See my other latest article on this topic here: DST Registration in Nepal
A context to this post
In my other post, written about a year ago, covering Digital Service Taxes in Nepal, in a Section of that article, there was a definitive question: “Does Nepal have any domestic laws that create a Digital PE in Nepal for digital services provided by non-residents in Nepal?” And the answer was: “No, Nepal doesn’t have any such provisions. The meaning of the Permanent Establishment is the same as those interpreted by OECD. The recommendations suggested by BEPS Action Plan 1 on modification of definition of a PE has not yet been adopted in Nepal.”
This is still true. The recent Digital Service Tax introduced under the Section 20 of Finance Act, 2079 still has not done anything to change the definition of the PE. No concept of the “Digital PE” has been introduced yet. But it has now adopted a straightforward taxing mechanism for the Digital Services provided into Nepal through the economic significance test and it applies for both direct and indirect taxes.
See my previous post on the Digital Service Tax here: Direct and Indirect Tax on Digital Services
The previous post
The previous post (link here Direct and Indirect Tax on Digital Services) discussed on:
(i) the meaning of the digital services,
(ii) Current position of the digital economy from OECD’s definition of PE
(iii) Some approaches to tax the Digital Services
(iv) Countries that have implement Digital Service Taxes (DST)
(v) USA’s investigation and findings on the DSTs implemented by the countries
(vi) Administrative challenges in the digital economy
(vii) Worldwide adopted digital service structures to minimize digital tax burden
(viii) Features of the digital economy
(ix) The, then prevalent position of Nepal regarding the DST in Nepal
If you want to revisit these topics, you can come back here after going through that article. You can also check out this article regarding the Ecommerce Business in Nepal to understand more on the distinction between the ecommerce and digital economy. How one is only a component of the other and not similar terms.
Amendment brought by Finance Act, 2079
Section 20 of Finance Act: Direct Taxes on the Digital Services
दफा २०: विद्युतीय सेवा कर
(१) गैरबासिन्दा व्यक्तिले नेपालका उपभोक्तालाई उपलब्ध गराएको विद्युतीय सेवाको कारोबार मूल्यमा दुई प्रतिशतका दरले विद्युतीय सेवा कर लगाई असुल गरिनेछ । तर विद्युतीय सेवाको वार्षिक बीस लाख रूपैयाँसम्मको कारोबारमा यस दफा बमोजिमको कर लाग्ने छैन ।
(२) नेपालमा विद्युतीय सेवा उपलब्ध गराउने व्यक्तिले आय वर्ष अनुसार आफ्नो कारोबारको विवरण तथा कर दाखिल गर्नु पर्नेछ।
(३) उपदफा (२) बमोजिम तोकिएको समयभित्र विवरण दाखिल नगरेमा वार्षिक कारोबार रकमको शून्य दशमलव एक प्रतिशत प्रति वर्षका दरले हुने रकम शुल्क लाग्नेछ र कर तिर्नु पर्ने तोकिएको मितिसम्म कुनै व्यक्तिले कर दाखिल नगरेमा वार्षिक पन्ध्र प्रतिशतका दरले व्याज लाग्नेछ । त्यसरी दाखिल गर्नु पर्ने कर कम दाखिल गरेमा वा लुकाए छिपाएमा त्यसरी कम गरेको कर रकमको पचास प्रतिशत जरिवाना समेत लाग्नेछ ।
(४) यस दफा बमोजिम कर दाखिला भएको आयमा आयकर ऐन, २०५८ बमोजिमको कर लाग्ने छैन ।
(५) विद्युतीय सेवा करको प्रशासन आन्तरिक राजस्व विभागले निर्धारण गरे बमोजिम हुनेछ ।
Section 20: Digital Service Tax
(1) Digital service tax will be levied at the rate of two percent on the transaction value of the electronic service provided to the consumers of Nepal by non-resident persons. But annual transactions upto Rs 2 million annually for digital services will not be taxed as per this section.
(2) The person providing electronic services in Nepal shall file the details of his transaction and deposit tax on income year basis.
(3) Failure to submit the details under sub section (2) will result in a fee amounting to 0.1% per annum on the amount of the transaction and in case of the failure to deposit the tax within the due date, interest will be charged at the rate of 15% per annum. Where such amount is concealed or inadequately reported a fine of 50% on such concealed or unreported amount.
(4) Tax under Income Tax Act, 2058 shall not be applied on the income taxed under this Section.
(5) The administration of electronic service tax shall be as determined by the Inland Revenue Department.
Amendment in VAT Act, 2052: Indirect Taxes on the Digital Services
दफा २: परिभाषा
(ट२): “विद्युतीय सेवा” भन्नाले उपभोक्तालाई सेवा प्रदान गर्नका लागि सूचना प्रविधि अत्यावश्यक पर्ने र न्यूनतम मानवीय हस्तक्षेपमा स्वचालित रूपमा इन्टरनेट मार्फत प्रदान हुने देहाय बमोजिमका सेवालाई सम्झनु पर्छः
(क) विज्ञापन सेवा.
