2081.3.15. Since the exchange rate on that day was Rs. 130 per US dollar, customs clearance was done at that rate and purchase costs of Rs. 65,00,000 were recorded. When payment was made on date 2081.8.3, the exchange rate published by Nepal Rastra Bank was NRs. 128 per US$, meaning the company paid Rs. 64,00,000 in total. Accordingly, the exchange gain of Rs. 1,00,000 must be included in the company's income for income year 2081/82. Similarly, if the buying rate of Nepali rupees against the dollar when paying US$ 50,000 was Rs. 132, the exchange loss of Rs. 1,00,000 must be claimed as an expense as an exchange loss in income year 2081/82. In this example, although the LC was opened and the goods were cleared in income year 2080/81, since the value of the goods cleared had not yet been paid by the end of that year, the difference computed by restating the outstanding amount at the year-end exchange rate cannot be included in income or claimed as an expense deduction.

(3) Notwithstanding anything contained in sub-section (2), if the Department has, by issuing a notice in writing, given permission for the purposes of that sub-section, any person may apply the average exchange rate prescribed by the Department for that income year.

Conversion to NPR (Sec 28): convert foreign-currency amounts at the exchange rate on the transaction date - use the SELLING rate when paying, the BUYING rate when receiving. FX gain/loss is recognised only on the date of actual receipt or payment, NOT on year-end restatement (unlike NAS-21 for accounting). The Department may permit use of an average exchange rate in writing (28(3))

29. Indirect payments

If any person gets indirect benefit from the payments made by the payer or a person associated with him or specifies another person to receive the payment, the Department may, by issuing a notice in writing, treat such person deriving such benefit or such other person so specified as the recipient of the payment.

Where any person, through a special arrangement, order or direction, causes a payment made by any payer or a person associated with the payer to be made to a third party with the intention of benefiting themselves, the Department may issue a written notice treating the person receiving such benefit or such other third party as the person receiving that payment.

Example 7.4.1: Suppose pursuant to an agreement between Zenith Co. and Suleiman Housing Co., Zenith Co. paid interest itself and sold a house to its Managing Director on an instalment basis. The interest expense paid, which indirectly benefited the Managing Director, is treated as a payment received by him.

Example 7.4.2: Suppose Suleiman Company insures its employee. The company pays the insurance premium for 20 years, and after that, the benefit received from the insurance company is to be received by the employee in the capacity of insured. Since the premium amount, shown as payment to the insurance company rather than to the employee is treated as a payment received by the employee, it must be included in that employee's employment income.

Indirect payments (Sec 29): where a payer routes a payment to a third party to benefit someone, the Department may treat the person actually benefiting as the recipient and tax them (e.g. employer paying an employee's child's school fee, or an insurance premium for an employee).

30. Investment under joint ownership

For the purpose of computing the income earned by any person from an investment under joint ownership with other persons, the amounts to be included or deducted in computing the income shall be allocated on the basis of proportion of the respective interests of the joint owners in that investment.

Joint investment (Sec 30): income and expenses from a jointly-owned investment are allocated among the owners in proportion to their ownership/contribution ratio

Example 7.5.1: Suppose Sania and Safiya contributed Rs. 20 lakhs and Rs. 30 lakhs respectively to purchase a piece of land. They purchased a piece of land in Sifaltar, Kathmandu for Rs. 45,00,000 and had it registered in joint names. Registration fees, commission and other costs totalled Rs. 5,00,000. The jointly invested land was sold for Rs. 86 lakhs, and sales commission and other costs totalled Rs. 6,00,000. In that case, the income of each person is allocated as follows:

Example 7.5.2: Suppose Sania deposited Rs. 20 lakhs and Safiya deposited Rs. 30 lakhs in a bank and opened a joint fixed deposit account. Since it is both their investment, this is a joint investment under Section 30, and the income earned from it constitutes each person's income in proportion to their investment. This year the bank paid Rs. 1 lakh 50 thousand interest on that account. Of that interest, Rs. 60,000 is Sania's income and Rs. 90,000 is Safiya's income. Since tax has been levied through the final withholding tax mechanism, they need not include this income in their annual income return.

