Finally, making peace with retirement taxes?

Bedbahadur v/s RBB (2078.08.21)

What is Bedbahadur v/s RBB about?

In a previous discussion, which extensively examined the case of बेद बहादुर लावती समेत विरुद्ध राष्‍ट्रिय वाणिज्य बैंक लि. केन्द्रीय कार्यालय सिंहदरबार समेत Case Number: 075-WO-0512, we critiqued that the Supreme Court’s judgment appeared to be lacking in depth and completeness. In light of the recent ruling pertaining to लिलामणी न्यौपाने बिरुद्ध नागरिक लगानी कोष, अर्थ मन्त्रालय, आन्तरिक राजश्व विभाग Decision Number 078-WO-1105 let us revisit this matter from an alternative standpoint to ascertain the coherence and rationality of the court’s decision.
See the previous post here: Bedbahadur vs. Rastriya Banijya Bank

Where did Bedbahadur v/s RBB deviate from Income Tax Act, 2058?

In a candid assessment of the decision: बेद बहादुर लावती समेत विरुद्ध राष्‍ट्रिय वाणिज्य बैंक लि. केन्द्रीय कार्यालय सिंहदरबार समेत Case Number: 075-WO-0512, it becomes evident that the court’s ruling appears somewhat superficial, having neglected to engage in an in-depth analysis and interpretation of the delineations between contributory and non-contributory retirement plans.

Setting forth the factual context of the case: Rastriya Banijya Bank administers the RBB Retirement Fund, an “approved retirement fund” for the purposes of Income Tax Act 2058, encompassing a spectrum of retirement schemes. Upon scrutiny of the court’s decision, it becomes discernible that the nature of these schemes bears notable similarity to those managed by the Citizen Investment Trust. Paragraph 2 of the decision delineates the essence of the schemes operated by the Fund, encompassing diverse categories such as the Employee Provident Fund, Medical Expenses, Welfare Provident Fund, Term Life Insurance, Gratuity Scheme, 7 Year Retirement Plan, Leave Payments, and others. Typically, these are also the customary retirement schemes overseen by myriad of entities and employers across Nepal.

Although the court’s verdict refrains from undertaking an exhaustive examination of the intricacies, entitlements, and contributions pertaining to each scheme, insights can be gleaned from the discourse in Paragraph 8 and Paragraph 11, indicating that the schemes function autonomously, in accordance with established practice. For instance, the Provident Fund scheme maintains a distinct identity from the Gratuity Scheme.

Notably, Paragraph 11 emerges as a pivotal juncture in the decision, as it encapsulates the RBB Retirement Fund’s pivotal assertion. The Fund contends that the Gratuity Scheme is a non-contributory plan, underpinned by the rationale that the employer’s contribution to the Gratuity Scheme (i) does not originate from the employee’s earnings and (ii) the employer’s contribution remains detached from the employee’s taxable income – and thus should be subject to 15% withholding taxation unlike other contributory schemes where 5% tax were applied. This assertion indeed holds true. However, intriguingly, the court’s decision neglects to visit this pivotal contention raised by the RBB Retirement Fund.

Is Proviso 1 of Section 88(1) discriminatory?

Yes, it seems discriminatory and now has been acknowledged by the Supreme Court as well in the case of Lilamani v/s CIT (we will be discussing in detail below). While there is no any need to take back the critique on the Bedbahadur’s Decision discussed in my other post, Bedbahadur vs. Rastriya Banijya Bank, we have another question that needs to be addressed regarding the discriminatory taxes under the provisions under Section 65(1), Section 88(1) and Proviso 1 of Section 88(1).

Section 65(1) of the Income Tax Act 2058, provides the method for computing the retirement payment gains from the “approved contributory plan” or the “retirement payment received from Government of Nepal” – Section 65(1) of the Income Tax Act, 2058 provides the method for determining the amount of such gain where:
Retirement Payment Gain = Retirement Payment – MAX [500000, Retirement Payment×50%]
On such gains, the retirement payment gain at the time of disbursement will be taxed at 5% under Section 88(1) Proviso (1) of the Income Tax Act, 2058.

This creates a discriminatory situation –
A government employee receiving any kind of retirement payment (both contributory and non-contributory) can avail the facility of computing retirement payment gains under Section 65(1) of the Income Tax Act 2058, whereas for non-government employees, this particular facility under Section 65(1) is available only in the context of the contributory retirement payments received from approved retirement funds. The foundational principle of equality should holds true across all contexts. In the realm of tax law, the principle stands that taxation should align with individuals’ financial capacity. Furthermore, guided by the principle of Horizontal Equity, individuals with similar earnings ought to contribute equivalent tax amounts.

