Direct Tax

A direct tax is a tax that individuals pay directly to the government. Examples include income tax, property tax, and land tax. The amount of direct tax is based on the taxpayer’s ability to pay, meaning that those with higher incomes will pay a larger share of the tax burden, while those with lower incomes will pay a smaller share. This ensures that taxpayers with greater financial resources contribute more in taxes compared to those with less income.

A direct tax is not transferable to another person, meaning that the companies or individuals to whom the tax is applied are responsible for paying it themselves.

What are the features of direct tax?

1) Direct Payment:

The tax is directly calculated from an individual’s income or property like income tax.

2) Transferability

Direct tax cannot be transferred to another person like indirect tax. If an individual is earning, he or she must pay the tax.

3) Ability to pay:

Those who do not have the ability to pay are exempt from taxes, but those who are earning and capable of paying taxes are required to do so.

4) Progressive Nature:

Often, direct taxes are progressive, meaning that the tax rate increases as the taxable amount, such as income or property value, increases. This ensures a fair distribution of the tax burden.

What are the types of Direct Tax?

1) Income Tax:

Income tax is imposed on individuals and businesses based on the income they generate over a month or year. The amount of tax owed is determined by government-established tax brackets. Taxpayers are required to file an Income Tax Return annually. Failure to file an income tax return can result in significant penalties.

2) Wealth Tax:

Wealth tax is paid annually by individuals who own property. Even if no income is generated from the property, the owner is still required to pay tax on the ownership.

3) Corporate tax:

Domestic companies, in addition to their shareholders, are required to pay corporate tax. Foreign corporations that generate income in Nepal must also pay corporate tax. Income earned from selling assets, technical service fees, dividends, royalties, or interest originating in India is taxable.

4) Capital Gain Tax:

Capital gains tax is levied on the profit generated from the sale of assets such as stocks, bonds, real estate, mutual funds, and other investments. The tax rate varies depending on whether the investment is held for the long term or short term, as well as the type of asset being sold.

5) Securities Transaction Tax:

The securities transaction tax is imposed on the purchase and sale of stocks, bonds, mutual funds, and derivatives from authorized markets.

6) Dividend Distribution Tax:

This levy is imposed on dividends distributed by companies to their shareholders. Dividend income is added to the recipient’s taxable income and taxed according to the applicable slab rate.

7) Entitlement Tax:

This form of direct tax is the basis for funding Social Security benefits. The entitlement tax is collected through deductions from payrolls.

8) Fringe Benefit Tax:

Fringe benefits tax (FBT) is a tax that employers pay on specific benefits provided to their employees, or to the family or other associates of their employees.
• motor vehicles available for private use
• low interest/interest-free loans
• free, subsidized or discounted goods and services
• employer contributions to sick, accident, or death benefit funds, superannuation schemes, and specified insurance policies

What are the advantage of direct tax?

1) Promotes equality

In direct taxation, everyone is required to pay a certain tax based on the income they earn, ensuring it is equitable for all.

2) Economical:

The direct tax system has a low cost of collection, as most taxes are deducted “at the source.” For example, income tax is deducted monthly from an employee’s salary. This method reduces administrative expenses, resulting in a higher percentage of tax revenue being collected.

3) Certainty:

The government has established tax rates and payment schedules for individuals. As a result, individuals are aware of how much tax they need to pay and when it is due.

4) Elasticity:

Taxes are a primary source of revenue for the government, so changes in government revenue can directly impact the amount of taxes we have to pay.

5) Productive:

Direct tax is a primary source of revenue for any government, enabling it to implement various measures to promote the country’s growth and productivity.

What are the disadvantages of direct tax?

1) Potential of tax evasion

The complexity of calculating direct taxes makes it easier for individuals to evade them. Additionally, since both individuals and businesses are required to declare their taxes, there is a significant risk of tax evasion.

2) Impact on Savings

Higher direct taxes discourage savings, which negatively impacts the country’s economy. Elevated tax levels also directly affect investment and entrepreneurship.

3) Arbitrary

If taxes are progressive, the rate of progression must be set arbitrarily; if they are proportional, they disproportionately burden the poor.

What is tax system in Nepal?

Taxes are levied under the provisions of the Income Tax Act 2002, which mandates the imposition and collection of taxes on company income. Resident companies are taxed on their worldwide income, while non-residents must pay tax on their net income earned or sourced in Nepal. The tax is applied to net income after deductions for specific expenses and allowances as specified in the ITA.

What is income tax rate for single and couple in Nepal?

