Q: Will I be taxed on my Social Security Benefits? | A: Short Answer: Yes Long Answer: Umm… Maybe Yes …. but sometimes No
Universal Social Security Schemes
The history of social security began with pensions paid to retired and old persons. A pension is a lump sum given to service holders after their retirement from service. There is no documentary evidence about when the pension was first paid in Nepal, but it is found that a system to provide annual lump sums to wounded soldiers returning from the British Army was practiced during the First World War. In 1991 B.S., a Military Money Fund was established, and then Prime Minister Juddha Shumsher announced one fifth of the salary as pension for retired soldiers in 1998 B S. In the civil service, it is found that one sixth of the salary was provided to the civil servants who had served 25 years as pension in 1999 B.S. At that time, the pension was distributed by the Land Revenue (Malpot) offices. From 2033 B.S., the Civil and Police services pension was distributed through the Nepal Rastra Bank (central bank), Rastriya Banijya Bank and Nepal Bank Limited (state run commercial banks). Civil Service Regulation 2050 Section 129 (A) entitled the Koushi Toshikhana to administer the pension for civil servants and the police force. From 2061 B.S., a pension for the community school teachers was also initiated. In 1993, a Labor Code was developed requiring private sector employers to pay 50% of the wages for the sick and leave of up to 15 days each year, and the employer was required to employ at least one year continuously. In 1992, the Civil Servant Act was enacted which provided maternity leave of 60 days to women before or after birth for up to two children. The universal flat pension of Rs. 100 to all the elderly above 75 years was first announced in Nepal by the then Prime Minister of Nepal, Mr. Manmohan Adhikari (who led the Communist Party of Nepal- Unified Marxists and Leninists) on December 26, 1994. Five districts from the five development regions of Nepal were selected to pilot the scheme, and the first disbursement of the Old age Allowance Program (OAP) was made on July 2, 1995 for a six-month period from January to June. The implementation of the pilot project in five districts was carried out by the Ministry of Education and Sports and distributed at the grass-roots level by the Village Development Committees. During fiscal year, 1995-96, the OAP was extended to the entire country and was implemented by the Home Ministry. During 1995-96, Rs. 280 crores was released for the implementation of the program. Since 1996-97, the Ministry of Local Development has been administrating the OAP, and the allowances were distributed by the ward offices in the urban areas and VDCs in the rural areas. When the Nepali Congress came to power through a verdict of the electorate in 1996-97, it introduced two additional social security programs, namely the Helpless Widows Allowance for widows above 60 years of age and the disabled pension of Rs. 100 per month. In the International Year of Elderly Persons (1999), the ruling Nepali Congress raised the old age allowance from Rs. 100 to 150. Eligibility criteria: All Nepalese, men and women, who had completed 75 years of age and above were eligible for the pension. According to the directives issued by the Ministry of Local Development, the age mentioned in the Nepalese Citizenship Certificate is the basis for accessing the old age allowance. In 1996, the widow’s allowance and disability pension were introduced.
Chronological History of Social Security in Nepal:
• Army Provident Fund (Sainik Drabya Kosh) –1934 (BS 1991)
• Non Contributory Pension Schemes for Government Employees –1936 (BS 1993)
• Civil Servant Provident Fund –1944 (BS 2001)
• Employees Provident Fund –1962 (BS 2019)
• First appeared in planning documents in 1985.
• Citizen Investment Trust – 1990 (BS 2047)
• Social Security Allowance to Elder Citizen –1994 (BS 2051)
• Concept of Retirement Fund by Income Tax Act –2001 (BS 2058)
• Social Security Tax –2009 (BS 2066)
• Social Security Fund – 2009 (BS 2066)
Current Legal/Policy Framework of Social Security
• Constitution of Nepal – 2015 (BS 2072)
• Employees Provident Fund Act –1962 (BS 2019)
• Citizen Investment Trust Act – 1990 (BS 2047)
• Civil Servant Act – 1993 (BS 2049)
• Civil Servant Regulation – 1993 (BS 2049)
• Labor Act and Regulation – 1991/92 (BS 2048/49)
• Bonus Act – 1974 ( BS 2030)
• Income Tax Act –2001 (BS 2058)
• Senior Citizen Act – 2006 ( BS 2063)
Current Universal Social Security Schemes for Nepali Citizen from GoN
• Senior Citizen Allowance
• Widow Women Allowance
• Marginalized Citizen Allowance
• Full Differently Abled Citizen Allowance
• Partially Differently Abled Citizen Allowance
• Pregnant women who give child birth (in Govt. Hospital)
• Child Protection Allowance (Karnali Zone and Dalit (Lower Cast) of other Zone)
Provision of Law
Section 10 of Income Tax Act 2058 deals with amounts exempted from Tax:
The following amounts shall be exempted from tax:
(e) All kinds of allowances provided by the Government of Nepal, Provincial Government or Local Level as social security,
Taxation of Social Security Allowances
The position of the taxation on the allowances under Universal Social Security Schemes is pretty clear. These allowances are exempted under Section 10 of Income Tax Act 2058 so they will not be considered for taxation in any head of income. Neither any withholding taxes applies on these form of allowances.