Notably, the difference in services and benefits between Nepal Government employees and those beyond the public sector during their employment or contractual tenure is evident and understandable. Yet, imposing a divisive tax based on retirement payments for these groups is inequitable. This unequal treatment leads to incongruent outcomes among citizens facing similar circumstances. This contradicts the idea of equal treatment through uniform laws, defying fundamental jurisprudential principles. 

So the decision on Bedbahadur v/s RBB was heartily welcomed despite its technical inaccuracies

And thus, we arrive at the conclusion – in the case of Bedbahadur, the Court, with all the legal narrations, ruled that the retirement payments from gratuity schemes of approved retirement fund shall be treated to a 5% taxation (and I’m quite liberally summing things up here and paraphrasing). Even in the midst of the technical inaccuracies in the Bedbahadur vs. Rastriya Banijya Bank, it was like the court had inadvertently sprinkled a pinch of “horizontal equity”. And for that much – the case of Bedbahadur vs. Rastriya Banijya Bank is very very welcome.

Discerning from paragraph 8 and 9 of the decision on the matter of Lilamani v/s CIT, despite the ruling in the case of Bedbahadur v/s RBB, the Inland Revenue Department persisted in directing the Citizen Investment Trust to apply a 15% tax deduction on non-contributory retirement payments disbursed by CIT to the beneficiaries. The department’s argument hinges on the contention that the matter concerning the taxation rate pertaining to non-contributory retirements was not adjudicated in the case of Bedbahadur v/s RBB. This lack of resolution further prolonged the discourse concerning the taxation of retirement payments, ultimately culminating in the recent ruling in the case of Lilamani v/s CIT.

Lilamani v/s CIT (2080.04.32)

In the case of लिलामणी न्यौपाने बिरुद्ध नागरिक लगानी कोष, अर्थ मन्त्रालय, आन्तरिक राजश्व विभाग Decision Number 078-WO-1105 the contention of the petitioner, Lilamani Neupane, as presented in the decision, revolves around a dispute regarding the rate of taxation on payment of retirement gratuity from Shree Investment and Finance Company Limited, whether it is be 15% as per the Citizen Investment Trust or 5% as per his argument. 

What is Lilamani v/s CIT about?

I am summing up quite liberally here. At the center, the petitioner Lilamani contends that the imposition of a 15% tax deduction by the Citizen Investment Trust from his Gratuity Payment constitutes a misinterpretation of both constitutional provisions and the extant tax legislation. The petitioner further cites Section 88(1) of the Income Tax Act 2058 and a precedent established by the Supreme Court, identified as बेद बहादुर लावती समेत विरुद्ध राष्‍ट्रिय वाणिज्य बैंक लि. केन्द्रीय कार्यालय सिंहदरबार समेत Case Number: 075-WO-0512, which explicitly endorses a 5% tax deduction on retirement payments.

The petitioner asserts that, given the absence of any other efficacious alternative remedy for redress, they invoke the provisions of Article 133(2) of the Constitution in their pursuit of legal recourse. Consequently, the petitioner respectfully petitions the court to annul the transfer order of CIT for 15% tax withholding, effectuate a tax deduction in accordance with the prescribed 5% rate as mandated by law, and issue requisite directives, including the disbursement of the outstanding tax amount owed to the petitioner. 

The court has made a decision in favor of the petitioner, indicating that the tax rate should be 5% for the retirement payments in the nature of the petitioner. 

Yes, the decision establishes horizontal equity

It is commendable that the court recognized the merit in the petitioner’s claim and ruled in their favor. This decision upholds the principles of justice and fairness, ensuring that individuals receive equitable treatment under the law, particularly in matters of taxation and retirement benefits. 

What was the discriminatory tax rate?

From the perspective of pure horizontal equity, the court’s ruling is grounded in the following legal rationale: 
Government employees, both within the contributory and non-contributory retirement payment frameworks, are entitled to avail themselves of the benefits provided under Section 65(1) and Proviso 1 to Section 88(1) of the Income Tax Act 2058, which allows the government employees the followings: 

  1. Under Section 65(1), in retirement payments made by the Government of Nepal, a portion of the payment equal to fifty percent of the paid amount or five hundred thousand rupees (whichever is higher) is deducted from the total amount and only the remaining balance is treated as the income of the individual for tax purposes. 
  2. Under Proviso 1 to Section 88(1), in the case of retirement payments from the Government of Nepal, tax is withheld at a rate of 5% on the income calculated under Section 65(1) of the Act. 