(ख) चलचित्र, टेलिभिजन, संगीत, ओभर द टप र सदस्यतामा आधारित यस्तै अन्य सेवा,
(ग) तथ्याङ्क संग्रह सम्बन्धी सेवा,
(घ) क्लाउड सेवा,
(ङ) गेमिङ्ग सेवा,
(च) मोबाइल एप्लिकेशन सम्बन्धी सेवा,
(छ) इन्टरनेट बजार स्थान सम्बन्धी सेवा र यस मार्फत उपलब्ध गराइने सेवा,
(ज) सफ्टवेयरको आपूर्ति र अद्यावधीकरण,
(झ) तथ्याङ्क, तस्वीर लगायतका डाउनलोड सेवा,
(ञ) परामर्श, सीप विकास तथा तालिम सेवा,
(ट) खण्ड (क) देखि (ञ) को अतिरिक्त अन्य यस्तै प्रकृतिका सेवा।
(ड१): “गैरबासिन्दा व्यक्ति” भन्नाले नेपालमा कारोबारको स्थायी ठेगाना नभएको, व्यवसायिक प्रतिनिधि वा कानूनी रुपमा मान्य प्रतिनिधि नभएको नेपाल बाहिरको व्यक्ति सम्झनु पर्छ।
१०ख१: विद्युतीय सेवा प्रदान गर्ने गैरबासिन्दा व्यक्तिको दर्ता सम्बन्धी व्यवस्था
(१) यस ऐनमा अन्यत्र जुनसुकै कुरा लेखिएको भए तापनि नेपालमा विगत बाह्र महिनामा बीस लाख रुपैयाँभन्दा बढी कर लाग्ने विद्युतीय सेवाको कारोबार गर्ने गैरबासिन्दा व्यक्तिले मूल्य अभिवृद्धि करमा दर्ता हुनु पर्नेछ ।
(२) विद्युतीय सेवाको कारोबार गर्ने गैरबासिन्दा व्यक्तिको दर्ता प्रक्रिया विभागले निर्धारण गरे बमोजिम हुनेछ ।
(३) उपदफा (१) बमोजिम दर्ता भएका विद्युतीय सेवाको कारोबार गर्ने गैरबासिन्दा व्यक्तिको कारोबार बन्द भएमा वा कारोबार गर्न छाडेमा विभागले निर्धारण गरेको प्रक्रिया बमोजिम दर्ता खारेज गराउनु पर्नेछ।
दफा १९: करको भुक्तानी
(७ख) यस दफामा जुनसुकै कुरा लेखिएको भएतापनि १०ख१. बमोजिम दर्ता भएको व्यक्तिको कर भुक्तानी प्रक्रिया विभागले निर्धारण गरे बमोजिम हुनेछ ।
Section 2: Definition
(Ta2): “Digital Service” means the following services, for rendering of which to the customer, there is essential need of the information technology and which are automatically provided through the Internet with minimal human intervention:
(Ka) Advertising services.
(Kha) Movies, television, music, over the top and other similar subscription based services,
(Ga) Data collection services,
(Gha) Cloud services,
(nGa) Gaming services,
(Cha) Mobile Application Services,
(Chha) Internet Marketplace Services and the services provided through it,
(Ja) Supply of and updating of software,
(Jha) Download services including data and pictures,
(Wyan) Consulting, Skill Development and Training Services,
(Ta) Services of similar nature other than clauses (a) to (j).
(Da1): “Non-resident person” means a person outside Nepal who does not have a permanent business address, business representative or legally recognized representative in Nepal.
Section 10Kha1: Arrangements for registration of non-resident persons providing electronic services
(1) Notwithstanding anything contained elsewhere in this Act, a non-resident person who provides digital services in Nepal for more than two million rupees in the last twelve months shall be required to register for value added tax purposes.
(2) The registration process of non-resident persons dealing in electronic services shall be as determined by the Department.
(3) If the business of a non-resident person doing business of electronic services registered pursuant to sub section (1) is closed or ceases to do business, the registration shall be revoked as per the procedure prescribed by the Department.
Section 19: Payment of Taxes
(7Kha): Notwithstanding anything written in this Section, the tax payment process of the person registered under Section 10Kha1 shall be as determined by the department.
