Taxation in Nepal

Difference between Direct and Indirect Tax?

Tax Advisor Nepal

In this Article, we have covered the differences between Direct and Indirect Tax in Nepal.

What is a direct tax?

A direct tax is a tax paid directly by an individual or organization to the government. It is imposed on and collected from the person or entity that bears the ultimate economic burden of the tax. The taxpayer pays the tax directly to the revenue authorities and cannot shift the burden to someone else. Direct taxes are based on the ability-to-pay principle, meaning those with higher incomes generally pay more. Common examples include income tax, corporate tax, wealth tax, and property tax. Direct taxes are considered more equitable as they are levied based on the taxpayer’s income or assets. They also help reduce income inequality by imposing higher rates on the wealthy.

What is an indirect tax?

An indirect tax is a tax levied on goods and services rather than on income or profits. It is imposed on one entity in the supply chain but ultimately paid by the consumer as part of the purchase price. The tax is collected by intermediaries like retailers and manufacturers and then remitted to the government. Common examples include sales tax, value-added tax (VAT), goods and services tax (GST), and excise duties. Indirect taxes are regressive in nature, as they are applied uniformly regardless of the buyer’s income level. They are typically hidden in the price of products and services. Indirect taxes allow governments to raise revenue from a broader base of economic activities and consumption.

How do direct and indirect taxes differ?

Direct and indirect taxes differ in several key ways:

1. Incidence: Direct taxes are borne by the person on whom they are levied, while indirect taxes can be shifted to others.

1. Nature: Direct taxes are progressive, with rates increasing for higher incomes. Indirect taxes are generally regressive.

1. Evasion: Direct taxes are harder to evade as they are based on income/assets. Indirect taxes are easier to evade through unreported transactions.

1. Collection: Direct taxes are collected directly by tax authorities. Indirect taxes are collected by intermediaries.

1. Impact: Direct taxes reduce disposable income. Indirect taxes increase prices of goods and services.

1. Examples: Income tax is direct; sales tax is indirect.

1. Calculation: Direct taxes are calculated on income/profit. Indirect taxes are calculated on sale price.

Who pays direct taxes & indirect taxes in Nepal?

In Nepal, direct taxes are paid by:

1. Individuals earning taxable income

1. Companies and businesses with taxable profits

1. Property owners (for property tax)

1. Employers (for social security tax)

Indirect taxes are ultimately paid by consumers, but collected and remitted by:

1. Retailers and service providers (for VAT)

1. Manufacturers and importers (for excise duty)

1. Customs department (for import duties)

1. Businesses in specific sectors (for telecommunication service charge, etc.)

All residents and businesses in Nepal are subject to various direct and indirect taxes based on their income, transactions, and consumption patterns. The government relies on both tax types to generate revenue.

What are examples of direct taxes?

Examples of direct taxes in Nepal include:

1. Income Tax: Levied on individuals and businesses based on their annual income or profits.

1. Corporate Tax: Imposed on the profits of companies and other business entities.

1. Property Tax: Charged on the ownership of land and buildings.

1. Capital Gains Tax: Applied to profits from the sale of assets like stocks or real estate.

1. Wealth Tax: Levied on the net wealth of individuals (not currently implemented in Nepal).

1. Social Security Tax: Collected from employers and employees to fund social security programs.

1. Vehicle Tax: Annual tax paid by vehicle owners.

1. Dividend Tax: Imposed on dividends received by shareholders.

1. Remuneration Tax: Deducted from salaries and wages of employees.

1. Rental Income Tax: Levied on income earned from renting out property.

What are examples of indirect taxes?