Conversely, individuals outside the purview of government service are eligible for the benefits under both Section 65(1) and Proviso 1 to Section 88(1) only when the retirement payments originate from the approved retirement fund and are of contributory nature. 

How were the beneficiaries taxed on retirement payments at the point of distribution, in the past?

The table below underscores a clear form of discrimination in taxation. Government employees, whether their retirement payments are contributory or not, enjoy tax benefits, with a portion of their payments exempted from taxation and a favorable 5% tax withholding rate. Conversely, non-government employees only receive these benefits when their retirement payments are both contributory and from approved retirement funds, leading to differential tax treatment based on employment sector and payment nature, which raises concerns regarding equitable taxation for individuals in similar financial situations.

Types

Unapproved Plan

Approved Plan

By Contributory Plan

The retirement payment gain at the time of disbursement is taxed at 5% if paid by resident plan, else at 15% if paid by non resident plan. [Section 88(2)(Ga) of Income Tax Act, 2058]

Clarification provided in Section 65 of the Income Tax Act, 2058 provides the method of determining the amount of gain from the unapproved contributory plan. Retirement Payment Gain = Retirement Payment – Retirement Contribution

The retirement payment gain at the time of disbursement is taxed at 5%. [Section 88(1) Proviso (1) of the Income Tax Act, 2058]

Section 65(1) of the Income Tax Act, 2058 provides the method for determining the amount of gain from approved contributory plan. Retirement Payment Gain = Retirement Payment – MAX [500000, Retirement Payment×50%]

By Non-Contributory Plan

The retirement payment at the time of disbursement is taxed at 15%. [Section 88(1) of the Income Tax Act, 2058]

The retirement payment at the time of disbursement is taxed at 15%. [Section 88(1) of the Income Tax Act, 2058]

By GoN

The retirement payment gain at the time of disbursement is taxed at 5%. [Section 88(1) Proviso (1) of the Income Tax Act, 2058]

Section 65(1) of the Income Tax Act, 2058 provides the method for determining the amount of gain from retirement payment made by GoN. Retirement Payment Gain = Retirement Payment – MAX [500000, Retirement Payment×50%]

Although we can acknowledge that differences do exist in the services and benefits afforded to Nepal Government employees as opposed to those in the private sector during their tenure of employment or contractual engagements, the imposition of a disparate tax regime based on retirement payments for these distinct groups is fundamentally inequitable.

Such disparate treatment results in incongruent tax outcomes for citizens facing analogous circumstances. This contravenes the fundamental tenets of jurisprudence advocating for equal treatment through uniform laws, thereby running counter to the principles of legal unity. Furthermore, such a practice contradicts natural law and thus deviates from the principle of legal uniformity by perpetuating division. Central to the court’s decision is the foundational principle of equality underpinning tax law. This principle dictates that taxation should be commensurate with an individual’s financial capacity. Moreover, guided by the precept of Horizontal Equity, individuals with comparable earnings are expected to make equivalent tax contributions.

The excerpt from the decision in paragraph 22, underscores the legal interpretation of taxation on retirement payments in light of constitutional provisions. Article 18 of the Constitution of Nepal, addressing the right to equality, and Article 34, concerning the right to social security for workers, are invoked. The court emphasizes that to safeguard the interests of employed citizens in their old age, there is a provision for “contribution-based retirement payment” under Article 34(2). The court asserts that interpreting Section 88(1) in a way that results in unequal tax liability for these two categories of employees contradicts the principle of equality enshrined in the constitution. Furthermore, it highlights that taxing retirement payments at a rate of 15 percent for non-government employees while government payments are taxed at 5 percent does not align with principles of fairness and social security, as guaranteed by Article 34(2) of the Constitution.

But did the decision get the meaning of Contributory and Non-Contributory fund correct?

A contributory retirement plan is one in which both the employee and the employer contribute money to the employee’s retirement savings. A non-contributory plan is a type of benefit plan, often a pension or retirement plan, in which all the contributions are made by the employer, and the employees are not required to contribute financially. See my other post here, where we discuss in detail about the meaning of contributory and non-contributory plans: Contributory and Non Contributory Retirement Plan 

The explanation on contributory and non-contributory plans in paragraphs 20, 21 and 22 from the decision demands a critical examination. Initially, it’s essential to establish the widely accepted definitions of contributory and non-contributory retirement plans, where the former involves both employee and employer contributions, while the latter is funded entirely by the employer, with no financial obligation on the part of the employees (as per established references above). 