31. Characterization of payment for compensation

If any person or his associated person has received any compensation amount, including payments for insurance, for the following matters, at the time of receipt of the amount for the compensation, such amount shall be included, as the case may be, in computing the income earned from employment, business or investment:-

Under this section, since expenses or losses are claimed as deductions in the relevant section when they occur, the full amount received as compensation for such expense or loss must be included in income in the year in which the right to receive it is created.

Where compensation is received for loss of an asset, if the taxpayer wishes to avail of the benefit under Section 46, such compensation need not be included in income, but the provisions of Section 46 must be complied with. See Section 46 for Better Understanding.

Example 7.6.1: Suppose Kumar Company Pvt. Ltd. is in the cloth trading business. On date 2080.3.20, a fire broke out in the company's warehouse, destroying stock valued at Rs. 5 lakhs. The company filed an insurance claim with the insurance company where the warehouse was insured on date 2080.3.22. However, the claimed amount was received only on date 2080.10.20. In this situation, the loss from trading stock must be claimed as an expense for income year 2079/80 under Section 15 of the Act, and the insurance claim amount received must be included in income for income year 2080/81 under Section 31 of the Act, since it was received (or the right to receive it was created) only in income year 2080/81.

Example 7.6.2: Suppose in the fire mentioned in Example 7.6.1 above, all furniture and office equipment at Kumar Company Pvt. Ltd. were also destroyed. The company filed an insurance claim with the insurance company on date 2080.3.22 for the loss of the furniture and office equipment, and received the insurance claim amount on date 2080.10.20. The depreciation base of that asset pool at year-end was Rs. 5,00,000. The company had filed an insurance claim of Rs. 6,00,000 under the Insurance Policy with the insurance company, but only Rs. 5,00,000 of the claimed amount was received on date 2080.10.20. In income year 2079/80: Since all assets of the furniture and office equipment pool (pool 'B') of this company were destroyed in the fire, the total depreciation base of Rs. 5 lakhs is deemed disposed of, and Rs. 5 lakhs may be claimed as a deduction under Section 19 of the Income Tax Act, 2058. In income year 2080/81: The amount of Rs. 5 lakhs received from insurance must be included in business income for this year under Sections 31 and 62 of the Income Tax Act, 2058.

(a) Compensation for any income earned or likely to be earned by that person from any business, employment or investment or for any amount to be included in the computation of that income, or

(b) Compensation for any loss suffered or likely to be suffered by that person from any business or investment or for any expenses to be deducted in the computation of the income of that person.

A taxpayer may receive the following types of compensation: income-related compensation (compensation for loss of profit, compensation for loss of income) and deduction-related compensation (compensation for loss of deductible expenses, compensation for loss of assets - trading stock, depreciable assets, business assets or non-business taxable assets).

Provided that

(1) The amount of payment of compensation for physical damage suffered by a resident natural person from a personal accident shall not be included in the income, and the expenses incurred in the treatment of such damage shall not be claimed for tax adjustment pursuant to Section 51.

(2) The compensation amount to be received for the death of an natural person shall not be included in the income.

Compensation / insurance characterization (Sec 31): compensation or insurance received for (a) income lost or foregone, or (b) a deductible loss/expense, is included in income - under the same head (employment / business / investment) and in the year the right to receive it arises. Excluded: (1) personal-accident physical-injury compensation to a resident natural person (and the treatment expenses cannot be claimed u/s 51); (2) compensation for a person's death. Asset-loss compensation may be deferred under Sec 46

32. Characterization of payment under annuities, installment sale and financial lease

(1) Any payment made by a person who acquires a property under annuities or installment sale, or payment made to any person for the use of any property under a financial lease, shall be treated as the interest and return of capital under the debt claim pursuant to this Section.

Amounts paid for receiving an asset through an annuity or instalment sale, or for using an asset under a finance lease, are divided into an interest portion and a capital portion. The lessee under a finance lease is treated as the owner of the leased asset, and the lessor has a loan claim against the lessee.

(2) All payments referred to in sub-section (1) shall be calculated in gross and the total sum thereof shall be divided into two portions as follows:-

(a) Capital portion comprising all payments for annuities as per necessity or equivalent to the market value of any property at the time of selling that property by installment or leasing it, and

(b) Interest portion to be set by subtracting the capital portion from the total sum of all payments referred to in sub-section (1).

