In this not so comprehensive discussion, we will delve into the prevalent challenges frequently encountered during the tax assessment process, commonly known as the “full audit,” conducted by the Revenue Authorities of Nepal. This exploration aims to shed light on the most common issues that businesses and individuals often deal with when undergoing thorough audit by the tax authorities.
VAT Claim on Loss and Damages
Section 16Kha of the VAT Act, 2052 provides taxpayers with the opportunity to claim input value-added taxes for goods affected by events such as theft, evasion, damage, expiration, accidents, fire, or destruction. This entitlement is subject to adherence to the prescribed procedures outlined in the VAT Rules, 2053.
The procedures stipulated under Rule 39Ka of the Income Tax Rules, 2053 can be summarized as follows:
Regarding the deduction of tax paid on damaged items – the taxpayer is required to submit an application to the tax officer within specific timelines based on the circumstances. In instances of loss due to fire, theft, accident, breakage, or vandalism, the application must be filed within thirty days from the occurrence. Reference: डाबर नेपाल प्रा.लि. विरूद्ध ठूला करदाता कार्यालय Case Number: 075-RB-0325
For expired items, the deadlines vary depending on the respective months, with specific dates as outlined below:
Goods that expires within
Should be reported to tax officer
Shrawan to Ashoj
Within 25th of Kartik
Kartik to Poush
Within 25th of Magh
Magh to Chaitra
Within 25th of Baisakh
Baisakh to Ashar
Within 25th of Shrawan
It’s important to note that the tax authority has the discretion to deduct the tax paid on damaged or expired items upon verification of the application submitted under the specified rules. Notably, in cases involving insured goods, the taxpayer is permitted to deduct the amount up to the extent of compensation received. This essentially means that where the lost goods qualify for insurance claim, there is no need to submit to the tax officer for approval to claim the damages to that extent.
💡In the event that the input tax credit for damaged goods has previously been claimed and subsequently, the goods incur damage, what course of action should be taken?
Consider the scenario where the input tax credit for damaged goods has been previously claimed, and subsequently, the goods incur damage. In cases where the tax authority exercises discretion to allow the claim of input taxes for the lost or damaged goods, no further adjustments are necessary if the input taxes have already been claimed. However, if such losses or damages do not qualify for an input VAT claim, the tax credit previously availed must be written off through adjustments when filing periodic VAT returns. In the event that a distributor asserts a loss to the producer, it is imperative to issue a Debit note. Consequently, the tax credit previously claimed should be written off, and replacement goods should be documented through a new invoice. This process ensures compliance with applicable regulations and accounting principles. Reference कर्माचार्य ब्रदर्श विरुद्ध ठूला करदाता कार्यालय Case Number: 077-RB-0031
💡Is the process slightly different for excise industries operating under physical control system?
As per the circular dated 2059.10.10 and 2061.5.22 – issued by Inland Revenue Department, an affirmation in form of documentation is required to be prepared in relation to the facts of the loss and damages with the involvement of the key stakeholders. These stakeholders include the representative of the tax office, the representative of the local trade/industry association, the representative of the district administration office or the treasury, and the accounting controller’s office. Furthermore, it is outlined that for the taxpayer’s application for claiming input VAT on such losses or damages are permitted upon approval of the department. Excise registered Industries operating under Physical Control System have to adhere to other stricter provisions as per the Excise Act, 2058 – which we will not be discussing here. Rule 23Ka, Rule 27 of the Excise Act 2059 deals with that in depth. Reference: ठुला करदाता कार्यालय विरुद्ध हिमालयन डिष्टिलरी, Case Number: 072-RB-0497
Own Your Vehicle Scheme
The issue of the Own Your Vehicle Scheme is a famous asset recognition issue, at least in the context of Nepal. The scope of the IAS 19: Employee Benefits and the definition of “asset” provided under the Conceptual Framework for the Financial Statement should be viewed to actually rationalize how the vehicles under the Own Your Vehicle Scheme should be accounted for.
The definition for the term asset provides: An asset is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits. Thus, an item of economic significance can only be recognized when (i) the entity has the right over the asset, (ii) the asset has the potential to produce the economic benefit and lastly, (iii) the entity controls the asset.
This is quite a tricky issue to deal with. Who would have thought something mundane like a company’s car would bring so much accounting and legal troubles? Who would have thought that such a huge debate would ensue over something as seemingly simple as using a company car? But, using a company’s car: how does an employee use the company’s car?
