Section 10 v/s Section 11: What is the difference?
To start, Section 10 is a provision for Primary Exemption and Section 11 is a provision for Business Exemption.
System of taxation, like Adam Smith said, is expected to meet the certain good principles, called canon of taxation: Equality, Certainty, Economy and Convenience. An ideal income tax law distinguishes between the primary exemptions and industry concessions, like Nepal practices under the separate Section 10 and Section 11 of the Income Tax Act, 2058. Primary exemptions provided within any country depends upon the different social values, social structures, level of resources, government funding arrangements and also including the level of reliance on other forms of taxation. It may also differ according to the political, cultural, social norms, geo-political as it is the stepping onto molding an ideal system of taxation.
The word “कर छुट” has been used willy-nilly randomly in the context of Section 10 and Section 11 of Income Tax Act, 2058. Legislators of tax laws have failed to put keen attention to structural issues regarding the nature of tax reliefs under Section 10 and Section11. At this point the provision of Section 10 and Section 11 are littered with provisions that appear under headings to which they do not relate and often times seems to cover only the part of the generic issue because that was the part that was initially causing a problem. Then during application of the tax laws, we later find that the variations of the problem continue to arise as the problem had not been addressed from the structural perspective in the first place. Another problem for the legislators of tax laws is that when the other legal system in the country is not sufficiently sophisticated. The scatteredness of the business concessions within many laws, the conflicts between the accounting and reporting standards within the laws and reporting standards leads to confusions in application of tax laws and thus tax laws cannot be in itself self standing.
Going into the main question of this topic? What exactly is the difference between Section 10 and Section 11?
Exemption under Section 10 are natural exemptions from income taxes. As a general categorization, incomes are separated into Business Income, Employment Income, Investment Income and Windfall Gains. In Nepal, income taxes are applicable in source basis for non-resident persons and on global basis for resident persons. The general categorization of the income into Business Income, Employment Income, Investment Income and Windfall Gains is such expansive and inclusive and wide that virtually any form of income derived under the sun in the green mother earth can be included in one of those headings. However, some nature of incomes are such that although they may be included in the income heads above, it would not make sense in taxing them from economy, efficiency, social, moral, national interest, diplomatic and political perspective. Some income items are thus required to be entirely excluded from the purview of taxes and such exclusion may be more or less permanent depending on the economy, efficiency, social, moral, national interest, diplomatic and political perspective. Such exceptions in taxable income are covered by the tax exemptions under Section 10 of the Act.
Business concession on the other hand are and should be in transitory in nature. A conventional tax wisdom, also supported by Income Tax Act of Symmetrica, suggests that particular industry concessions should always to kept to minimum. When they are provided in long term permanent nature conventional wisdom suggests that these types of concessions often cause more harm than good. So business concessions are generally focused in providing a termed benefits, benefits with limited life to limited specific businesses and industries. There may be some particular intended objective like: employment, gender and social inclusiveness, poverty alleviation, sustainable development goals, national interest projects etc. Thus the concessions under Section 11 are not permanent in nature, they are transitory and are aimed with social political objective, or maintaining level playing field.
Section 11 concessions can also looked from another perspective: employment, gender and social inclusiveness, poverty alleviation, sustainable development goals, national interest projects are the plans and objective of the government. When these objectives could otherwise be met through the private sectors based on the qualification criteria, this is an opportunity for the government to ensure the better utilization of its time and resources, which would have to be achieved after the actual recovery of the taxes from the businesses/industries. This is also a reason why the concessions under Section 11 are reported as cost of the government rather than reporting the reduced/net tax collection from such industries as tax revenues.
What kind of tax exemptions are provided under Section 10?
Income exempted by the reason of bi/multi lateral treaties with the GoN, income of public servant’s income from foreign countries. amount provided from public fund of foreign countries. income of GoN/NRB, gift/bequest/inheritance/scholarship that do not qualify to be employment/investment/business income, income derived by tax exempted entity relating to its objective and social security payments from GoN.
What kind of business concessions are provided under Section 11?
Concessions to agriculture business (Sustenance Agriculture, Tea Industry, Dairy Industry etc), certain forms of cooperatives, special industries, IT industry, employment generating industries, renewable energy sectors, transportation and rural area based industries.
The detailed dissection on the exemptions and concessions are quite expansive but generally the gist is, Section 10’s exemption is different from the concession under Section 11 in that: (i) it is more permanent in nature rather than transitory, (ii) it is an entire exemption rather than a partial or termed exemption, (iii) it is more influenced by efficiency, social, moral, national interest, diplomatic and political reasons whereas those under Section 11 can be viewed as government’s way of getting its intended objective obtained though private sector by way of motivation through tax concessions.
Consequences of enjoying the benefits under Section 11
You can't set off the losses with other businesses or investments that you may have
Section 11(4) of the Act provides that if any person carries on transactions qualifying for different tax exemption facilities pursuant to Section 11, income shall be computed to obtain such facility as if that income were derived by separate persons. This provision will have many tax consequences but one of the most impact is seen on the part of inter-business/investment loss setting off by the person. A person may have several businesses or investments but the losses derived from the business that qualify for concession under Section 11 can only be set off with the profits derived from the same business.
You may not be able to carry forward the losses
Section 20(8) of the Act provides that if any person has received full tax exemption in respect of income of business or investment in any income year, the loss incurred in that income year shall not be carried forward to upcoming income year. This is very consequential and also a very disastrous provision to the person carrying out the businesses that are covered by Section 11. Concessions under Section 11 are also sometimes aimed at providing benefits to newer industries, leveling the playing field or encouraging such industries to pursue such business activities in the future. But when the business may have received full tax exemption under Section 11 (i.e. by way of 100% tax concession or tax holiday period), the entity will not be able to carry the losses in the future. This will cause tax losses to such entities as the initial tax holiday period are the period with losses, which then cannot be carried forward.
Your borrowers may have to defer the tax deduction of interest being paid to you
An entity who is entitled to concession under Section 11 and lends to borrowers deemed to be controlled by it under Section 14 of the Act, will have to review the lending/borrowing transactions from the perspective of the borrower. The borrower when making interest payment to such “exempted controlling entity” may not always be able to take tax deduction for the entire interest amount as it is capped for deduction under Section 11. This deferral of the tax expense recognition may lead to loss in the form of time value of money.
Availing non-recognition benefit under Section 45 may be a challenge
As stated in para above, The word “कर छुट” has been used willy-nilly randomly in the context of Section 10 and Section 11 of Income Tax Act, 2058. Legislators of tax laws have failed to put keen attention to structural issues regarding the nature of tax reliefs under Section 10 and Section 11. This will potentially create confusion in the implementation of non-recognition rule under Section 45. More on the Section 45 principle here: Transfer of tax base between associates
The potential problem here is that whether the word “tax exempt” used in Section 45(6) creates confusion in its application. However, looking at the provision of the Act and the commentary provided in the Income Tax Act of Symmetrica, the intention of the condition of transferee not being a tax exempted person is to ensure that the asset or liability remains in the tax net in the hands of the transferee. If transfer of assets between associated person is made at tax base and the transferee is tax exempt entity, this would mean the erosion of the potential income at the point of transfer had it been at the market value. So if the transferee is enjoying business concession under Section 11, the condition would still be satisfied non recognition could still be invoked. However, there may be some potential conflicts with the tax authorities as this has not be tested legally. But as per the natural argument, commentary from Peter Harris and intention behind the law, this should not be a problem.