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.
Daily Allowances and its withholding taxes and short history
In accordance with Section 8 of the Income Tax Act, 2058 – an individual’s employment income encompasses the compensation received as an employee. Section 8(2) of the Act enumerates various categories of income that fall under employment income. These include:
- Wages, salary, leave pay, overtime pay, fees, commissions, prizes, gifts, bonuses, and other facilities.
- Personal allowance, encompassing costs like cost of living, subsistence, rent, entertainment, and transportation allowance.
- Reimbursement of costs incurred by the individual or an associate of the individual.
- Payments for the individual’s agreement to any conditions of employment, redundancy, or loss or termination of employment.
- Retirement contributions, including those made by the employer to a retirement fund on behalf of the employee, and retirement payments.
- Incomes categorized under Chapters 6 and 7.
- Other payments made in connection with employment.
It is imperative to note that any payments associated with employment must be included as employment income for income tax computation purposes. Nevertheless, Section 8(3) carves out exceptions to this rule, stating that the following types of income need not be included in employment income:
- Meals or refreshments provided in premises operated by or on behalf of an employer to the employer’s employees, available to all employees on similar terms.
- Discharge or reimbursement of costs incurred by the individual serving the proper business purposes of the employer.
- Payments of prescribed small amounts that are so negligible and impractical to account for, considering their unreasonably small nature.
The question arises: are daily allowances subject to taxation as employment income? Upon examining the broad provision of Section 8(2) of the Act, it appears affirmative. A daily allowance constitutes a specified sum allocated for an individual’s daily requirements, primarily covering expenses like food, transportation, and other essentials. This predetermined amount aims to address the costs associated with daily living and finds application in various scenarios, such as travel allowances for business trips, per diem allowances for employees, or daily stipends for specific activities. For instance, individuals on a business trip might receive a daily allowance encompassing meals, accommodation, and other incidentals. Similarly, organizational policies may grant employees a daily allowance to offset expenses during official duties.
Although Section 8(2) mandates the inclusion of daily allowances in employment income, an argument could be advanced asserting exemption under Section 8(3). This argument posits that these allowances constitute costs borne by the individual, essentially serving the employer’s business purposes, and therefore should be exempt from employment income of an individual. However, this argument faces challenges. Business expenses typically necessitate the submission of detailed invoices and expense breakdowns, itemization and establishing commercial expediency — a practice not commonly followed when disbursing and settling daily allowances. A not so straight but similar interpretation has also been made in the case of ठूला करदाता कार्यालय विरुद्ध कान्तिपुर पब्लिकेशन्स् Case Number 072-RB-0498
Another intriguing and creative link can be established with Section 8(3)(Gha) of the Act. This section stipulates that amounts deemed small, making accounting impractical or unreasonably burdensome in the context of employment, need not be included in employment income. Contrary to the common misconception that such “small amounts” are limited to Rs. 500, as per Rule 6 of the Income Tax Rules, 2058, this restriction only applies to specific payments related to tea, stationary, tips, rewards, emergency medical treatment, and other categories specified by the Department. Consequently, daily allowances, if reasonably minimal and prevalent within the company, posing administrative challenges for detailed accounting and itemization, could logically fall under the exemption from inclusion in employment income.
But how did the convention of excluding general daily allowances from the employment income heading become widespread?
Credit for this practice goes to the Income Tax Act, 2031, which was the predominant income tax law in Nepal before the current law, i.e., The Income Tax Act, 2058, took effect. Section 8 of the Income Tax Act, 2031 delineated the elements to be encompassed within employment income. According to Section 8(a) of the Act, various forms of remuneration, such as wages, salary, special salary, special allowance, salary in lieu of leave, commission fee, charge, bonus, and other perquisites received in cash or kind, were to be included in employment income. However, certain categories, including medical allowance, daily or traveling allowance, remote area allowance, pocket allowance or leader allowance for delegates on foreign tours, casual expenses, Dashain expenses, amounts received as reimbursement, telephone facility provided by the employer institution, as well as gratuity and pension, consolidated home leave, sick leave, decoration, and medals awarded by His Majesty’s Government, government corporations, institutions dedicated to public utilities, and other prescribed institutions were explicitly excluded from remuneration income. This exception essentially excluded various components of employment income taxes, including daily allowances associated with business provided to employees. This historical influence has persisted over time. Even today, allowances and similar categories for government staff are not subjected to taxation, creating an unwritten market practice of excluding reasonable daily allowances from being considered part of employment income.
Does not deducting TDS make a payment non-deductible?
The deductibility of payments for tax purposes can be influenced by various factors, and the absence of withholding tax deductions may impact the deductibility of the payment in certain jurisdictions or under specific tax laws.
Nevertheless, the argument that the deductibility of an expense should not be affected solely due to non-compliance with withholding taxes carries merit. The withholding tax requirements are primarily designed as a mechanism for efficient tax collection, and the failure to comply may indeed lead to fines and interest charges. However, the direct impact on the deductibility of the expense itself can be viewed differently. In many jurisdictions, including Nepal, the tax laws generally focus on ensuring that the tax liability is appropriately fulfilled by collecting taxes at the source. While non-compliance with withholding tax obligations may result in penalties and interest, it may not necessarily render the underlying expense non-deductible. The deductibility of an expense is often contingent on its nature, ordinary and necessary business purpose, and compliance with other relevant tax regulations.
The case of प्रोबायोटेक इण्डष्ट्रिज विरुद्ध ठूला करदाता कार्यालय (Case Number 074-RB-0194) serves as a notable exception. The Court affirmed the decision of the Revenue Tribunal, which denied the deductibility of expenses solely based on the lack of withholding tax compliance for the specific payment. This decision reflects a strict interpretation of the tax regulations, emphasizing the significance of adhering to withholding tax obligations as a condition for expense deductibility. It is conceivable that there exist legal grounds to contest this decision in subsequent cases in future.