This debate touches three accounting standards in total. Let’s discuss them one by one:
IAS 19 Employee Benefits
These proponents cite IAS 19, which covers employee benefits and more specifically the treatment of short-term employee benefits, or essentially all forms of consideration given by an entity in exchange for service rendered by employees or for the termination of employment. It may seem obvious, then, that cars given as part of the employment package as a fringe benefit would fall into the category of “all forms”. And if one were still in doubt, IAS 19 is nice enough to list cars as an example of other short-term employee benefits. However, there may be some vesting period provisions, which will make difference in the accounting approach:
- Where an employee should have been engaged with the company for a certain period after which he receives the car: Under such condition, the cost of the car at the time of grant is directly expensed off to the income statement as employee benefits as the vesting period has already been satisfied before or at the time of grant. Another famously asked question is, does the company have to recognize the provision for the cost of the car before the grant date based on the vesting period? The answer is no. IAS 37 Provisions, Contingent Liabilities and Contingent Assets doesn’t apply on the expenses to be recognized under the IAS 19 Employee Benefits.
- Where an employee receives the car but should be engaged with the company for a certain period after the grant: Such contract with employee allows the company to recognize the employee receivable under the IFRS 9 Financial Instrument in form of financial asset. And the residual cost is charged to the income statement over its vesting period as an employee cost under IAS 19 Employee Benefits.
Let’s see how the courts have interpreted this matter. These are the decisions made by the revenue tribunal regarding the recognition issue of the assets under Own Your Vehicle Scheme:
- Mega Bank Limited v/s Large Taxpayer’s Office
- Nabil Bank Limited v/s Large Taxpayer’s Office
- Sunrise Bank Limited v/s Large Taxpayer’s Office
- Prime Commercial Bank Limited v/s Large Taxpayer’s Office
- Prime Commercial Bank Limited v/s Large Taxpayer’s Office
- National Insurance Company Limited v/s Large Taxpayer’s Office
- Lumbini General Insurance Company Limited v/s Large Taxpayer’s Office
- Everest Insurance Company Limited v/s Large Taxpayer’s Office
- Siddhartha Bank Limited v/s Large Taxpayer’s Office
In these decisions, the tribunal has taken a view that the company’s car provided to employee should be accounted as cost of employee benefits rather than as the depreciating asset of the company. This conclusion has been reached due to the following inherent characteristics of the Own Your Own Vehicle Scheme:
- बैंकको हित वा सेवा शर्त विपरीत कार्य गरेमा सुविधाबाट वञ्चित गर्न मात्र बैंकको स्वामित्व कायम राख्न सवारी साधन बैंकको नाममा राखिएको, The title has been retained by the company only to ensure the withdraw the facility if the employee actually doesn’t complete the vesting period or does any harm or damage to the bank
- उपलब्ध गराईएको सवारी साधन निर्वाध रुपमा उपयोग गर्ने अधिकार Possession Right सम्बन्धित कर्मचारीमा नै रहने, The employee assumes the risks, rewards and possession of the car
- ब्यबसायिक काममा समेत अन्यले प्रयोग गर्न नपाउने, The car cannot be utilized for the company’s purpose other than by the particular employee
- ईन्धन र मर्मतको खर्च निश्चित सीमा भन्दा माथिको सम्बन्धित कर्मचारीले नै ब्यहोर्ने, Only a certain capped fuel and repair expenses are borne by the company, other than those, they are borne by the employee himself
- कर्मचारी को रोजाईमा रकम थप गरेर सवारी साधन खरिद गर्न सकिने, The vehicle can be purchased at the option of the employee and employee can also contribute to purchase the vehicle of the choice of the employee
- सवारी साधनको प्रयोग बैंकको आय आर्जन सँग सम्बन्धित कामका लागि मात्र नहुने, व्यक्तिगत प्रयोजनमा बढी उपयोग हुने, The vehicle can be utilized for the personal purpose of the employee and the vehicle is not required to be substantially be used for the company’s purpose (say =, some metric like, 4:3 ratio, business to domestic use ratio based on 7 days of the week etc. is not required by the contract)
- पछि तोकिएको समयमा कर्मचारीलाई नै हस्तान्तरण भै सम्पतिको निसर्गबाट बैंकलाई कुनै प्रतिफल प्राप्त नहुने भएकाले, The vehicle is transferred at the end of the vesting period to the employee for no consideration
These conditions present in the Own Your Vehicle Scheme led to the decision from the Revenue Tribunal to conclude that the company actually doesn’t own the assets and do not fulfill the recognition criteria under IAS 16 Property, Plant and Equipment. Thus, the recognition of expense should have been made as employee cost under the IAS 19 Employee Benefits rather than depreciation cost under IAS 16 Property, Plant and Equipment. Due to this differing opinion from the Revenue Tribunal, the entities were faced the following consequences for tax purposes:
- Derecognition of the cars as assets of the company (citing Para 65 of IAS 16: Property, Plant and Equipment)
- Disallowance of the depreciation charged on the cars
- Disallowance of the Insurance Expense, Vehicle Tax Expense, Fuel Expense and Repair/Maintenance Expense incurred on the vehicles
Drawing corollary from the decision of the Revenue Tribunal, regarding the Insurance Expense, Vehicle Tax Expense, Fuel Expense and Repair/Maintenance Expense incurred on the vehicles, these costs should have been charged in the form of the employee benefits and subject to inclusion as employment income of the employees.