However, the court’s decision ventured into different territory by introducing a novel and arguably unreasonable interpretation of contributory and non-contributory plans. This departure from established definitions raises questions about the necessity for such reinterpretation. Rather than directly addressing the discriminatory provisions of Section 65(1) and Proviso 1 to Section 88(1) and potentially striking them down on grounds of inequality and discrimination, the court chose a different path by redefining these fundamental and well-defined and understood terms. This deviation from established legal norms raises concerns regarding the clarity and consistency of legal interpretation in the decision. 

I respectfully find it challenging to comprehend the intricate and seemingly unconventional rationale employed by the court in arriving at the determination that contributory retirement plans encompass those arrangements funded exclusively by employers, such as gratuity. This determination appears to stem from an association between the definition of “retirement contribution” as articulated in Section 2(cha) of the Income Tax Act and the provisions set forth in Article 34 of the Constitution of Nepal, 2072, pertaining to labor rights. While acknowledging the court’s authority and expertise, I am left with a sense of uncertainty regarding the logical nexus between these provisions that led to the conclusion that solely employer-funded contribution plans should be categorized as contributory plans. Frankly, I found this connection quite imaginative and lacking logical reasoning. Would be happy to hear your comments below for further discussion. See paragraph 20, 21 and 22 of the decision in this context. 

Why contributory and non-contributory plans?

Why is there a difference between the two?

The retirement schemes are divided broadly into two categories of (i) Contributory Schemes and (ii) Non-contributory Schemes. There is a need to separate retirement schemes into these categories mainly because of the following reasons:

  1. Due to the fact that the contribution of the employer and employee may be different
    • Both of them may contribute equally, (e.g. Provident Fund)
    • Both of them may contribute but unequally, or (e.g. Social Security Fund)
    • Only one may contribute (e.g. Gratuity)
  2. Due to the fact that in most tax jurisdictions the employment income is taxed on cash/realization basis so the Non-contributory Schemes needs to be separated for the taxation purposes
  3. The “realization principle” of taxation

Understanding “realization principle” of taxation vis-a-vis non/contributory plans

The major principle that requires the distinction of contributory and non-contributory scheme is “realization principle”in taxation. The realization principle is a fundamental concept in taxation that determines when income is recognized and becomes subject to taxation. In the case of employment income, income becomes taxable when it is realized, meaning when it is received in cash or its equivalent or when it becomes accessible and certain.

At the stage when employment income is realized it becomes taxable as employment income. When a portion of this employment income is invested in some other assets, the realization of income from such assets are then taxed as investment income because although it is the same amount of money, it now has two stages of realization, one as employment income and other as investment income. This should not be confused with double taxation. This could be understood as an economic double taxation but not a “double taxation” per se, because the income has changed its form and there have been two separate points of income realization. This is the basic principle of taxation – and also the reason for why we have separate taxation provisions for employment, business and investment. 

And obviously, this is a concept that is baked in our Income Tax Act as well. Section 2(da) of the Income Act, 2058 defines an interest of a beneficiary in a retirement fund as Non-Business Chargeable Asset. Further, Section 2(KaKha) of the Act clarifies that the act of holding non-business chargeable assets is treated as an investment. So the act of contributing employment income into a retirement fund is an investment. 

This raises another question: Why was the gratuity contribution (a non-contributory plan) made by the employer under Labor Act, 2048 not treated as employment income at the stage of contribution but only at the point of distribution? The quick answer for that would be: The reason for the non-recognition of the Gratuity Liability under Labor Act 2048 (and as employee’s income for that matter) for Income Tax Purpose was due the presence of a likelihood that the employee could be disqualified / ineligible to receive the Gratuity benefits under Rule 23(3) of the Labor Rules, 2050 which could mean that: the employee could be far from having the “opposite entitlement” to the gratuity obligation of the employer. The provision under Rule 23(3) of the Labor Rules, 2050 limited the virtual certainty of the gratuity liability tax authorities in Nepal has been treating this limitation of virtual certainty as a disqualifier for expense recognition for tax purposes. Again, this topic presents another intricate subject to explore and discuss comprehensively. Therefore, I would redirect you to my previous blog posts, where I have delved into this matter in more detail:

  1. from Gratuity48 to Gratuity74: Ep01
  2. from Gratuity48 to Gratuity74: Ep02
  3. from Gratuity48 to Gratuity74: Ep03

If so, then why the different rates of taxes: 5% and 15%?

The rate of different taxes for gains from contributory and non-contributory schemes has to do something with the taxation of investment income and employment income. The retirement payment received in the contributory plan is in the nature of investment of the employee, and as with other investment incomes, the rate of taxation is lower i.e. 5%. However, in the case of the retirement payment from a non-contributory scheme, this is a payment of the employment income, thus as with other employment income, the rate of taxation is higher. A trivia: Countries around the world tax employment income higher but investment income at comparatively lower rates, because investment is the utilization of savings into the productive sector, that allows the financial institutions to be the lender of the money and create value in the economy. However, in the case of the employment income, it could very well be consumption and the government doesn’t interfere with the rights of the consumers but incentivizes them to save and invest (e.g. through reduced tax rates).