(3) A total payment schedule shall be provided by clearly setting out the capital and interest portions, in determining installments, at the time when annuity, installment sale or financial lease is made. One who cannot provide such a schedule shall treat the interest and principal portions, annuity, installment sale or financial lease as if they were mixed loans with interest to be kept on adding in every six months and allocate them among the payments referred to in sub-section (1).

(4) The borrower shall pay the principal in part and the interest in part by working out the portion of interest in the due and payable principal at the time of each payment in a manner that the rate of interest remains the same during the period of the loan of payment to be made pursuant to sub-section (1) as if it were a mixed loan.

(5) The following conditions shall be fulfilled in making a lease under a financial lease pursuant to this Section:-

(a) Where the lease agreement contains an option that ownership is transferred after expiry of the validity period of the lease, or the lessee can purchase that property at a certain or foreseen price after expiry of the validity period of the lease,

Example 7.7.1: Suppose XYZ Co. rented an Excavator from YZ Co. for five years at an annual rent of Rs. 10 lakhs, and the agreement clearly states that XYZ Co. has the option to purchase it at Rs. 20 lakhs after the rental period expires. Since the agreement includes an option to purchase the leased asset at a fixed price of Rs. 20 lakhs at the end of the lease period, the arrangement between XYZ Co. and YZ Co. to rent the machine is a finance lease.

(b) Where the period of lease exceeds seventy-five percent of the useful life of that property,

If the effective useful life of an asset is 8 years, the lease period must exceed 6 years for this condition to be satisfied.

(c) Where the estimated market value of that property after expiry of the period of the lease is less than twenty percent of the market value of that property prevailing at the beginning of the lease,

Example 7.7.2: Suppose YB & Co. leased a machine from BY Co. for 5 years with annual instalments of Rs. 1,00,000. At the time of the lease, the market value of the machine was Rs. 20 lakhs. If the machine were to be sold after 5 years, its estimated market value would be Rs. 2 lakhs. In this situation, the estimated market value of the machine is 10 percent (2 lakhs / 20 lakhs x 100), which is less than the specified 20 percent; therefore, this is also treated as a finance lease.

(d) In the case of a lease that commences prior to the ultimate twenty-five percent of the useful life of the property, where the current value of the minimum lease payment is equal to ninety percent of the market value of that property at the time of commencement of the period of the lease or more than that, or

Example 7.7.3: Suppose the useful life of an asset is 20 years. The asset was made available on lease on date 2080.10.1 within the first 15 years of useful life, and its market value at that time was Rs. 10,000. The prevailing interest rate is 10 percent, the lease term is 5 years, and the annual instalment at the end of each year is Rs. 2,500. The Discounted Value over 5 years is Rs. 9,477 (more than 90 percent of Rs. 10,000), so that transaction is treated as a finance lease.

(e) Where a property has been prepared in a special manner for the lessee and, after expiry of the period of lease, that property is not of practical use for any other person except the lessee.

(6) Each payment referred to in sub-section (1) shall be divided into two portions pursuant to sub-section (3), and the interest portion under the debt claim shall be treated as paid or to be paid interest and the capital portion as repayment of capital.

Practical Illustration: Section 32(4) - Mixed Loan Amortization

When no payment schedule separating principal and interest has been provided under Section 32(3), each instalment is treated as a mixed loan payment. The interest component each period is computed on the outstanding (reducing) principal at a constant effective rate, so the interest rate remains uniform throughout the loan term.

Given Facts

• Capital portion (loan / instalment sale price): Rs. 1,00,000

• Annual interest rate: 10% per annum, compounded semi-annually (as required by Section 32(3))

• Loan term: 3 years

• Payment frequency: Annual (end of each year)

Step 1: Compute the Effective Annual Rate

Semi-annual rate = 10% / 2 = 5%

Effective annual rate = (1.05)^2 - 1 = 10.25% per annum

Step 2: Compute the Fixed Annual Instalment (EMI)

Formula: EMI = P x [r(1+r)^n] / [(1+r)^n - 1]

Where: P = Rs. 1,00,000|r = 10.25% (0.1025)|n = 3 years

(1.1025)^3 = 1.3401

EMI = 1,00,000 x [0.1025 x 1.3401] / [1.3401 - 1]

EMI = 1,00,000 x 0.13736 / 0.3401

EMI = Rs. 40,389 per year (constant for all 3 years)

Step 3: Amortization Schedule (Allocation of Each Payment)

Interest each year = Opening principal x 10.25%. Principal repaid = EMI - Interest. Closing principal = Opening principal - Principal repaid.