As it can be inferred from the above, given the revenue tribunal has somehow preferred the more dominant approach of accounting the asset under IAS 19 and IFRS 9, this view on lease accounting of the company car, may not be that relevant in that context. In addition to that when the costs are accounted as employee benefit expenses, this also arguably holds some sentimental basis for adverse assessment, as tax allowance of the employee benefit expenses are also usually protected by other laws like Labor Laws, Industrial Enterprise Laws and is counted as a significant value addition within the company. So, this method is the most preferable method of accounting for the company’s car and benefits, at least in the context of Nepal.
IFRS 16 Leases
If we look at the company cars that are provided to the employees, where an employee receives the car but should be engaged with the company for a certain period after the grant, it can very well be accounted under the principles of IFRS 9 Financial Instrument and IAS 19 Employee Benefits, as discussed above. But some accounting practitioners advocate for ownership of company cars based on the scope of IFRS 16, which says that the standard applies to all leases (with limited exceptions). They would go further to say that behind the arrangement of a company car for employee use is the lessee-lessor relationship established by the employer, who is in fact leasing the car from a provider in order to be able to provide said car to the employee. IFRS 16 does require the additional step of considering whether this contract is, or contains, a lease. This aspect alone may warrant a separate blog post but, in short, the focus of the assessment should be on whether the company has the right to direct “how and for what purpose the asset is used” and whether it is getting, substantially, all the economic benefit from the asset.
The accounting treatment under the two standards differs greatly. If you apply IAS 19, you would recognize an expense and a liability based on a simple fringe benefit calculation. Applying IFRS 16, however, would entail bringing the car onto the books in the form of a right-of-use asset with a corresponding lease liability, the calculations of which are significantly more complex than the calculations that would be necessary under IAS 19.
But what is the point? It’s just that a careful consideration should be given to both standards until more conclusive guidance has been issued. But in the context of Nepal, given the revenue tribunal has somehow preferred the more dominant approach of accounting the asset under IAS 19 and IFRS 9, this view on lease accounting of the company car, may not be that relevant in that context.
IAS 16 Property, Plant and Equipment
There is not much to discuss on the recognition of company cars under IAS 16. The car is recognized as an asset of the company. The same old principle of asset recognition should be satisfied for the company’s car to be recognized as an asset of the company. The definition for the term asset provides: An asset is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits. Thus, an item of economic significance can only be recognized when (i) the entity has the right over the asset, (ii) the asset has the potential to produce the economic benefit and lastly, (iii) the entity controls the asset.
Under this approach, the entity retains the full ownership of the assets and the employee cannot possess the asset significantly for their personal use. Similarly, the title is also retained by the company and the company can at any time direct the use of the company car for other purposes of the company’s objectives. So, also referring to the basis for the revenue tribunal’s decision, as indicated above, it is extremely necessary to determine if the asset is in fact in the ownership of the company or the employee for deciding the accounting approach.
Does the decision from the Supreme Court treat it as Employee Expense?
In the decision of नेपाल इन्भेष्टमेण्ट बैंक विरुद्ध आन्तरिक राजस्व विभाग Case Number: 074-RB-0190, the Supreme Court examined a case concerning the deduction of depreciation expenses related to vehicles owned by a bank and provided to its employees under a Car Scheme. The initial decision disallowed the deduction, asserting that the vehicles were owned by the employees, not the bank, and thus ineligible for depreciation claims under Section 19 of the Income Tax Act. The Court held that, based on legal provisions in Section 19(1) of the Income Tax Act, 2058 assets eligible for depreciation must be owned and used by the taxpayer for income generation. The Court found that, under the Car Scheme, the vehicles were classified as permanent assets of the bank but were intended for the use, purpose, and ownership of the employees. Moreover, the provision allowing employees to purchase vehicles at the end of the scheme’s tenure was considered as creating a liability and thus not appropriate for asset recognition.
Consequently, the Court upheld the Revenue Tribunal’s decision that the claimed depreciation expenses should not be deducted for vehicles used by employees. Although the vehicles were registered in the bank’s name, the appeal to deduct depreciation expenses for these vehicles was deemed legally untenable.
While the court refrained from explicitly determining the nature of the expense, should it not fall within the category of depreciation, there exists a strong likelihood that the court would align with the perspective of categorizing such expenses as Employee Benefits under IAS 19 of the Financial Reporting Standards, as discussed above from the interpretations of the Revenue Tribunal.
If it's an Employee Expense, will the VAT be credited?