However, the reasoning that the taxes on investment income is usually lower than the employment income may not always translate into picture. The retirement payments like provident fund, gratuity and many facets of the labor laws in welfare states like ours are strictly regulated by the government and the decision of the employee to actually invest or consume their earnings do not always depend on the employee, but more on the provisions of the labor regulations. 

Another reason for the higher taxation of retirement payment from non-contributory schemes is that the employer’s contributions to such schemes are not stubbed as taxable income to the employee at the time of contribution unlike contributory schemes. In contributory schemes like Provident Fund, the employer’s contribution is already stubbed as employee’s taxable income at the time of contribution and hence the taxes at the time of actual distribution is applied at the reduced rate. 

The interpretation on final withholding taxes opens a separate can of worms

Paragraph 15 of the decision ventures into potentially disruptive terrain within tax principles. During the Lilamani v/s CIT case, government attorneys argued that if the non-contributory retirement payments should be taxed at the same reduced rate of 5% as contributory retirement payments, then the contributions should also be taxable as employment income at the point of depositing it into the the retirement plan.

However, the court adopted a coordinated and somewhat unconventional interpretation of the relevant tax provisions, particularly Section 8, to exclude these contributions from being considered part of employment income. Section 8(3) of the Income Tax Act, 2058, specifies that certain payments, including those subject to final tax withholding, should not be included when calculating a natural person’s remuneration from employment. Additionally, Section 92(1)(chha) of the Income Tax Act categorizes various retirement payments as final withholding payments (including that paid by GoN, approved retirement fund or unapproved retirement fund).

This is frankly very perplexing conclusion on the part of court because, as discussed above, once the contribution has been made to the retirement plan, the income has already changed its nature, i.e. from employment income to investment income (non-business chargeable asset) and Section 92(1)(chha) essentially is intended to put the finality of the taxation in the income derived at the point of the realization/disbursement of the interest of beneficiary in such retirement plans – which essentially are a form of investment asset as per Section 2(KaKha) of the Act. As discussed above, the income from employment has already been changed to the form of investment at the point of contributing the amount into the retirement scheme. 

The decision took quite a unexpected deviation and concluded that because taxes in the retirement payments are withheld in finality under Section 92(1)(chha), they are not subject to inclusion as employment income under Section 8(3), without even considering the misinterpretations it may lead to, as follows:
(1)
Why should provident fund income even be stubbed in employment income at the point of contribution, as retirement payments from provided are also subject to final taxation under the law?
(2) And for that matter, why should SSF contributions from employers even be stubbed in employment income at the stage of contribution?

IRD was slow to give administrative clarities

In the context of the evolving provisions of the Income Tax Act, 2058, with respect to the distinctions between contributory and non-contributory schemes, it is observable that Section 88(1) of the Income Tax Act, 2058, which pertains to retirement payments, has undergone a series of modifications over time. Upon closer examination of the pivotal provision within this section, a noteworthy transformation is evident: the Finance Act, 2059, replaced the term “payment” with “provident fund and gratuity paid from the approved retirement fund.” Subsequently, in 2063, the term “retirement payment” was introduced, and in the Finance Act, 2071, it became “retirement payment from the approved retirement fund.” Significantly, the term “contribution-based retirement fund” was introduced in the Finance Act of 2075.

It is plausible that the court may have been influenced to rule in favor of the petitioner, affirming the reduced 5% taxation even in the case of non-contributory funds because these changes in the law are only very recent. This decision appears to have been reached without a meticulous consideration of the nuanced definitions and implications of contributory and non-contributory funds, possibly due to the relatively recent introduction of these concepts in the law or lack of strong administrative clarities on the topic issued by the Inland Revenue Department. Given the recent inclusion of the phrase “contribution-based retirement payment” in the Act through the Finance Act of 2075, it appears that the court may have opted to overlook these recent changes altogether, in favor of adhering to the original foundational provisions of Section 88(1), accepting the arguments of the petitioner. 

What we have come to finally

Finance Act, 2079 has introduced an additional clarification regarding the definition of “contributory interest” under Section 65 of the Income Tax Act, 2058. It provides: 
स्पष्टीकरणः यस दफाको प्रयोजनको लागि “योगदानमा आधारित हित” भन्नाले दफा ६३ को उपदफा (३) बमोजिम तोकिएको सीमाभित्र रही गरिएको अवकाश योगदानसँग सम्बन्धित हितलाई सम्झनु पर्दछ ।
Explanation: For the purposes of Section 65, “Contributory Interest” means the interest related to the retirement contribution made within the limits prescribed by Section 63(3).

