Taxation
Business Studies — Grade 11 | Chapter 7 | NEB Nepal
Contents
Introduction
In every functioning society, governments must raise revenue to finance public goods and services — roads, schools, hospitals, security, courts, and the administrative infrastructure without which modern economic life would be impossible. Taxation is the primary mechanism through which governments collect this revenue. For businesses, taxes are both a legal obligation and an economic reality that shapes profitability, pricing, investment decisions, and competitive strategy.
Chapter 7 of NEB Grade 11 Business Studies introduces students to the concept of taxation in the business context. It covers what tax is, why it exists, the major types of tax — direct and indirect — and the specific mechanism of the Permanent Account Number (PAN), which is the gateway through which every business and individual formally enters Nepal’s tax system.
Understanding taxation is not merely an academic requirement for NEB students — it is a practical necessity for every Nepali entrepreneur, employee, and citizen. As Benjamin Franklin famously observed, “In this world, nothing is certain except death and taxes.” In Nepal’s developing economy, where tax compliance is essential for funding public services and reducing dependence on foreign aid, every business that understands and fulfils its tax obligations contributes to national development.
1. Introduction to Tax in Business
1.1 Concept of Tax
A tax is a compulsory financial contribution levied by the government on individuals, businesses, and transactions, without any direct and specific benefit in return, for the purpose of funding public expenditure and achieving social and economic objectives.
According to Philip E. Taylor, “Taxes are compulsory payments to the government without expectation of direct benefit to the taxpayer.”
According to Seligman, one of the most cited authorities on public finance, “A tax is a compulsory contribution from a person to the government to defray the expenses incurred in the common interest of all, without reference to special benefits conferred.”
According to Dalton, “A tax is a compulsory contribution imposed by a public authority irrespective of the exact amount of service rendered to the taxpayer in return.”
According to Bastable, “A tax is a compulsory contribution of the wealth of a person or body of persons for the service of the public powers.”
According to the Income Tax Act, 2058 BS of Nepal, tax is defined as the amount payable to the government by a natural person, entity, or partnership as a proportion of their taxable income, as determined by law.
Several key features emerge from these definitions:
i. Compulsory: Unlike voluntary contributions or charitable donations, tax payment is legally obligatory. Failure to pay attracts penalties, interest, and legal action.
ii. No Direct Quid Pro Quo: A taxpayer does not receive a specific, direct benefit proportional to the tax paid. Rather, taxes fund collective public goods — roads, defence, health, education — from which all citizens benefit generally.
iii. Imposed by Public Authority: Only governments — national, provincial, or local — have the legal authority to levy taxes. Private individuals or organizations cannot impose taxes.
iv. For Public Purpose: Taxes are used for the common benefit of society — not for the personal gain of government officials or to benefit specific individuals.
1.2 Objectives of Taxation
According to Adam Smith, in his classic work The Wealth of Nations (1776), taxes should serve the following objectives — captured in his famous Four Canons (Maxims) of Taxation:
i. Canon of Equality (Equity): “The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities.” Tax burdens should be distributed fairly — those with greater ability to pay should contribute more.
ii. Canon of Certainty: “The tax which each individual is bound to pay ought to be certain and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor.” Taxpayers must know in advance exactly what they owe, when it is due, and how to pay.
iii. Canon of Convenience: “Every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenient for the contributor to pay it.” Taxes should be collected in ways that minimize inconvenience — for example, income tax deducted at source from salaries.
iv. Canon of Economy: “Every tax ought to be so contrived as both to take out and to keep out of the pockets of the people as little as possible, over and above what it brings into the public treasury.” The cost of collecting a tax should be far less than the revenue it raises.
Beyond Smith’s canons, modern tax systems also pursue:
v. Revenue Generation: The most basic objective — raising sufficient funds to finance government expenditure.
vi. Economic Regulation: Taxes can be used to discourage harmful behaviours (high taxes on tobacco, alcohol) or encourage beneficial ones (tax exemptions for investment in renewable energy or rural areas).
vii. Redistribution of Income: Progressive taxation — where tax rates rise with income — transfers resources from higher-income to lower-income groups, reducing inequality.
viii. Protection of Domestic Industry: Import duties (customs) can protect nascent domestic industries from foreign competition until they are strong enough to compete on their own.