Tax Treatment Under Section 32(6)

Each annual payment of Rs. 40,389 is split as shown above. Under Section 32(6), the split is recognised as follows:

Interest portion (Rs. 10,250 in Year 1; Rs. 7,161 in Year 2; Rs. 3,755 in Year 3) - treated as interest income for the lender and interest expense for the borrower under the debt claim rules.

Principal portion (Rs. 30,139 in Year 1; Rs. 33,228 in Year 2; Rs. 36,634 in Year 3) - treated as return of capital; neither income nor deductible.

Key Principle

The constant effective rate of 10.25% in every year is what Section 32(4) demands. If a party attempted to inflate interest in early years (to accelerate deductions) or defer it to later years, the Department would recharacterise the payments using this uniform-rate amortization method. The total interest recognised over the term (Rs. 21,166) and total principal recovered (Rs. 1,00,000) remain unchanged regardless of how the payments are structured - only the timing attribution per year is regulated.

(7) A lessee under a financial lease shall be treated as the person having ownership of the property leased, and the lessor shall be treated as having a debt claim over the lessee.

(8) The current value of the lease payment shall be computed by applying a discount rate equal to the general interest rate.

Explanation: "Period of lease" means and includes an additional period for which the lessee is entitled to have the lease renewed.

Annuity / instalment sale / finance lease (Sec 32): each payment is split into a CAPITAL (principal) portion = market value of the property + an INTEREST portion = the balance; if no payment schedule is given, allocated like a mixed loan with 6-monthly compounding.

Under a finance lease the LESSEE is treated as the owner and the lessor as holding a loan claim. A lease is a FINANCE lease if ANY one applies: (a) ownership transfers, or the lessee can buy at a fixed/foreseen price at lease end; (b) lease term exceeds 75% of the asset's useful life; (c) residual value at lease end is under 20% of the initial market value; (d) the lease begins before the final 25% of useful life AND the present value of minimum lease payments is 90% or more of market value; (e) the asset is specially made for the lessee and is useless to others

Example 7.7.4: Suppose Aban Construction Company Pvt. Ltd. is a construction company. In the first year, it rented a Heavy Duty Earth Moving Machine from Zircon Exim Pvt. Ltd. for 5 years at an annual rent of Rs. 5 lakhs. At the end of the 5th year, Aban Construction Company Pvt. Ltd. has the option to purchase the machine for Rs. 30,00,000. Based on the above provisions, since there is an option for Aban Construction Company Pvt. Ltd. to purchase at a fixed price of Rs. 30 lakhs at or after the end of the lease period, such an agreement or contract is called a Finance Lease under Section 32(5)(a). Since such a lease is treated as a sale, Aban Construction Company Pvt. Ltd. is the owner of the rented machine. The rent payment under the lease must be re-characterised as principal repayment and interest payment under a loan liability. In this lump sum of Rs. 55 lakhs (Rs. 30 lakhs + Rs. 25 lakhs), the capital portion is the market value of the machine and the remainder is interest. If the market value of the machine is Rs. 35 lakhs, Rs. 20 lakhs constitutes the interest portion. Each lease payment must be separated into capital and interest portions as follows:

Since no interest rate was available, this interest calculation is based on a PVIF Table simulation (12.04 percent) as shown below. Lease cash flows

So:

PV of future payments = 35,00,000

We solve for r (interest rate) such that:

35,00,000= 5,00,000 * PVIFA (i,5) + 3000000 * PVIF (i,5)

Using Trial and Error Method, Using i=12% and i=13%, we get the interest rate of 12.04%

As illustrated above, tax must be withheld on the interest portion of the payment at the time of payment, and Aban Construction Company Pvt. Ltd. may claim the interest portion as an expense under Section 14 of the Act. Since Aban Construction Company Pvt. Ltd. is treated as having purchased the machine at the commencement of the lease under Section 32(7) of the Act, the market value of the machine (Rs. 35 lakhs) constitutes an outgoing for Aban Construction Company Pvt. Ltd. As the owner of the asset, Aban Construction Company Pvt. Ltd. may claim depreciation expense from the commencement of the lease.