This has led to differing opinions among the tax practitioners: 

  1. One view, a rather regressive view: Because of this amendment the actual amount that will be considered as gain from retirement payment from retirement fund will be limited to the amount of the retirement contribution deductible for tax purposes, year on year basis, and the rest would be treated as non-contributory amount. But this treatment would not lead to any tax implications because since the decision of case of Bedbahadur vs. Rastriya Banijya Bank all kinds of retirement payments from approved retirement funds are subjected to 5% taxes, whether the plan is contributory or non-contributory.
  2. Another view, a better view: Through this amendment, the Income Tax Act has aimed to assimilate the decision in the case of Bedbahadur vs. Rastriya Banijya Bank into the tax laws. The case of Bedbahadur vs. Rastriya Banijya Bank had decided that the retirement contributions made in the approved retirement fund are subjected to 5% taxes at the point of disbursement, whether the plan is contributory or non-contributory. But this amendment has still not been able to provide the basis for the 5% taxes on the amount deposited in the approved non-contributory plan (e.g. RBB Gratuity Scheme in the aforementioned decision of Bedbahadur v/s RBB). It however, clarifies that the amount of the non-contributory amount that is deposited in contributory scheme (e.g. depositing the 8.33% gratuity amount into CIT’s Investment Scheme, rather than Gratuity Scheme) is subjected to taxes just like the contribution made in approved retirement plan. But this clarification was not necessary to that effect because a gratuity contribution consciously deposited in the scheme like CIT’s Investment Scheme is already a contributory retirement scheme upon such contribution and will be subjected to taxes as such. So, in my personal opinion, this amendment from Finance Act, 2079, in the form of explanation under Section 65 has actually been for nothing. 

To sum things up, in conclusion, here is what our taxing provisions on retirement payments stands at currently: 

Types

Unapproved Plan

Approved Plan

By Non-Contributory Plan

The retirement payment at the time of disbursement is taxed at 15%. [Section 88(1) of the Income Tax Act, 2058]

The retirement payment at the time of disbursement is taxed at 15%. [Section 88(1) of the Income Tax Act, 2058]

The retirement payment gain at the time of disbursement is taxed at 5%. [Section 88(1) Proviso (1) of the Income Tax Act, 2058]

Section 65(1) of the Income Tax Act, 2058 provides the method for determining the amount of gain from approved contributory plan. Retirement Payment Gain = Retirement Payment – MAX [500000, Retirement Payment×50%]

By Contributory Plan

The retirement payment gain at the time of disbursement is taxed at 5% if paid by resident plan, else at 15% if paid by non resident plan. [Section 88(2)(Ga) of Income Tax Act, 2058]

Clarification provided in Section 65 of the Income Tax Act, 2058 provides the method of determining the amount of gain from the unapproved contributory plan. Retirement Payment Gain = Retirement Payment – Retirement Contribution

By GoN

The retirement payment gain at the time of disbursement is taxed at 5%. [Section 88(1) Proviso (1) of the Income Tax Act, 2058]

Section 65(1) of the Income Tax Act, 2058 provides the method for determining the amount of gain from retirement payment made by GoN. Retirement Payment Gain = Retirement Payment – MAX [500000, Retirement Payment×50%]

A trivia: Back on 2070.07.24 in the case of विदुर वन समेत बिरुद्ध नेपाल इन्स्योरेन्स कम्पनी लिमिटेड समेत (Case Number: 067-WO-0026), a similar petition was filed by gratuity scheme beneficiaries, arguing that they were unfairly slapped with a 15% tax rate on their retirement payments instead of the more favorable 5%. However, in that bygone era, the Court ruled in favor of the Tax Authorities, upholding the 15% tax rate for such payments. It’s a glimpse into how the landscape of law and court decisions has shifted over the years on this intriguing matter.

About Voluntary Retirement Scheme

A Voluntary Retirement Scheme (VRS), also known as a Voluntary Separation Scheme (VSS) or Early Retirement Scheme (ERS), is an employee-friendly initiative offered by organizations, typically in the corporate or government sectors. The primary objective of a VRS is to reduce the workforce through voluntary means, often with the aim of achieving cost savings, optimizing organizational structure, or managing changes in business priorities.