Nature of the Digital Service Tax in Nepal
As previously discussed in my other article Direct and Indirect Tax on Digital Services, there are various modes of taxing digital services in Nepal, if the country is to tax such digital services at all. Some of the better recommendation made by the OECD BEPS Action Plan 1: Tax Challenges Arising from Digitalisation, following approaches have been suggested as best forms of the taxation of digital services:
(i) Modification in the “Exception to PE”
(ii) Modification in the definition of “Agency PE”
(iii) Revision in “Transfer Pricing Guidelines”
(iv) Introduction of the “Digital PEs”
(v) Introduction of “Significant Economic Presence” Test
This new provision of taxation of the digital services has failed to adopt the first four approaches. Nepal has adopted the “Significant Economic Presence” test for the taxation of digital services. The significant economic presence is computed on the basis of the volume of the transaction made by the foreign digital service provider in Nepal. Similar approach has also been adopted in India and you can go back to my previous post to learn more about the overview on India’s Position on DST: Direct and Indirect Tax on Digital Services
Meaning of Digital Service?
This is an important question. Who does this provision apply to and what is the meaning of Digital Service? We have seen drafters to mess up the meaning of the digital service. A classic example of this, we had discussed in my other post: Ecommerce Business in Nepal, where the proposed Ecommerce Bill has failed to correctly define the meaning of ecommerce.
Fortunately, that does not seem to be the case here in the definition of the digital service provided in the VAT Act, 2052. Section 2(Ta2) of the VAT Act, 2052 has provided key two components when defining the meaning of the digital service:
(i) The rendering of the service essentially requires the need of the information technology, (i.e. IT method are specifically designed for providing such services) and
(ii) It is rendered with the minimal human intervention (i.e. the data are received, sent, analyzed or processed through the use of a computer or automated process, with little to no human intervention)
This definition could resolve any conflicts with the tax authorities in future. In cases where authorities contend include any specific service to be deemed as digital services, these two tests provided in the definition could potentially resolve them. This is a sophisticated definition adopted from the OECD’s report on the digital economy. However, considering the dynamism of the industry it cannot be guaranteed that this definition could hold its ground for all the foreseeable future.
How does the direct and indirect tax apply?
We can expect the Income Tax Rules and VAT Rules to bring more clarity regarding the administration and recovery of the taxes. The methods of the administration and recovery of the digital service taxes has not yet been introduced. I think the recovery could be a “vendor collection model” considering that Nepal has introduced this DST to particularly tax the high income earning established foreign players like Facebook and Google in Nepal. Under OECD’s recommendation there could be three models for the recovery of the taxes.
These models are: (1) the traditional collection model; (2) the purchaser collection model; (3) the vendor collection model; and (4) the intermediary collection model. The distinction between these collection models is essentially based on the person liable to account and deposit the taxes.
The traditional collection model
The traditional collection model, where taxes is assessed at the border for imports, is generally found not to be an efficient model for collecting the taxes on the digital services as they do not get rendered in the traditional means of the customs route and since the services are not subjected to customs.
The purchaser collection model
A model relying on the purchaser to self-assess and pay the taxes on its imports of the digital services is not likely to provide a sufficiently robust solution for an efficient collection of the tax. Although the purchaser collection model is likely to involve only limited compliance burden for vendors, the level of compliance by purchasers is expected to be low and this model would be highly complex and costly for customs and tax administrations to implement and operate.
The vendor collection model
A model requiring the non-resident vendors to charge, collect and remit the taxes in the country of importation could improve the efficiency of the collection of direct and indirect taxes on the value of the imports of the digital services thus create opportunities for governments to remove or reduce exemption thresholds if they wish to do so. While a vendor collection model would create additional burden for non-resident vendors, these can be mitigated by complementing this model with a simplified registration and recovery process.
The intermediary collection model
A model where taxes on digital services would be collected and remitted by intermediaries on behalf of non-resident vendors could improve the efficiency of the collection of taxes, assuming that such intermediaries would have the required information to assess and remit the right amount of taxes in the country of importation. The taxes collection by intermediaries would involve minimal compliance burdens on vendors. It may, however, come at an additional cost that may be passed on to the purchaser. This model may be particularly effective when the taxes are collected by intermediaries that have a presence in the country of importation (e.g. digital service aggregators, resellers and locally implemented e-commerce platforms). The intermediaries’ understanding of local tax and customs rules and procedures could provide benefits to both vendors and tax administrations.
The rates of taxes
The Digital Service Taxes apply in the form of Income Taxes and Value Added Taxes. The rate of the direct tax under Section 20 of the Finance Act, 2079 is 2% on the turnover and the rate of the indirect tax under Section 7 of the VAT Act, 2052 is 13% on the turnover amount.
The threshold requirement
The test for Significant Economic Presence for the purpose of the Digital Service Tax is Rs. 2 million. This is the turnover of the particular digital service provider within Nepal. Unlike this exemption threshold, India has adopted a different threshold for the application of the digital service tax. If we compare this threshold with India it is 10 times lower. In March 2020, India adopted a 2% DST. The tax applied only to non-resident companies, and covers online sales of goods and services to, or aimed at, persons in India. The tax applies only to companies with annual revenues in excess of approximately Rs. 20 million (approximately U.S. $267,000). The tax went into effect on April 1, 2020.
