Meaning of Quantification
Quantification in the context of income tax refers to the process of determining and specifying the exact monetary value of various income, deductions, credits, and tax liabilities for tax reporting purposes. It involves calculating the precise amounts that are subject to taxation, allowable deductions, and any tax credits that may apply.
In the context of Nepal, under Section 27 of the Income Tax Act, 2058 – only income quantification is provided. Income Quantification involves identifying, measuring and calculating specific sources of income that may not have specific monetary value but do fit the criteria of the income but are required to be measured for the purpose of taxation of the person.
Section 27 of the Act contains the primary rules for the quantification of the amounts used in calculating income. The general approach of the Section 27 is to quantify the “non-cash” payments in reference to the market value of the benefit. This approach has been followed in the quantification of the following benefits under Section 27:
1. Payments made through transfer of assets
2. Lower interest rate loan facility
Sometimes, the general approach of quantification through the reference to the market value may not be appropriate in all circumstances, where alternative approaches are followed. Sometimes, in the context of the facilities that are provided for as per the policy / method of the benefit provider rather than the need and requirement as particular to the beneficiary, sometimes subjective or arbitrary rules may be viewed as appropriate. Circumstances where market value rules may be inappropriate are with respect to the “unwanted” payments. Sometimes a beneficiary may receive a payment the person would not acquire in the market price This can be the case with many types of fringe benefits provided to employees. In these types of payments a more subjective valuation rule than the market value rule may be considered appropriate.
In the context of Section 27, non-market value quantification are followed in the benefits of the following nature:
1. Vehicle Facility
2. Housing Facility
3. Assorted Facilities like assistants, refreshments and utilities
4. Other Facilities
Quantification Under Income Tax Act, 2058
Like many other areas of the Income Taxes, the quantification rules of the Income Tax Act, 2058 in Nepal are adjusted to meet the local considerations following both the objective and subjective rules as discussed in the section above. While Section 27 adopts the basic market value rule, it also applies alternative arbitrary quantification techniques to some typically difficult areas of valuation.
Lets dissect the quantification techniques provided for various types of “non-cash” benefits under Section 27 of the Act – to be read with the provisions in the Chapter 7 Quantification, Allocation and Characterization of the Amounts in the Income Tax Directive, 2066:
Payments made through transfer of assets - Section 27(1)(Ka)
The quantification technique under Section 27(1)(Ka) of the Income Tax Act pertains to payments made by transferring assets from one person to another. The taxable amount is calculated based on the market value of the asset at the time of the transfer. This ensures fair taxation and prevents underreporting of asset values. In other words, the value of the asset is assessed based on what it could be sold for in the open market.
Section 27(1)(Ka) is somewhat of a supplement to the other provisions of Section 27(1). It may be argued that a payment that cannot be transferred to another person or readily converted into cash has no, or a very low, market value. Section 27(1)(Ka) overrides this argument and ensures that fringe benefits cannot easily be excluded from income of the recipient by placing restrictions on transfer or conversion.
Vehicle Facility - Section 27(1)(Kha)(1)
Read with Rule 13(1) of the Income Tax Rules, 2059 – this provision outlines the quantification method for payments made for using a motor vehicle for private purposes in an income year. The quantification is based on the status of the person using the vehicle:
1. If the person using the vehicle is an employee, worker, or someone receiving monthly remuneration from the payer, the taxable amount is 0.5% of their remuneration.
2. If the person falls outside the above categories, the taxable amount is 1% of the market value of the vehicle.
Relating to this quantification here are some additional clarification provided in the Income Tax Directive, 2066:
1. Definition of Motor Vehicle: The term “Motor Vehicle” in this context refers to motor cars, jeeps, and other similar vehicles. However, it does not include bicycles, motorcycles, or combined bus facilities provided to all employees.
2. Inclusion of Driver, Fuel, or Repair Facilities: If the provision of a motor vehicle to an employee also includes the facilities of a driver, fuel, or vehicle repair, these facilities are not counted separately for tax purposes. They are considered as already included in the quantification method described earlier.
3. Non-Reduction of Income: It’s important to note that the income characterized in this manner is not reduced by any contributions made by the employee towards the provision of the motor vehicle. The taxable amount is determined according to the quantification method specified, and any employee contributions do not alter this calculation.
Housing Facility - Section 27(1)(Kha)(2)
Read with Rule 13(2) of the Income Tax Rules, 2059 – this provision outlines the quantification method for payments made for providing a house for private purposes in an income year. The quantification is based on the status of the person using the house:
1. If the person using the house is an employee, worker, or someone receiving monthly remuneration from the payer, the taxable amount is 2% of their remuneration.