Section 2(nga) of the Income Tax Act, 2058 provides the definition of retirement payment as follows:
दफा २(ङ) अवकाश भुक्तानी: “अवकाश भुक्तानी” भन्नाले देहायका व्यक्तिलाई दिइने भुक्तानी सम्झनु पर्छः
(१) प्राकृतिक व्यक्तिले अवकाश लिएको अवस्थामा निजलाई दिइने भुक्तानी, वा
(२) प्राकृतिक व्यक्तिको मृत्यु भएको अवस्थामा निजको आश्रितलाई दिइने भुक्तानी ।

An important question – Does the payments made under the VRS Schemes come under the definition of “retirement payment”? Looking at the definition of the “retirement payment” offered in the Income Tax Act – it certainly seems so – but we will discuss this in more detail referring the case of महेन्द्र राज पाण्डे बिरुद्ध ने.रा.बैंकको संचालक समिति समेत below. Here are some explanations offered in Income Tax Directive: Link 1, Link 2

Before discussing the case of महेन्द्र राज पाण्डे बिरुद्ध ने.रा.बैंकको संचालक समिति समेत Case Number: 2677 Decision Date: 2064.08.16 – we should delineate how the amounts under VRS Schemes are defined.

Normally in Nepal the employees are offered as a minimum starting negotiation point – an amount of employer’s social security contribution (gratuity, provident fund etc.) for the remaining service period of each employee (had they continued the employment) but not exceeding the agreed maximum number of years. This is not a rule but is followed mostly in practice given the trends. Any amount that is agreed above that maybe negotiated and agreed upon. These could include:
(1)
A payment proportional to each year of past service
(2) Medical allowance payment depending on the age of the employees
(3) Enhanced pension plan, if employees are eligible to receive pension etc.

However, there is no defined way on how a VRS amount is negotiated. The negotiation process for a VRS amount can vary depending on the organization’s policies, practices, and the legal and regulatory framework of the country. VRS negotiation involves the organization designing the offer with eligibility criteria, incentives, and terms. Consultation with representatives may occur, and eligible employees apply. The organization evaluates applications, potentially entering a negotiation phase, where employees discuss aspects like lump-sum payment and timing. Individual circumstances, such as position and tenure, are considered. Terms are finalized, participants accept, and the organization processes payments. This process varies based on policies, labor laws, and organizational context.

Mahendra Raj Pandey v/s NRB (2064.08.16)

The the case of महेन्द्र राज पाण्डे बिरुद्ध ने.रा.बैंकको संचालक समिति समेत Case Number: 2677 Decision Date: 2064.08.16 – is quite unique and very likely to be misinterpreted. There is also an additional judicial advice offered by Justice Balaram KC offered in the decision in relation of taxation of pension income.

Let’s look at the facts of the case carefully:
In this case – the employees of the NRB opted for voluntary retirement and received a lump sum amount equal to pension of 10 years as per the entity bylaws. NRB withheld a 15% tax in such payment under Section 88(1) of Income Tax Act 2058. The employees pleaded before the court that the pension amount received in advance should not be taxed on lump sum basis, rather it should be taxable on annual basis as per Section 3 of the Income Tax Act. NRB and Revenue Authorities argued that the since the amount have been received in lump sum, the receipt and taxation of the amount should coincide and should be taxed on cash as per Section 22 of the Income Tax Act, 2058.

Though the amount stipulated under the VRS scheme seemingly fits with the definition of a “retirement payment” under Income Tax Act 2058, the court’s ruling diverged from that view. The court clarified that the current matter, entailing the lump-sum release of a prospective ten-year pension, lay beyond the scope of the Income Tax Act, 2058 and offered a more liberal and just view on its taxation. When tax laws are absent, silent, or ambiguous, an interpretive bias in favor of taxpayers should be exercised. Income tax of each year’s pension should be calculated as per the rates prevalent for each year. The court decided that the government cannot be nourished at the expense of amount withheld from the applicants and thus the act of withholding flat 15% taxes by NRB and Revenue Department is quashed by certiorari.

The Supreme Court’s passing also encompassed a recommendation to the Government concerning pension taxation. While the Court refrains from challenging the legality of pension taxation as outlined in the Income Tax Act 2058, acknowledging its alignment with constitutional provisions, it suggests a reevaluation of taxing pensions for individuals in public positions and employees.

Pensions, a compensatory measure for prolonged service, align with the Constitution’s focus on safeguarding and providing social security for the elderly. Despite designations as senior citizens, retired employees are elderly individuals. Except for the limited old age allowance under section 35(17) of the Senior Citizen Act 2064, there exists no legal framework for incentivizing elderly citizens financially. Retirees’ pensions reflect compensation for devoted years adhering to conduct codes within an organization, rather than being a gratuitous provision. Characterizing pension as income is incongruent with its intent for supporting livelihood during old age, particularly within a nation lacking an established social security safety net. The question of whether taxing pension by deeming it as income aligns with justice is raised, warranting the Finance Minister’s attention.

