What is double taxation?
Double taxation is the double levy of tax by one or more jurisdictions:
(a) On the same income, in the case of income taxes
(b) On the same asset, in the case of capital taxes
(c) On the same financial transaction, in the case of sales taxes
What is Economic Double Taxation?
Where the same income, asset or financial transaction is double taxed to two different persons, then it is termed as economic double taxation. Example: The profit earned by a company is taxed as corporate income and dividend income before it reaches to the hand of the beneficial owner.
Economic Double Taxation is not treated as double taxation in the interpretation of tax laws and little/no relief is provided by the Double Tax Avoidance Agreements in the economic double taxation
What is Juridical Double Taxation?
Where the same income, asset or financial transaction is double taxed to a same person, then it is termed as juridical double taxation. Example: When a person is a tax resident of multiple tax jurisdiction and if the jurisdiction follows global taxation on income of residents, then the same person ends up paying taxes in multiple jurisdiction.
What are the systems of taxation?
The taxation system can be broadly categorized into three categories:
Source Principle Taxation
In this principle, the income of the person that are sourced in a tax jurisdiction is taxed in that particular tax jurisdiction, irrespective of the residency of that person.
Residence Principle Taxation
In this principle, the income of the person who is a resident in a tax jurisdiction is taxed in that particular tax jurisdiction, irrespective of the source of that income.
Mixed Principle Taxation
In this principle, income are taxed in source principle as well as residence principle.
What system of taxation is followed in Nepal?
Nepal follows mixed system for taxation. Section 3 of Income Tax Act 2058 states that Income tax is imposed on and realized from every person as follows for each income-year:
a. A person, who has taxable income for the year;
b. A foreign permanent establishment of a non-resident person situated in Nepal and has repatriated income for the year as mentioned in subsection (3) and (4) of section 68; and
c. A person, who receives a final withholding payment during the year.
Important Note: Although it is expected that the Section for Imposition of Tax (i.e. Section 3 of Income Tax Act 2058) is supposed to cover the taxation system of Nepal, there is a limitation. The withholding tax charged to non-residents under Section 88Ka and Section 89 on income that are not sourced in Nepal and similarly, the tax charged to non-residents under Schedule 1(2)(7) on income that are not sourced in Nepal, are also taxes applicable under Income Tax Act 2058, but they are not covered by the section for imposition of tax.
This graphical representation is a guide for listing income that are subject to income tax under Income Tax Act 2058.
Important Definitions
Definition:
Section 6 of Income Tax Act 2058: Subject to this Act, the following income of a person for an income-year from any employment, business, investment or windfall gain shall be treated as the assessable income:
a) Income of a resident person from the employment, business, investment or windfall gain of the year irrespective of the location of the source of the income; and
b) Income of a non-resident person from the employment, business, investment or windfall gain of the year but only to the extent the income has a source in Nepal,
Provided that, the assessable income does not include any income exempt under Section 11 or Section 64 or both.
Meaning:
Assessable Income of Resident Person = Resident Person’s income from Employment, Business, Investment or Windfall Gain of the year irrespective of the location of the source of the Income
Assessable Income of Non Resident Person = Non Resident Person’s income from Employment, Business, Investment or Windfall Gain of the year but only to the extent the income has a source in Nepal
Definition:
Section 2(Ka.Na.1) of Income Tax Act 2058: Adjusted taxable income means an amount of taxable income of a person for an income year as calculated by ignoring reductions referred to in Section 12 and deductions referred to in Section 14(2), Section 17, and Section 18.
Meaning:
Adjusted Taxable Income = Taxable Income + Reduction u/s 12 + Deduction u/s 14(2) + Deduction u/s 17 + Deduction u/s 18
Definition:
Section 5 of Income Tax Act 2058: The taxable income of a person for an income-year is equal to the amount as calculated by subtracting reduction, if any, claimed for the year under Section 12, Section 12Ka, Section 12Kha or Section 63 or Schedule 1 or all, from the total of the person’s assessable income for the income year from each of the following income heads: (a) business; (b) employment; and (c) investment and (d) windfall gain.
Meaning:
Taxable Income = Assessable Income – Reduction u/s 12 – Reduction u/s 12Ka – Reduction u/s 12Kha – Reduction u/s 63
As per the definition of the terms Assessable Income, Adjusted Taxable Income and Taxable Income from the previous tabs, we can derive the given table for computation of taxable income and we can easily notice that there occurs circular reference complication when the computation for (a) Donation Reduction u/s 12Ka, (b) Donation Reduction u/s 12Kha and (c) Retirement Contribution Reduction u/s 63 is involved.