2. If the person falls outside the above categories (e.g., consultants, directors), the taxable amount is 25% of the rent of the house (if rent is paid by the payee) or 25% of the market value of the rent of the house (if rent is not paid by the payee).
Relating to this quantification here are some additional clarification provided in the Income Tax Directive, 2066:
1. When a housing facility is provided within office premises to security guards, messengers, or office helpers for security reasons, no taxable benefit is attributed to these employees.
2. It’s important to note that the income, in this case, is not reduced by any contributions made by the employee towards the provision of housing. The tax treatment is such that these specific employees do not incur a tax liability for this benefit.
Assorted Facilities like assistants, refreshments and utilities - Section 27(1)(Ga)
This provision deals with payments made for specific facilities provided by the payer, and the taxable amount is calculated based on expenses incurred by the payer, minus any contributions made by the payee. These facilities include:
1. Services of a housekeeper, chauffeur, driver, gardener, or other domestic assistant: The taxable amount is determined by the expenses borne by the payer for these services, minus any contributions made by the payee.
2. Any meal, refreshment, or entertainment: For this category, the taxable amount is the payer’s expenses on these items, reduced by any contributions from the payee.
3. Drinking water, electricity, telephone, and similar utilities for the payee’s residence: The taxable amount is the expenses incurred by the payer for these utilities, with any contributions by the payee subtracted.
Lower interest rate loan facility - Section 27(1)(Gha)
This provision applies when the interest paid by the payee on a loan during the year is less than the interest amount that should have been paid based on the standard interest rate. The taxable amount is the difference between the interest paid and the interest that would be due at the standard rate. In essence, this quantification method ensures that the tax calculation takes into account the discrepancy between the actual interest paid and what would have been payable at the general interest rate.
Other benefits - Section 27(1)(Gna)
Section 27(1)(Gna) relates to payments that don’t fall under Sections 27(1)(Ka) to 27(1)(Gha). The quantification method involves assessing the value of the benefit from these payments as it would appear to a reasonable person in the position of the payee. In essence, it considers how a typical recipient would perceive the value of the payment for tax purposes.
Many unwanted types of payments will take the form of the provision of services or the use of an asset. With respect to residual payments of this kind, the law adopts a more subjective approach in Section 27(1)(Gna), valuing such payments by reference to a “reasonable person in the position of the payee”. Often this will not be the market value of the payment. A common example is fringe benefits provided to government employees in developing countries like ours. These can exceed the actual cash remuneration of such employees and are of questionable value to many of these employees. In these cases, a tax authority may employ a substantial discount on the market value of a particular fringe benefit for the purpose of quantification.
All quantifications are equal but some are more equal than the others
I like quoting George Orwell wherever I can – All animals are equal, but some animals are more equal than others, (From Animal Farm – A fairy Story by George Orwell) – even when the quote hardly fits the context that I am discussing. Apologies, and let’s move on !!
Here is what the Income Tax Directive, 2066 provides in the context of quantification of the Lower Interest Rate Loan Facility:
प्रचलित ब्याजदर भन्नाले प्रवाह गरिएको ऋणको प्रकृति अनुसार बजारमा उपलब्ध हुने ब्याजदरलाई जनाउँदछ । यस प्रयोजनका लागि ब्याजदर घोषणा गर्ने र सोलाई पुष्ट्याई गर्ने दायित्व करदाता स्वयंको हुन्छ । कर्मचारीलाई रोजगारदाताले उपलब्ध गराउने निब्र्याजी वा कम ब्याज दरको कर्जाको ब्याज सहुलियत समेत आयमा समावेश गर्नु पर्दछ । उक्त व्यवस्था तलको उदाहरणमा खुलाइएको छ ।
उदाहरण ७.२.१७: मानौं, कुनै व्यक्तिलाई रु.१,००,०००।– वार्षिक ४५ का दरले ब्याज तिर्ने गरी कुनै कर्जा उपलब्ध गराएको रहेछ र प्रचलित ब्याजदर ८५ रहेछ भने फरक दर ४५ का हिसाबले हुने रु.४,०००।– सो कर्मचारीले प्राप्त गरेको ब्याज सहुलियतका रूपमा गणना गरी रोजगारीको आयमा समावेश गर्नुपर्दछ ।
Why do tax officers typically refer to 15% as the general interest rate?
In the case of loans at low interest rates, it may be difficult to determine what the appropriate market interest rate is, in order to determine the amount of payment made in this form. In such situations the tax law generally identifies a statutory interest rate that is likely to be on the conservative side. Strange but yes, this is a principle laid down in paragraph 128 of the Commentary on Income Tax Act of the Commonwealth of Symmetrica. And then such conservative statutory rate is used to quantify the amount of a payment in the form of a low interest loan.