Social Security Fund
Provision of Law
Social Security Fund discussed in blog post above is a contributory retirement fund. More on contributory and non-contributory retirement fund here. Contributory and Non Contributory Retirement Plan
An individual making contribution to an approved retirement fund is eligible to reduce the contribution amount (inlcuding the contribution made by both employer and employee) from their taxable income in a prescribed limit.
Rule 21 of Income Tax Rule 2059 states that: An individual who is a beneficiary of an approved retirement fund may reduce, as retirement contribution made to the fund, the lower of Rs. 300000 or one third of his assessable income from his taxable income. But, an individual who is a beneficiary of Social Security Fund established as per Contribution Based Social Security Act 2074 may reduce, as contribution made to the fund, the lower of Rs. 500000 or one third of his assessable income from his taxable income. Also, as per Section 63(1) of the Income Tax Act 2058, Social Security Fund is also an Approved Retirement Fund.
Meaning and Example:
Lets say, for an income year, An individual has Rs. “Z” assessable income and has contribution of Rs. “X” in ARF and Rs. “Y” in SSF (including both employer and employee). Either:
1. He can deduct minimum of (X+Y) OR (300000) OR (Z/3), or
2. He can deduct minimum of (Y) OR (500000) OR (Z/3)
Option 1 is beneficial if Y<300000 and Option 2 is beneficial if Y>300000.
There is also an addtional confusion in the market concerning if the contribution made by the employer into Social Security Fund is taxable at the hands of the employee at the point of contribution.
I my view the entire SSF plan is a contributory plan, hence, we can view the entire 20% contribution of employer to be the employer’s contribution on the contributory-social-security-plan of the employee. In this regard and in spirit of the meaning of contributory plan (in a contributory plan, the employee pays into the plan from their income) the amount of entire 20% SSF contribution should be treated as a part of employee’s income for the year and be taxed on normal slab basis.
The principle behind the contributory plan is, in a contributory plan there is a investment interest of employee in the amount deposited. The employer’s contribution of 20% is a payment as per the terms of employment which is deposited in schemes under Social Security Fund, which is essentially an addition in the investment amount of the employer in SSF. This increment in investment interest of the employer as per the terms of employment is hence an employment income. However, at the point of the distribution of the amount from the fund, it will be the disbursement of the interest of an employee in a retirement fund, thus, it will be treated in the form of investment income rather than employment income, the taxability of which has been discussed below.
Taxation of Benefits from Social Security Fund
Here it should be noted that the contribution made by the employer (20% of the Basic Salary) and employee (11% of the Basic Salary) will be utilized in various schemes of the Social Security Fund Program as follows:
- Medical, Health and Maternity Scheme (1%)
- Accident and Disability Scheme (1.4%)
- Dependent Family Security Scheme (0.27%)
- Old Age Scheme (28.33%)
However, even in between these four schemes, there are distinct difference between the first three schemes and the last one. Contributions made in Old Age Scheme is a type of contribution made into Retirement Fund. However, the contribution made in other funds (Medical, Health and Maternity Scheme; Accident and Disability Scheme; Dependent Family Security Scheme) constitutes a non-life insurance plan, in nature. Thus, their taxability will be different in the context of characterization as per Income Tax Act 2058. To be more precise here, an exception to Section 31 of Income Tax Act 2058, on Characterization of Compensation Payments provides that:
1. Compensation payments received by resident natural person in relation to the corporal (body) damage caused by personal accidents need not be included in the income.
2. Compensation payments received in relation to the death of a natural person need not be included in the income.
This provision intends to provide the exception that when the compensation is derived only as a result of the personal accident or death of an indivdual, then they need not be included in computation of income.
However, the payment made under Old Age Scheme will be treated as amount derived from approved retirement fund and its taxation will depend on the provision of the Income Tax Act 2058. As per Section 88(1)(1): 5% withholding is made on retirement payment gain (RPG) for retirement payment (RP) by GON or contributory retirement payment made by ARF. RPG = RP-MAX[500000,RP×50%]
Furthermore, as per Section 92(1)(Chha): RP made by GON/ARF/UARF and all other RP (except for regular pension received under pension scheme) are treated as payment made after final withholding taxation.
Umm. but these benefits are received from GoN, does it make sense to tax them?
Absence of Specific Exemptions
As discussed above, there are not any specific provision that exempts the taxation of the payment of the amount from the Old Age Scheme of the Social Security Fund. So taxes would be applicable. However, there still are concerns on how this amount will be taxed?
1. Since the Old Age Scheme operates as an Pension Plan will the gain amount be spread over the disbursement period and taxed at the point of pension disbursement? OR
2. Will the amount under Old Age Scheme be taxed at the point of contributor being eligible to receive this amount as a lumpsum amount or pension?
Relevant Case Law
There always is a concern on taxation on the disbursements received from GoN or under the plan of GoN. A writ petion was filed by Nepal Pensioners’ Association contending that the amount derived as persion from GoN or its plans/fund itself being a contribution from GoN, should not be taxable at the hands of the servicemen who served thier public duties during their working period. However, this sentiment was not upheld by Suprement Court’s Special Bench. Nepal Pensioners’ Association Writ Petition