| Heading | Result | Capped On | |
| Add: | Income u/s 7,8,9 | ||
| Less: | All other Deductions (Including Loss Set Off) | ||
| Gives | Adjusted Taxable Income (ATI) | ||
| Add: | Donation Deduction u/s 12 | Nulled 1 | ATI |
| Add: | Donation Reduction u/s 12Ka | Nulled 2 | AI |
| Add: | Donation Reduction u/s 12Kha | Nulled 2 | |
| Add: | Retirement Contribution Reduction u/s 63 | Nulled 2 | AI |
| Less: | Donation Deduction u/s 12 | Nulled 1 | ATI |
| Less: | Interest Deduction u/s 14(2) | ATI | |
| Less: | Pollution Control Expense u/s 17 | ATI | |
| Less: | Research and Development Expense u/s 18 | ATI | |
| Gives | Assessable Income (AI) | ||
| Less: | Donation Deduction u/s 12 | ATI | |
| Less: | Donation Reduction u/s 12Ka | Nulled 2 | AI |
| Less: | Donation Reduction u/s 12Kha | Nulled 2 | |
| Less: | Retirement Contribution Reduction u/s 63 | Nulled 2 | AI |
| Gives | Taxable Income (TI) | ||
| Less: | Donation Deduction u/s 12 | ATI | |
| Less: | Donation Reduction u/s 12Ka | AI | |
| Less: | Donation Reduction u/s 12Kha | ||
| Less: | Retirement Contribution Reduction u/s 63 | AI | |
| Less: | Reductions u/sch 1 | ||
| Gives | Net Taxable Income |
What is DTAA and how does it provide relief from double taxation?
When a person is subject to taxation in multiple tax jurisdiction, their income, asset or financial transaction maybe taxed by both the tax jurisdiction, hence, the double taxation. Double Taxation Avoidance Agreement (DTAA) also referred as Tax Treaty is a bilateral economic agreement between two nations that aims to avoid or eliminate double taxation of the same income in two countries.
Double tax liability may be mitigated in a number of ways, by the application of DTAA. DTAA mainly aims to:
Step 1: Decides to whom the DTAA applies
DTAA is applicable to person who are resident of one/both contracting states. A person is resident of a state when he is liable to tax therein by the reason of domicile, residence or place of management.
Step 2: Determine if the person is the resident of one state or the other
Due to the difference in parameter for deciding the residency of a person in different tax jurisdictions, a person may become resident of multiple tax jurisdiction at a same time. Further, due to the difference in parameter for applicability of taxes to the residents and non-residents, the tax on income, asset or financial transaction is likely to be charged in multiple jurisdiction. DTAA helps to tie break the multiple residency status of the same person in different contracting states and decide in which state the person is actually a tax resident, irrespective of the local laws applicable in deciding the residency of a person.
Tie breaker rule for dual residency of individual
1. place of permanent home
2. place of vital interests
3. place of habitual abode
4. place of which he is a national
5. as per the mutual decision of states
Tie breaker rule for dual residency of entity
1. place of effective management
2. as per the mutual decision of states
Step 3: DTAA aims to provide relief from taxes applicable in a jurisdiction, not impose taxes
The various types of income are categorically dealt by DTAAs. In each of this income heading, DTAA aims to either provide unlimited or limited taxing rights or the resident or non-resident country, but in no case the taxation right provided by DTAA is more than that provided by the local tax administration of the contracting states.
Income are classified as:
1. Income from Immovable Property,
2. Business Profits,
3. Shipping and Air Transport,
4. Associated Enterprises,
5. Dividends,
6. Interest,
7. Royalties,
8. Capital Gains,
9. Independent Personal Services,
10. Dependent Personal Services,
11. Directors’ Fees,
12. Artistes and Sportspersons,
13. Pensions,
14. Government Service,
15. Professors, Teachers and Research Scholars,
16. Students,
17. Other Income,
18. Capital
Step 4: Provide relief for double taxation
Even with the application of the DTAA, the contracting states might still have taxing right in the same income in each of their states. Relaxation for these double taxation are provided by the mechanism of tax credit. Where income of resident person of one state may be taxed in other state, the first mentioned state shall allow deduction for tax paid in other state subject to the limit of effective tax rate in the first mentioned state. Effective tax rate shall be calculated taking also into consideration the income from other state that may be exempted in the first mentioned state.
DTAAs that Nepal has executed
Nepal has executed DTAAs with eleven countries. India 1987, Norway 1996, Thailand 1998, Sri Lanka 1999, Mauritius 1999, Austria 2000, China 2001, Pakistan 2001, South Korea 2003, Qatar 2007, Bangladesh 2019
The Duosoft Overseas Nepal Pvt Ltd Case
Now you would think the DTAA benefit would be availed by the person who may be taxed in both states. But a Supreme Court Decision on Duosoft Overseas Nepal Pvt Ltd, decided that withholding taxes was applicable on the service fee payment made to entity in India (Nepal and India has DTAA), on its income which was not attributable to its permanent establishment situated in Nepal. This is not in line with the taxation of the business profit envisaged in the Double Tax Avoidance Agreement 1987 between Nepal and India.
Link to the case: Duosoft Nepal Pvt Ltd vs Department of Revenue Investigation