Gyanbahadur v/s KSC (2068.01.02) + Chaturbhuj v/s KSC (2070.01.12)

Let’s discuss another case of of ज्ञानबहादुर चौधरी वि. कृषि सामग्री कम्पनी लि. समेत (Page 18/30) Case Number: 066-WO-0333 Decision Date: 2068.01.02

The summary of the decision is as follows:
मा.न्या. श्री कल्याण श्रेष्ठ र मा.न्या. श्री सुशीला कार्की, २०६६ सालको WO-०३३३, उत्प्रेषणयुक्त परमादेश, ज्ञानबहादुर चौधरी वि. कृषि सामग्री कम्पनी लि. समेत
निवेदकले स्वेच्छिक अवकाश लिएबापत कम्पनीले उपलब्ध गराएको थप वा अतिरिक्त सहुलियत अवकाश प्राप्त गर्ने कर्मचारीले कुनै कानूनको व्यवस्थाबमोजिम वा कम्पनीको विनियमावलीमा साविकदेखि उल्लेख भएको कारणले पाउने अवस्था नभएकोले यो अवकाश कोष वा सञ्चय कोषमा राखिने अधिकारस्वरूप दावी गर्न सकिने प्रकृतिको रकम हो भनी मान्न मिलेन । यस अवस्थामा कम्पनीले आफ्ना कर्मचारीलाई थप सुविधास्वरूप अवकाश प्राप्त जीवनको आर्थिक सुरक्षण हुने उद्देश्यले उपलब्ध गराएको रकममा आयकर ऐन, २०५८ को दफा ८८(१) बमोजिम उक्त सहुलियत रकममा मात्र १५ प्रतिशत कर कट्टी हुने गरी भएको निर्णय वेरीतपूर्वकको मान्न नमिल्ने । इजलास अधिकृतः बिमल पौडेल इति संवत् २०६८ साल बैशाख २ गते रोज ६ शुभम् ।

And another case of चतुर्भुज भट्ट वि. कृषि सामाग्री कम्पनी लिमिटेड समेत Case Number: 069-WF-0008 Decision Date: 2070.01.12
The summary of the decision is as follows:
सामान्यतः आय गरिन्छ भने त्यसमा कानूनबमोजिम कर लाग्दछ भन्ने कुराको अनुमान गरिनु पर्दछ । त्यसमा पनि कर लाग्ने र नलाग्ने भन्ने कुरामा कानूनमा भएका दुई व्यवस्थाबीच असमाञ्जस्यता देखिन्छ भने अन्यथा प्रमाणित नभएसम्म कर लाग्दछ भन्ने व्यवस्थाको पक्षमा अनुमान गर्नुपर्ने (प्रकरण नं.१०)
अवकाश भुक्तानीबापत दिइएको अतिरिक्त सहुलियत रकममा पन्ध्र प्रतिशत वा पाँच प्रतिशतमध्ये के कति कर लाग्ने हो भन्ने सम्बन्धमा द्विविधा भएको भए सोही प्रक्रियाबमोजिम स्पष्ट हुन सकिनेमा कर प्रशासन गर्ने कर कार्यालयलाई विपक्षी नै नबनाई सिधै रिट क्षेत्रमा प्रवेश गरेको समेत कानूनसम्मत देखिँदैन । (प्रकरण नं.१३)

In the matter of चतुर्भुज भट्ट वि. कृषि सामाग्री कम्पनी लिमिटेड समेत, the employees were extended an initial point of negotiation amount for VRS Scheme, comprising the employer’s gratuity contribution for their remaining service tenure. but not exceeding the agreed-upon maximum of 5 years, as delineated by the VRS Policy. Furthermore, as an enhancement to the attractiveness of the VRS Scheme, employees were presented with an additional fixed payment, proportionate to their cumulative years of prior service – denoted as the “additional amount.”

The court, in both instances, elucidated that the “additional amount” is liable to a taxation rate of 15%, as per Section 88(1), rather than the 5% tax stipulated by Section 88(1) Proviso 1. The court expounded that the 5% withholding specified in Section 88(1) Proviso 1 for gains computed in accordance with Section 65(1) does not apply in cases where the retirement payment does not emanate from a retirement fund (the VRS Policy in this case) – irrespective of whether it is the government that administers the retirement payment or otherwise.

Thank you for reading !!