Examples of indirect taxes in Nepal include:

1. Value Added Tax (VAT): Applied at each stage of production and distribution of goods and services.

1. Customs Duty: Levied on imported goods.

1. Excise Duty: Imposed on the manufacture of certain goods like alcohol, tobacco, and petroleum products.

1. Sales Tax: Applied to the sale of specific goods (replaced by VAT for most items).

1. Service Tax: Levied on certain services (now integrated into VAT).

1. Entertainment Tax: Charged on entertainment activities like movies and concerts.

1. Telecommunication Service Charge: Applied to telecom services.

1. Health Risk Tax: Levied on tobacco and alcohol products.

1. Education Service Tax: Charged on students pursuing education abroad.

1. Infrastructure Development Tax: Applied to petroleum products.

Are sales taxes direct or indirect?

Sales taxes are indirect taxes. Here’s why:

1. Shifting of burden: The tax is imposed on the seller but passed on to the buyer through higher prices.

1. Collection method: Sellers collect the tax from consumers and remit it to the government.

1. Uniformity: The same rate applies regardless of the buyer’s income or ability to pay.

1. Consumption-based: It’s levied on the sale of goods and services, not on income or wealth.

1. Hidden nature: The tax is often included in the listed price, making it less visible to consumers.

1. Regressive impact: Lower-income individuals pay a higher proportion of their income in sales tax.

1. Broad base: It affects a wide range of consumers and transactions.

Economic incidence: The final consumer bears the economic burden of the tax.

Is income tax direct or indirect?

Income tax is a direct tax. Here’s why:

1. Direct payment: Taxpayers pay it directly to the government, usually through withholding or periodic payments.

1. Based on ability to pay: Tax rates typically increase with higher income levels.

1. Non-transferable burden: The person earning the income cannot shift the tax burden to someone else.

1. Personal nature: It’s levied on an individual’s or entity’s income, taking into account personal circumstances.

1. Progressive structure: Higher earners generally pay a larger percentage of their income in tax.

1. Identifiable taxpayer: The government knows exactly who is paying the tax and how much.

1. Difficult to evade: Income is often reported by employers or financial institutions, making evasion harder.

1. Direct impact on disposable income: It reduces the taxpayer’s available income after tax.

How to calculate direct tax?

Calculating direct tax, specifically income tax for individuals in Nepal, involves the following process:

1. Determine taxable income: Start with total income from all sources (employment, business, investment). Subtract allowable deductions and exemptions.

1. Identify tax bracket: Nepal has progressive tax rates. For the fiscal year 2023/24, the brackets for individuals are:
  1. First NPR 500,000: 1% (social security tax)
  1. Next NPR 200,000: 10%
  1. Next NPR 300,000: 20%
  1. Next NPR 1,000,000: 30%
  1. 1. Above NPR 2,000,000: 36%

1. Calculate tax for each bracket: Multiply the amount in each bracket by its corresponding rate.

1. Sum up the tax: Add the tax calculated for each bracket.

1. Apply tax credits: Subtract any applicable tax credits (e.g., foreign tax credit, medical tax credit).

1. Adjust for advance tax paid: Subtract any advance tax or tax deducted at source.

The result is the final tax payable. Remember to consider special provisions for couples, non-residents, and specific industries. Consult a tax professional for complex situations.

How to calculate indirect tax?

Calculating indirect tax, particularly Value Added Tax (VAT) in Nepal, involves the following steps:

1. Determine taxable value: Start with the sale price of goods or services. For imports, include customs duty and other applicable taxes.

1. Apply VAT rate: The standard VAT rate in Nepal is 13%. Multiply the taxable value by 0.13.

1. Calculate input VAT: Sum up the VAT paid on purchases related to your taxable supplies.

1. Compute VAT payable: Subtract input VAT from output VAT (VAT collected on sales). If positive, this is the amount payable to the government. If negative, it’s a VAT credit.

1. Adjust for exempt and zero-rated supplies: No VAT is charged on exempt items. Zero-rated items allow input VAT recovery.

1. Consider time of supply rules: VAT is generally due when an invoice is issued or payment received, whichever is earlier.

1. File VAT return: Submit monthly returns showing all calculations.

For other indirect taxes like customs duty or excise, multiply the applicable rate by the taxable value of goods. Always check current rates and special provisions for specific industries or products.