Under Section 2(KaBa) of the Income Tax Act, 2058 – the Standard Interest Rate in relation to an income-year means 15% p.a. Tax officers typically refer to a 15% interest rate as the general benchmark, but this practice isn’t without its issues. The reasoning behind this standard rate is rooted in the conservative approach laid out in paragraph 128 of the Commentary on the Income Tax Act of the Commonwealth of Symmetrica. This conservative statutory rate is intended to quantify payments for low-interest loans when it’s challenging to determine the actual market interest rate.
However, in the context of Nepal, this 15% rate is, quite frankly, on the higher side. This reality makes the adherence to the Commonwealth of Symmetrica’s Commentary seem somewhat outdated and inapplicable. Nevertheless, tax officers in Nepal continue to employ the 15% interest rate as the general benchmark for consultations and assessments, despite its apparent mismatch with the local financial landscape.
This practice raises questions about the adaptability of tax regulations to local conditions and whether a one-size-fits-all approach truly serves the best interests of both taxpayers and the government. But a good news for us all is that the decision from the Supreme Court (which we will discuss below), among other principles, laid down the meaning of the general interest rate in the context of Lower Interest Rate Loan Facilities.
Supreme Court’s Decision - the principle for quantification is quite different
The decision that we will refer to below is नेपाल बैंक लिमिटेड बिरुद्ध ठूला करदाता कार्यालय Decision Number 073-RB-0206 dated 2079.03.27
The decision involves a dispute related to the income tax treatment of interest expenses on loans provided by Nepal Bank Limited to its employees at subsidized interest rates. The decision addresses the question of whether the differential interest expense of the employee loans should be included in the net income for tax purposes and if yes to what extent.
The key points in the decision are as follows:
- Yes, quantification is necessary: The decision cites Section 27(1)(Gha) of the Income Tax Act, 2058 – which deals with situations where interest paid on a loan during an income year is less than the amount of interest payable according to the prevailing interest rate. It suggests that if the interest paid is less, the taxable amount should be quantified to the extent of the difference amount and subject to be included as income.
- But the comparison should be made with the borrowings of the same category: The decision emphasizes that the bank’s loans to employees, provided at subsidized interest rates in accordance with the bank’s staff regulations, should not be compared with commercial loans provided to other borrowers. It argues that equality among equals should be used when determining the net income, and it is within the bank’s rights to provide loans to its employees at concessional rates based on approved standards. This highlights that the nature of loans provided to the bank’s employees at subsidized rates differs from loans given to other borrowers and should only be compared to the general interest rate applicable to the employee’s borrowings while comparing it with the particular employee for the purposes of quantification under Section 27(1)(Gha).
Can the interpretation of this decision be extended to entities other than BFIs?
While the specific case involving Nepal Bank Limited pertained to the banking sector, in my view, the principles articulated in the decision can be applied to other entities. By recognizing the distinct nature of employee loans and applying consistent tax treatment based on these principles, the tax system can ensure fairness, equity, and conformity across industries.
The rationale behind the ruling in the banking institution case offers insights that can be extended to entities outside the financial sector. Here’s why:
- Principle of Differentiation: The core principle of the ruling is that loans provided to employees at subsidized rates, for reasons such as staff regulations, should be treated differently from commercial loans. This principle can be applied to other sectors, where entities offer benefits or loans to their employees on favorable terms, based on their unique circumstances and regulations for the purposes of housing, education and other employment related needs.
- Equality Among Equals: The concept of equality among equals is a fundamental principle in tax law. If entities in different industries provide similar benefits or loans to their employees at subsidized rates, it’s logical to apply consistent tax treatment. This principle of fairness supports the application of the ruling’s logic beyond the banking sector.
- Consistency in Taxation: Tax authorities often seek consistent tax treatment across different industries and sectors. Extending the logic of this ruling to other entities ensures a level playing field in terms of taxation. It promotes transparency, fairness, and predictability in the tax system.
Lastly, Article 128(4) of the Constitution of Nepal, 2072 unequivocally states that “everybody shall follow the legal principles interpreted or propounded by the Supreme Court in the matter of the case.” It goes on to emphasize that the Supreme Court has the authority to penalize those who obstruct the execution of justice or defy the orders and judgments of the Court. This constitutional provision makes it clear that the interpretations made by the Supreme Court should be universally acknowledged and adhered to by all.
Consequently, when we scrutinize the Supreme Court’s interpretation of Section 27, it becomes evident that if a bank offers its employees loans at a reduced interest rate compared to what it charges other borrowers, these favorable terms should not be regarded as part of the employees’ taxable income. This perspective aligns not only with sound legal reasoning but also with the constitutional mandate that necessitates compliance with the Court’s interpretations. Therefore, I believe it is necessary for entities across different industries to recognize the weight of the Supreme Court’s rulings in such matters.
Thank you for reading !!