Tax Banding	Tax Rate
Unmarried Person	2023-24 (FY 2080-81)		2022-23 (FY 2079-80)
(a) Band 1	First 500,000	1%*	First 500,000	1%*
(b) Band 2	Next 200,000	10%	Next 200,000	10%
(c) Band 3	Next 300,000	20%	Next 300,000	20%
(d) Band 4	Next 1,000,000	30%	Next 10,00,000	30%
(e) Band 5	Next 3,000,000	36%**	Remaining above 2,000,000	36%**
(f) Additional Tax	Remaining above 5,000,000	39%***
Married Person
(a) Band 1	First 600,000	1%*	First 600,000	1%*
(b) Band 2	Next 200,000	10%	Next 200,000	10%
(c) Band 3	Next 300,000	20%	Next 300,000	20%
(d) Band 4	Next 9,000,000	30%	Next 9,000,000	30%
(e) Band 5	Next 3,000,000	36%**	Remaining above 2,000,000	36%**
(f) Additional Tax	Remaining above 5,000,000	39%***

What are deductions to be made form income tax in Nepal?

A. Deductions on Income	Remarks
Natural persons working in remote areas are entitled to Remote Area Allowance	Additional deduction from taxable amount up to Rs 50,000. (A-50,000, B-40,000, C- 30,000, D-20,000, E-10,000).
A natural person with pension income included in the taxable income	An additional deduction equal to 25% of the amount prescribed under the first tax band or actual pension receipts, whichever is lower shall be allowed from taxable income.
Incapacitated natural person	Additional deduction from the taxable amount equal to 50% of the amount prescribed under the first tax band or actual income whichever is lower.
B. Reduction in Income
Life insurance premium	A natural person who has procured life insurance and paid the premium amount thereon shall be entitled to a deduction from the taxable income the lower of the actual annual insurance premium or Rs 40,000.
Medical insurance	A natural person who has been insured with a resident insurer/insurance company for health insurance shall be entitled to a deduction from the taxable income the lower of the actual premium paid or Rs 20,000.
Insurance of private building	A resident natural person who has insured a private building in his/her ownership with a resident insurer/insurance company shall be entitled to a deduction of the actual annual premium paid for such insurance or Rs 5,000 whichever is lower.

What are the biggest challenge of Direct Tax in Nepal?

1. Tax Evasion and Avoidance

– Informal Economy: Difficulty in tracking and collecting taxes due to a large informal sector.
– Underreporting: Common underreporting of income and profits in the formal sector.

2. Administrative Inefficiency

– Limited Resources: Insufficient skilled workers and modern equipment.
– Bureaucratic Obstacles: Complex and outdated tax laws leading to inefficiency and corruption.

3. Compliance Issues

– Lack of Awareness: Many taxpayers are unaware of their tax obligations.
– High Compliance Costs: Expensive and time-consuming tax filing processes deter compliance.

4. Political and Policy Instability

– Frequent Changes: Inconsistent tax laws hinder compliance and business planning.
– Political Influence: Tax policy and enforcement can be undermined by political pressures.

5. Economic Challenges

– Low-Income Levels: Small taxable base due to widespread poverty.
– Agricultural Dependency: The large subsistence farming sector is often untaxed.

6. Taxpayer Trust and Perception

– Mistrust in Government: Doubts about tax dollar usage discourage payment.
– Perception of Inequality: Belief in an unfair tax system reduces compliance.

7. Technological Constraints

– Outdated Systems: Lack of modern technology for effective tax management.
– Cybersecurity Risks: Ensuring data security become

Difference between Direct Tax and Indirect Tax

Aspect	Direct Taxes	Indirect Taxes
Definition	Levied directly on income, wealth, or property	Levied on goods and services
Examples	Income Tax, Property Tax, Wealth Tax	VAT, Sales Tax, Excise Duty, Customs Duty
Collection Method	Collected directly from the taxpayer	Collected by intermediaries from consumers
Burden	Borne by the taxpayer	Borne by the consumer
Impact on Taxpayer	Cannot be shifted to another party	Can be shifted to consumers through higher prices
Administrative Costs	Higher, due to detailed records and individual assessments	Lower, integrated into existing sales processes
Equity	Typically progressive (higher rates for higher incomes)	Typically regressive (higher burden on lower-income individuals)
Visibility	More visible to the taxpayer	Less visible, included in the price of goods/services
Progressiveness	Generally progressive	Generally regressive
Compliance Requirements	Higher compliance and administrative requirements	Lower compliance requirements
Examples of Use	Income redistribution, funding public goods and services	Encouraging or discouraging consumption of specific goods (e.g., tobacco, alcohol)