Example 7.7.5: (Incorrect in Directive)

Suppose Aban Construction Company Pvt. Ltd. purchased a Heavy Duty Earth Moving Machine from Zircon Exim Pvt. Ltd. on date 2066.10.1 with annual instalments of Rs. 10 lakhs payable at the start of each year for 5 years. Section 32 of the Act applies to such instalment sales. The present value of the lease payment (principal) must be computed by discounting the total value using the prevailing interest rate under Section 32(8) as follows:

The principal repayment and interest portion for the above transaction are as follows:

Based on the above computation, of the total instalments of Rs. 50 lakhs to be paid by Aban Construction Company Pvt. Ltd. over five years, Rs. 8,30,134.55 is treated as interest payment and Rs. 41,69,865.45 is treated as loan claim repayment. The company must record the principal of Rs. 41,69,865.45 as an asset purchase in the first year and record the same amount as a loan liability. The company may claim the total interest portion of Rs. 8,30,134.55 as an expense deduction under Section 14 of the Act. Similarly, Zircon Exim Pvt. Ltd. must record the present value of the lease payment as a sale in the first year and the same amount as a receivable. In subsequent years, Rs. 41,69,865.45 must be treated as capital repayment and Rs. 8,30,134.55 must be treated as interest income and included in income.

33. Transfer pricing and other arrangements between associated persons

(1) If any arrangement is made between associated persons and if the Department determines that the arrangement does not reflect the taxable income or payable tax that could be set for them as if it were operated as per arms length, the Department may, by issuing a notice in writing, distribute, appropriate or allocate the amounts to be included or deducted in computing the income between those persons.

(2) In carrying out anything mentioned in sub-section (1), the Department may do as follows:-

(a) To re-characterize any income, loss, amount or source and type of payment, or

(b) Where various expenses including main office expenses which any person had to incur to operate any business have yielded benefits to associated persons, to allocate such expenses between the associated persons on the comparative basis of the turnover of the business.

(3) The transfer pricing valuation method between associated persons pursuant to this Section shall be as determined by the Department.

Rule 15(1): In cases where any one or more than one person makes a request in writing to become clear as to the distribution, allocation or allotment to be made by the Department on the basis of arm's length in respect of the amounts to be included or deducted in computing the income of any person pursuant to Sub-section (1) of Section 33 of the Act, the Department may issue a notice in writing as follows: (a) in a manner that the period of the notice in writing does not exceed five income years at a time; (b) in a manner that the notice in writing can be renewed notwithstanding anything contained in Clause (a).

Rule 15(2): The notice in writing referred to in Sub-rule (1) shall be binding on the Department and the party making such request. Provided that in cases where the Department agrees to the request made by the concerned applicant, the notice in writing shall be invalid.

In this regard, the Transfer Pricing Directive 2081 issued in Ashwin 2081 specifies the Methods of Arm's Length Price Determination in Chapter 5. As provided in the directive, associated persons engaged in cross-border transactions must select an appropriate method from among the following through comparative analysis to determine the arms' length price: (1) Comparable Uncontrolled Price Method; (2) Resale Price Method; (3) Cost Plus Method; (4) Transactional Net Margin Method; (5) Transactional Profit Split Method.

Example 7.8.9: Suppose ABC Global Incorporated sold raw materials to ABC (Nepal) Pvt. Ltd. at Rs. 3 per unit, but the prevailing price of that item in the foreign market was Rs. 2.50. In that case, the Department may, by issuing a notice, re-characterise the expense deduction claimed by ABC (Nepal) Pvt. Ltd. at Rs. 3 per unit and recompute it at Rs. 2.50 per unit. Similarly, if ABC (Nepal) Pvt. Ltd.'s products were purchased by ABC Global Incorporated at Rs. 5 per unit, but the prevailing price of that item in the foreign market was Rs. 6 per unit, the Department may, by issuing a notice, re-characterise the difference of Rs. 1 per unit and include it as income of ABC (Nepal) Pvt. Ltd.