The fundamental principle governing the input Value Added Tax (VAT) credit, as outlined in Section 17 of the VAT Act, 2052, stipulates that the tax paid during the importation or receipt of goods/services pertaining to the taxable transactions of a business can be offset against the tax collected from taxable sales.
Concerning the deduction of expenses for Income Tax purposes, Section 13 of the Income Tax Act, 2058 mandates a general deduction criterion. It necessitates that for an expense to be eligible for deduction from income, it must be incurred in the income year by the person and be directly related to the generation of income. The phrase “related to earning such income” underscores the allowance of deductions for expenses incurred in the production of income, while expenses not meeting this criterion typically do not qualify for deduction.
In essence, the permissibility of claiming input VAT credit and income tax deduction for the company car facility hinges on the assertion that such a facility is not purely of a domestic or personal nature. If these facilities are deemed as alternative compensation to the conventional remuneration or employee benefits offered to employees, then, axiomatically, the input VAT paid on such company cars should be eligible for VAT credit and income tax deduction as employee expenses.
However, a caveat exists based on a Supreme Court decision in the case of सिद्धिगणेश पुनरावेदक इन्टरप्राइजेज प्रा.लि. विरुद्ध ठुला करदाता कार्यालय Case Number 074-RB-0081. The court, albeit without substantive reasoning, held that VAT input on company cars provided as a facility to employees is not eligible for credit. Regrettably, this decision remains the current status quo. But not all is doom and gloom. I think a inference can be set from the decision from Supreme Court ठूला करदाता कार्यालय विरुद्ध याक एण्ड यति होटल Case Number: 073-RB-0003. In this decision the Court asserted that VAT input on Staff Meal, a nature of employee expense, is eligible for VAT credit.
MP < CP: Whose responsibility is it to prove that price below cost is unreasonable during audit?
More detailed discussion on this topic here in my other post: Selling Price < Cost Price means Taxman’s Eyes Wide Open
The “loss leader” pricing strategy is common, but businesses must be mindful of legal and tax implications. While setting prices is generally free, anti-competitive practices like predatory pricing or price-fixing agreements are illegal. Tax authorities scrutinize such practices, viewing the difference between sales prices and costs as gains in intangible assets, leading to potential taxation. While pricing is generally free, selling below cost can be unlawful in certain circumstances. Businesses must navigate competition laws, tax considerations, and market dynamics for fair and legal practices. Transparency in justifying pricing strategies to authorities is crucial.
Competition laws, like those in Nepal, aim to maintain fair competition and prevent monopolies. Case laws highlight the importance of businesses justifying pricing strategies when questioned by revenue authorities. Determining the real sales price is complex, and tax authorities may question prices below costs. In situations where a business with financial advantages aims to eliminate competitors, the impact on the perfect market is debated. Often during the “full audits” that are made by the Revenue Authorities on its taxpayers – this issue regarding selling products or services below cost arises which forms a significant issue of debate between the tax officers and taxpayers.
Let’s delve into more detail. Market-Based Pricing is the principle that prices are determined by market competition, taking into account factors like demand and supply. There have been few favorable decisions from the Supreme Court that underscores the importance of considering market dynamics in pricing decisions.
In the decision हुलास वायर इण्डष्ट्रिज प्रा लि विरुद्ध ठूला करदाता कार्यालय, हरिहरभवन (ने.का.प. २०६३, अङ्क ७, निर्णय न. ७७३०) – text emphasizes that when a tax officer claims a certain amount is not deductible or subject to include as income, it is the responsibility of the tax officer to prove it with logic and reasoning as with any other judicial work. The burden of proof is considered crucial in tax-related disputes. The text cites that tax officers must show that an amount is taxable when a taxpayer asserts otherwise. This decision reinforces the need for transparency and evidence in tax assessments and places the burden on tax authorities to justify their claims.
Similarly, in the case of आन्तरिक राजस्व कार्यालय बिरूद्ध शिवशक्ति आयल प्रा लि Case Number 071-RB-0210 and श्रीराम सुगर मिल्स लिमिटेड बिरूद्ध आन्तरिक राजस्व विभाग (ने.का.प. २०७६, अङ्क ८, निर्णय न. १०३३८) text from the decisions acknowledges that, in special circumstances, such as a decline in demand or the need to sell unused or low-quality goods, selling below cost may be justified. It mentions that additional expenses, like renting extra storage space, may necessitate selling goods at reduced prices. The decision also recognizes that selling goods at a lower price than the market price is justifiable in certain circumstances. This decision takes into account practical business considerations and the challenges businesses may face in managing their inventory.
In summary, these decisions underscore the importance of considering market dynamics, the burden of proof in tax disputes, and recognizing special circumstances that may justify selling goods below cost. They reflect a nuanced approach to taxation, taking into account the realities of business operations and market conditions.
Other relevant decisions: