TDS on Payment for Goods: Nepal Tax Perspective

tdsGoods

See my other post on Section 89 discussion here: Section 89 of ITA 

Important Questions @ First

What is the difference between goods and services?

As per Value Added Tax Act 2058: Goods means any kind of moveable/immovable property and Service means anything other than goods. Well, this can’t get any simpler. 
Lets discuss some key characteristics of goods and service and their differences: 

  • Tangibility: Goods are tangible whereas Services are intangible items. 
  • Delivery: Delivery of Goods means change in ownership of goods. Delivery of Service means rendering of service. 
  • Consumption: Goods are produced and then consumed. Services are produced and consumed at the same time. 
  • Separability: Goods can be returned to or exchanged with the seller, but it is not possible to return or exchange services, once they are provided.

When is the payment for goods/service treated as Nepal sourced?

Income Tax Act 2058 doesn’t clearly differentiate between goods and services. It treats income in several heading such as: Remuneration Payment, Interest Payment, Natural Resource Payment, Royalty Payment, Rent Payment, Service Fee Payment, Commission Payment, Sales Bonus Payment, Retirement Payment, Dividend Payment, Investment Insurance Payment, Windfall Gain Payment, Contract Payment and Other Payments. It might be wise to discuss in which circumstance these income heads becomes income sourced in Nepal. 

PaymentWhen is this payment considered to be sourced in Nepal?
Dividend PaymentSection 67(6)(a):
dividend payment made by resident entity
Interest PaymentSection 67(6)(b):
interest payment made by resident person
Natural Resource PaymentSection 67(6)(c):
natural resource payment made in respect of those natural resource taken from land situated in Nepal, or calculated in its reference
Rent PaymentSection 67(6)(d):
rent payment made for the use of asset situated in Nepal
Royalty PaymentSection 67(6)(e):
royalty payment made for the use of, right to use, or forbearance from using  asset situated in Nepal
(asset situated in Nepal includes both domestic as well as non domestic asset that are in Nepal. E.g. If foreign patent is used in Nepal, it is situated in Nepal.)
Insurance PaymentSection 67(6)(f):
general insurance premium and general insurance proceeds payment made in respect of insurance risk in Nepal

Service Fee Payment

Commission and Sales Bonus Payment

Windfall Gain Payment

Section 67(6)(g):
payment made for and received in Nepal by person who conducts business of land/sea/air transport/charter in respect of carriage/transport of passenger/mail/livestock that embark from Nepal other than transshipment
Section 67(6)(h):
payment made for and received by person who conducts business of transmitting messages by cable, radio, optical fiber or satellite communication  in respect of transmission of messages through apparatus established in Nepal, whether or not such messages originate in Nepal
Section 67(6)(i):
payment for service rendered in Nepal or forbearance from rendering service in Nepal of a type not mentioned in paragraph (g) or (h), regardless of place of payment
Remuneration PaymentSection 67(6)(i):
• payment for employment rendered or forbearance from rendering employment in Nepal, regardless of place of payment
• payment made by GON for employment rendered or forbearance from rendering employment, regardless of place of payment
Retirement PaymentSection 67(6)(j):
following payments not falling under Section 67(6)(i)
• payment of retirement payments made by resident person
• payment made to resident person to secure retirement payments
Investment Insurance PaymentSection 67(6)(j):
following payments not falling under Section 67(6)(i)
• payment of annuities, proceeds of investment insurance made by resident person
• payment made to resident person to secure annuities, proceeds of investment insurance
Other PaymentSection 67(6)(k):
gifts extended in respect of business or investment conducted with domestic assets
Section 67(6)(l):
payment [other than referred to in (a) to (k)] in respect of
• disposal of domestic asset [L&B situated in Nepal, resident person’s assets (other than foreign L&B), resident person’s interest in CFE] or incurring domestic liability [resident person’s liabilities]
• activity conducted in Nepal

Let's marinate the brain

When is payment for goods considered to have source in Nepal?

As per Section 67(6)(l) of Income Tax Act 2058, payment for goods is considered to have source in Nepal when the payment relates to the disposal of asset situated in Nepal. These are the assets situated in Nepal: 
1. Land and Building situated in Nepal (irrespective of whether it is owned by resident or non-resident person)
2. All assets owned by resident person other than Land and Building situated in foreign country

Okay, let’s marinate our brain in the meaning of this. This means that when a payment is made in respect of disposal of goods (e.g. trading stock but not foreign land/building) owned by resident person then that payment is considered to be Nepal sourced. But, if the payment is made in respect of disposal of goods (e.g. trading stock but not land/building situated in Nepal) owned by non resident person it is not considered to be Nepal sourced. 
But does the liability that is created against the payment of a asset-not-situated in Nepal create a domestic liability? No, domestic liability is created against the payment for domestic asset only. Meaning, if we acquire goods from non resident person, liability that is created against it not a domestic liability, because domestic liability is created against the payment for domestic asset only. 

What does the Income Tax Act 2058 say?

Let’s dissect the question. What are the preconditions for the deduction of TDS in any payment?

Generally it is understood that in order for the TDS to attract in a payment, the payment should have following characteristics: 
1. The payment should be taxable under Section 3
2. The payment should be Nepal sourced under Section 67
3. The payment should be made by Resident Person under Section 2(KaGna)
4. The payment should be listed under Section 87, 88, 88Ka or 89

Let’s list them in reference to Income Tax Act 2058 and interpret literally with Section 87, Section 88, Section 88Ka and Section 89, the Sections that lists the applicability of TDS and highlight some Red Flags in the literal interpretations: 

What characteristics should a payment compulsorily have for the applicability of TDS under these Sections?

Section 87

Section 88

Section 88Ka

Section 89

The payment should be taxable under Section 3?

Yes

Yes

Yes

Yes

The payment should be Nepal sourced under Section 67?

Yes

Yes

No(🚩)

No(🚩)

The payment should be made by Resident Person under Section 2(KaGna)?

Yes

Yes

No(🚩)

Yes

Let’s discuss the red flags in the literal interpretation: 
1. The payment need not be Nepal sourced income for the application of TDS under Section 88Ka?:
2. The payment need not be made by Resident Person for the application TDS under Section 88Ka?:
Section 88Ka doesn’t state that the Section 88Ka specifically applies in the case of Nepal sourced payment only. This omission certainly brings some confusion but it could just be that the Section 88Ka is not mentioning the obvious. Section 88Ka applies in the case of windfall gain. How do you determine the source of windfall gain? And if someone receives windfall gain from foreign country (e.g. winnings of foreign lottery paid by foreign company), surely that foreign company won’t be deducting 25% TDS as per Nepal Regulation and deposit the TDS in Revenue Department of Nepal. The foreign company in this case is neither interested nor obligated to deposit such TDS in Nepal, other than complying the tax regulation of that particular foreign country. So, will the person in Nepal be paying income tax on such windfall gain by self declaring the income? Yes, this will be the case. As per Section 90(5) of the Income Tax Act 2058, in case where the withholder fails to withhold the tax from payment as required by Section 87, 88, 88Ka and 89, both the withholding agent and withholdee shall jointly and separately be liable, for the payment of the tax, to the Department. The taxes paid under Section 88Ka is treated as final withholding tax under Section 92(1)(Jha) so claiming foreign tax credit against such taxes paid by self declaration is also not possible. This double taxation cannot be avoided unless there is specific treaty between the countries for avoiding such double taxation. 
We prove yet again, we can’t avoid death and taxes.

3. The payment need not be Nepal sourced income for the application of TDS under Section 89?:
The root for all the headaches regarding tax compliances in Nepal is in this confusion. Is section 89 applicable even on payments that are not sourced in Nepal? 
We have established that: 
1. When a payment is made in respect of purchasing goods from resident person, then that payment is considered to be Nepal sourced, as per Section 67(6)(l). 
2. When a payment is made in respect of purchasing goods from non-resident person, then it is not considered to be Nepal sourced, as per Section 67(6)(l). 

So, is TDS applicable in case of payment for goods?

We have established that: 
1. When a payment is made in respect of purchasing goods from resident person, then that payment is considered to be Nepal sourced, as per Section 67(6)(l). 
2. When a payment is made in respect of purchasing goods from non-resident person, then it is not considered to be Nepal sourced, as per Section 67(6)(l). 
It seems the applicability of TDS under Section 89 occurs irrespective of whether the payment is Nepal sourced or not and interpretation along this line would imply that in case of payment under a contract to resident person would attract 1.5% TDS (if the payment exceeds 50,000 Rs) and in case of payment under a contract to non-resident person would attract 5% TDS. 

Several questions arises here: 
1. Is TDS intended to be applied on payment for procurement of goods? If so, in what circumstance is it applicable in in what situations is it not?
2. Is the intention of Section 89 to apply TDS on income not sourced in Nepal as well?

Addressing the elephant(s) in the room

Is TDS intended to be applied on payment for procurement of goods? If so, in what circumstance is it applicable in in what situations is it not?

TDS stands for ‘Tax Deducted at Source’. It was introduced to collect tax at the source from where a person’s income is generated. The government uses TDS as a tool to collect tax in order to minimize tax evasion by taxing the income (partially or wholly) at the time it is generated rather than at a later date. 
So we understand that TDS is a tool that is intended to collect the applicable tax in advance to minimize tax evasion. Clearly, TDS could be and has been applied in the case of procurement of goods as well. 

Section 89(1) of Income Tax Act 2058 states that when a resident person shall deduct 1.5% TDS in making payment under contract/agreement exceeding Rs. 50,000. 
What is Contract?: Contract/agreement (ठेक्का/करार) for the purpose of this Section 89 means the contract/agreement for: 
• supply of goods or labor, or
• construction, installation or establishment of a tangible assets or structures and payment for service under such agreement, or
• the jobs prescribed by the Department as a contract (eg. Insurance Contract)

Does this contract/agreement needs to be a formal contract/agreement or is it intended to include all the types of contract like deemed contract as well? Well, both Act and Directive doesn’t seem to provide clarity in this matter. Should the definition of Contract be explicitly limited to include only the manufacturing/supplying a product based on some additional requirement and specification of customers than normal sales terms? This may include specifying the terms for regular delivery of goods, brokerage, unique requirement for quantity, unique requirement for quality, domicile and shipments etc. There is no such clarity in the definition provided in Income Tax Act. 

Is the intention of Section 89 to apply TDS on income not sourced in Nepal as well?

Nepal follows Residency based tax system. In residency based tax system, all the income of the resident person is taxed irrespective of the location of the source of income and income of non-resident person is taxed only to the extent of the income having source in Nepal. This has been the principle for Income Tax Act 2058 of Nepal. 

There are no any exception to this principle in Nepal except other than taxation under proviso to Schedule 1(2)(7) dealing with nonresident person making service available in water transport, air transport, or telecommunication service which have no destination to another foreign country from Nepal. In this case tax is applicable in Nepal even in the income that are not sourced in Nepal, also some exemption is provided in income that are sourced in Nepal. This is due to internationally adopted practice in taxation of civil aviation industry as per Chicago Convention on International Civil Aviation (International Civil Aviation Organization) and Berlin Convention on International Radiotelegraph (International Telecommunication Union) discussed in another blog. 

Apart from these two exceptional cases no other income of non-resident person that is not sourced in Nepal is taxable in Nepal. So it can be wisely assumed that the Section 89 doesn’t intend to apply in cases of income that do not have source in Nepal just like Section 87, Section 88 and Section 88(Ka). 

Hence, we can safely assume that when a payment is made in respect of purchasing goods from non-resident person, then it is not considered to be Nepal sourced, as per Section 67(6)(l) and the provision of application of 5% TDS under Section 89(3)(Ka) doesn’t apply. 

Do also visit this other post where I discuss the problems surrounding the Section 89 of the Income Tax Act: Section 89 of ITA: shallow and shameless