Example 7.8.10: Suppose an international contractor operating in Nepal claimed head office expenses in Nepal that were found to be higher than warranted relative to the work done in Nepal. In this situation, the Department may allow a deduction only for the portion properly attributable to Nepali operations and disallow the remaining claim.

Transfer pricing (Sec 33): for arrangements between associated persons not at arm's length, the Department may re-distribute, re-characterise or re-allocate income, loss, payments & expenses (incl. head-office expenses, allocated by turnover) to reflect an arm's-length result.

As Per the Transfer Pricing Directive 2081, the arm's-length price is set by one of 5 methods: (1) Comparable Uncontrolled Price, (2) Resale Price, (3) Cost Plus, (4) Transactional Net Margin, (5) Profit Split.

An advance ruling is available (Rule 15, up to 5 years)

33A. Special Provisions Relating to Safe Harbour Rules

(1) Notwithstanding anything contained in Section 33, a person having an annual turnover of up to NPR 100 crore and fulfilling the conditions prescribed in subsection (3) may determine the transfer price of a controlled transaction at the ordinary market transaction (arm’s length) value under the Safe Harbour Rule.

(2) A person opting for the Safe Harbour Rule under subsection (1) shall, while filing the income tax return, accept the transfer price as the ordinary market transaction (arm’s length) value in the manner prescribed by the Department.

(3) To qualify for the Safe Harbour Rule, any one of the following conditions must be satisfied:

(a) The operating profit margin from Information Technology (IT) service exports is maintained at not less than fifteen percent (15%) of operating costs.

(b) The interest rate on intra-group loans denominated in foreign currency is fixed at a rate not exceeding the relevant benchmark rate plus 200 to 400 basis points, as prescribed.

(c) For services with low value addition as prescribed by the Department, the service provider has added a profit mark-up of not more than five percent (5%) on the total cost of such services.

(4) Once a taxpayer elects to apply the Safe Harbour Rule under this section, such arrangement shall continue to apply for five consecutive income years, unless there is a material change in the nature and circumstances of the transaction.

(5) The procedures relating to the implementation of the Safe Harbour Rule under this section shall be as prescribed by the Department.

33B. Advance Pricing Agreement (APA)

(1) Notwithstanding anything contained elsewhere in this Act, the Department may enter into an Advance Pricing Agreement (APA) with a taxpayer regarding the basis and methodology for determining the arm’s length value of an international transaction between associated persons.

(2) Where the Government of Nepal has entered into a Double Taxation Avoidance Agreement (DTAA) under Section 73 with a foreign country and such agreement contains provisions relating to the Mutual Agreement Procedure (MAP), the competent authority of Nepal may coordinate with the competent authority of the relevant foreign country and enter into an agreement under subsection (1) on a bilateral or multilateral basis.

(3) An agreement under subsection (1) or (2) shall specify the methodology to be applied for determining the arm’s length price of the international transaction, (a) comparable assumptions, (b) critical assumptions, and (c) other necessary conditions. The value determined according to the methodology and procedure specified in the agreement shall, for the purposes of this Act, be treated as the arm’s length value.

(4) An agreement entered into under subsection (1) or (2) shall remain effective for the period specified in the agreement. However, such period shall not exceed five consecutive income years.

(5) While entering into an agreement under subsection (1) or (2), the parties may mutually agree to include a rollback provision covering international transactions of up to four income years immediately preceding the year in which the agreement becomes effective.

(6) An agreement entered into under this section shall be binding on both parties. Provided that, if there is a material change in the conditions specified in the agreement or in the applicable legal provisions, the agreement shall cease to be binding.

(7) If it is established that a person obtained the agreement by fraud, misrepresentation of facts, or by submitting incorrect or false information, the Department may cancel such agreement with retrospective effect from the beginning. The Department shall provide notice of such cancellation to the concerned person.