Although the approach adopted by Nepal to define the exemption threshold is better in the context of applying the Significant Economic Presence, the threshold could be higher and therefore better allocate the inter-nation equity. We do not want to impede the development of the digital sector in Nepal do we? Nor do we want to challenge the benefit that we have actually gotten from the huge digital service providers like Facebook and Google in countries like ours. This could be an issue of debate with the foreign companies when actually applying it.
Contradicts the existing Service PE definition?
While applying the digital service taxes we should also consider if the newly introduced significant presence test under the digital service taxes contradicts the meaning of Service PE as per the prevalent tax laws. In the context of the Nepal the definition of the Service PE doesn’t contradict the significant presence test for the purpose of digital service tax.
Typically, the DST taxes companies with no permanent establishment in countries, contravening the international tax principle that companies should not be subject to a country’s corporate tax regime absent a territorial connection to that country. However, no physical presence in the country is required for the DST to apply. So many tax authorities and laws also suggest that this taxation of revenue absent a physical presence is inconsistent with principles of international tax policy.
Treaty rules provide that business profits derived by an enterprise are taxable exclusively by the state of residence unless the enterprise carries on business in the other state through a PE situated therein. In the latter situation, the source state may tax only the profits that are attributable to the PE. The PE concept is thus used to determine whether or not a contracting state is entitled to exercise its taxing rights with respect to the business profits of a non-resident taxpayer. Special rules apply, however, to profits falling into certain enumerated categories of income, such as dividends, interest, royalties, and capital gains.
However, if the foreign service provider has reseller representative in Nepal
The international tax system reflects the principle that companies are not subject to a country’s corporate tax regime in the absence of a territorial nexus to that country. This is reflected in international tax treaties, which typically establish that a company need not pay a country’s corporate income tax unless it has a “permanent establishment” in that country. DSTs adopted by countries flip this rule on its head. Rather than limit the DST’s applicability to companies with permanent establishments in the particular country, the DSTs apply only to companies without permanent establishments in such countries. Thus, where there is already a permanent establishment of the foreign digital service provider in Nepal, the idea of applying the digital service tax doesn’t come into play. That is well covered by the meaning of the “foreign digital service provider” in the Finance Act, 2079.
However, the Finance Act has failed to provide that, the digital service tax doesn’t apply where the foreign digital service provider already has an agent or business representative in Nepal. Generally, the presence of the foreign company’s business representative or agent in Nepal creates a Service PE or Agency PE so this would altogether not be an issue in most cases. But in case where the company has no permanent establishment in Nepal and it resells its digital services through independent agent in Nepal, the present provision of the digital service tax under Finance Act, 2079 would allow the foreign service provider to skip its higher withholding rates under the Income Tax Act, 2058 through the application of DST under Section 20 of the Finance Act. There may be two views here:
(i) One view is that the drafters failed to foresee this situation, or
(ii) The other view could be that the tax laws of Nepal finally have accepted that the business profits of the foreing company who do not have PE in Nepal are not taxable in Nepal.
This again is a whole another topic for discussion. See my posts on this here: DTAA Benefit In Nepal
Negative impact of gross-basis taxation and relationship with trade and other obligations
The digital service tax could be construed as being discriminatory becase it targets digital services, but not similar services provided non-digitally. This differential treatment of like transactions is a textbook example of discrimination. Furthermore the application of the 2% direct tax and 13% indirect tax could potentially bring huge cost disadvantages to the recipients of those services. Although the 13% indirect tax may be set off against the other indirect tax liabilities, it may not be available for all for VAT set off. This could lead to the local companies facing difficult situations regarding the cost efficiency of doing business digitally.
So what companies are likely to be registered for DST?
From the definition of the digital service provided in Section 2(Ta2) of the VAT Act, 2052; we could see the following companies being registered for DST purposes in Nepal:
- Advertising services: Facebook, Google
- Movies, television, music, over the top and other similar subscription based services: Netflix, Amazon Prime, Youtube Premium
- Data collection services: Rakuten, AOC Research
- Cloud services: Amazon AWA, Microsoft Azure
- Gaming services: Nintendo, Ubisoft, Activision, Sony
- Mobile Application Services: Google, Apple
- Internet Marketplace Services and the services provided through it: Amazon
- Supply of and updating of software: Oracle, SAP, IBM, Adobe
- Download services including data and pictures: Google, Apple, Microsoft
- Consulting, Skill Development and Training Services: Not likely to be any companies as consulting, skill development and training are made with significant human intervention, but there could be cases where standard mass contents are provided at unlimited group of people
Thank you for reading !!