(8) The fee payable by a person wishing to enter into an agreement under this section shall be as prescribed.

(9) The format of the application, required documents, renewal procedures of the agreement, and other related procedures under this section shall be as prescribed by the Department.

34. Division of income

(1) If any person attempts to divide his income with another person and it appears that it will reduce the payable tax, the Department may, in order not to allow such reduction in liability, have the amounts to be included or deducted in computing the income of each person adjusted by giving a notice in writing.

Where any person attempts to divide their income with another person and such division is seen to result in a reduction in the tax payable, the Department may, by issuing a written notice, cause adjustments to the amounts to be included or deducted in computing the income of each such person, to prevent the reduction of that person's tax liability.

For example, where tax rates of 10% and 20% apply, if a person still has unused capacity within the 10% tax slab, shifting income to that person (through value transfer, payments, or indirect benefits) is an example of income splitting.

(2) The situations mentioned in sub-section (1) shall also include the transfer of the following amounts directly or indirectly between any person and an associated person through one or more interposed entities, and circumstances where attempts are made to divide income to reduce the tax required to be paid by such person or associated person by virtue of that transfer:-

(a) The amounts to be received and expenses to be incurred, or

(b) The amounts to be received or used from any property by the transferee of that property or expenses incurred or payment made by that person for the acquisition of ownership of that property.

Income splitting is an arrangement to reduce current or future tax liability by establishing a structure for earning income that reduces the possibility of taxation. Transfer pricing is also a type of income splitting, but while transfer pricing is done only between associated persons, income splitting may occur in other circumstances as well. Income splitting occurs where arrangements are made to distribute taxable income among persons so that a lower tax rate applies mutually.

(3) In determining as to whether or not any person has attempted to divide any income pursuant to sub-section (2), the Department shall take the market value of any payment made for the transfer as the basis.

Income splitting (Sec 34): if a person divides income with another to lower tax (incl. through interposed entities), the Department may adjust each person's income, using market value as the basis. Transfer pricing is splitting between associated persons; splitting can also arise otherwise.

35. General rule against tax avoidance

For the purposes of ascertaining the tax liability pursuant to this Act, the Department may carry out the following:

(a) To re-characterize any arrangement or any part of such arrangement made or attempted to be made as a part of a tax avoidance scheme,

(b) To disregard any arrangement or any part of such arrangement that does not show any substantial economic effect, or

(c) To re-characterize any arrangement or any part of such arrangement that does not show any substantial element.

Explanation: For the purposes of this Section, "tax avoidance scheme" means any arrangement with the main objective of having avoidance of tax liability or of reducing the tax liability.

For example, if concessional tax rates are granted for industrial promotion in remote or Himalayan regions, and an enterprise genuinely establishes an industry there and earns income while enjoying such concessions, this is considered legitimate tax planning, and GAAR should not apply.

However, if arrangements are made only on paper to claim such concessions, for instance, where real economic activity such as employment, production, and infrastructure remains in urban areas, and the structure exists only to reduce tax, then GAAR should be applied and such arrangements invalidated.

Tax avoidance scheme: An arrangement with the main purpose of avoiding or reducing tax.

Can be done:

• with other persons, or

• by the taxpayer alone.

If tax reduction is the primary objective, tax authority may:

• ignore the arrangement, and

• recalculate tax as if the scheme did not exist.

This power is called General Anti‑Avoidance Rule-GAAR.

• Originated from court decisions (e.g., Australia, New Zealand).

• Targets artificial, non‑commercial arrangements made only for tax benefits.

• Recognized in Nepal’s Income Tax Act, 2058.

If the legal form of a transaction does not match its economic substance: (SUBSTANCE OVER FORM)

• The Department or office may invalidate or re‑characterize it.

The tax authority must also clearly distinguish between:

• Tax planning, where the State intentionally provides incentives to promote certain economic or business activities, and

• Tax avoidance, where arrangements are made only to reduce tax without real economic substance.

GAAR (Sec 35): the Department may re-characterise or disregard any arrangement whose main purpose is to avoid or reduce tax, or that shows no substantial economic effect, and tax as if it did not exist. Genuine tax planning (using a concession the state intended) is allowed; only substance-less avoidance is struck down