1.3 Importance of Taxation for Business
i. Funds Public Infrastructure: Businesses depend on public roads, power grids, communication networks, water supply, and courts. These are funded by taxes. According to John Maynard Keynes, “The engine of capitalism runs on public goods — infrastructure, education, law — that only government can provide and only taxes can fund.”
ii. Shapes Business Decisions: Tax rates and incentives directly influence where businesses invest, how they finance operations, whether they expand or contract, and how they structure transactions. Tax planning — the legal arrangement of business affairs to minimize tax liability — is a major function of corporate financial management.
iii. Levels the Playing Field: When enforced fairly and consistently, tax law prevents businesses that evade taxes from gaining an unfair competitive advantage over those that comply honestly.
iv. Determines Cost Structure: For businesses, taxes — corporate income tax, VAT, customs duties, payroll taxes — are direct costs that affect profitability. Understanding tax obligations is essential for accurate financial planning.
v. Access to Government Services: A business registered for PAN and compliant with tax obligations has access to government procurement contracts, bank financing, and formal trade channels. Tax compliance is a gateway to the formal economy.
2. Types of Tax
Taxes are broadly classified into two major categories: Direct Taxes and Indirect Taxes. This is the most important classification in the NEB syllabus, and NEB examinations regularly ask students to explain, compare, and give examples of each.
2.1 Direct Tax
A direct tax is a tax levied directly on a person or entity — the person or entity on whom it is imposed is also the person who actually bears the burden of the tax. Direct taxes cannot be shifted to another party.
According to Dalton, “A direct tax is one which is demanded from the very persons who it is intended or desired should pay it.”
According to Seligman, “Direct taxes are those which are assessed on and paid by the same person or institution.”
According to J.S. Mill, “A direct tax is one which is demanded from the very persons who, it is intended or desired, should pay it.”
Key characteristics of direct taxes:
- The impact (who pays the tax) and incidence (who bears the burden) fall on the same person
- They are generally progressive — rates increase with the taxable base
- They are assessed periodically (usually annually)
- They require the taxpayer to file a return with the tax authority
- They are difficult to evade but also difficult to avoid entirely
Major Direct Taxes in Nepal (under the Income Tax Act, 2058 BS):
i. Income Tax on Individuals (Personal Income Tax) Levied on the taxable income of natural persons — salaries, business income, rental income, dividends, and capital gains. Nepal uses a progressive tax rate structure:
| Annual Income (Rs.) | Tax Rate (approximate) |
|---|---|
| Up to 5,00,000 | 1% |
| 5,00,001 – 7,00,000 | 10% |
| 7,00,001 – 20,00,000 | 20% |
| 20,00,001 – 50,00,000 | 30% |
| Above 50,00,000 | 36% |
(Note: These are illustrative; students should verify current rates with the Inland Revenue Department as rates are revised annually in the Budget.)
ii. Corporate Income Tax Levied on the taxable income (profits) of companies and other corporate entities registered in Nepal. The standard corporate tax rate in Nepal is 25% for most businesses, with reduced rates for specified sectors (manufacturing at 20%, special industries, exports) and higher rates for banks, financial institutions, insurance companies, and petroleum businesses.
iii. Tax on Dividends Dividends paid by companies to shareholders are subject to withholding tax at source — the company deducts tax before distributing dividends. The recipient shareholder receives the after-tax dividend.
iv. Capital Gains Tax Profits arising from the sale of business assets, shares, or property are subject to capital gains tax. The rate varies depending on the nature of the asset and the holding period.
v. House and Land Tax (Property Tax) Levied on the value of land and buildings owned. Collected by local governments (municipalities and rural municipalities) under Nepal’s federal structure.
Advantages of Direct Taxes:
- Equitable — higher burden on those with greater ability to pay (progressive)
- Certain — taxpayers know exactly what they owe
- Elastic — government can raise rates to increase revenue in emergencies
- Reduces income inequality
Disadvantages of Direct Taxes:
- Tax evasion is common — particularly among the self-employed and informal sector
- Can discourage savings and investment if rates are very high
- Complex — requires elaborate assessment, filing, and enforcement mechanisms
- Can be unpopular and politically contentious
2.2 Indirect Tax
An indirect tax is a tax levied on goods and services (transactions) rather than directly on persons or income. The person who initially pays the tax (the seller or producer) passes it forward to the buyer through higher prices. The ultimate bearer of the tax is the final consumer.
According to Dalton, “An indirect tax is one which is demanded from one person in the expectation and intention that he shall indemnify himself at the expense of another.”
According to Seligman, “Indirect taxes are those which are assessed on one person but paid partly or wholly by another.”
According to John Stuart Mill, “Taxes on commodities are indirect. They are paid, in the first instance, by the producer or dealer but are ultimately paid by the consumer.”
Key characteristics of indirect taxes:
- Impact (who pays the tax) and incidence (who bears the burden) fall on different persons
- They are generally regressive — poor people spend a higher proportion of their income on goods and therefore bear a relatively greater burden
- They are collected at the point of sale or production, not through annual returns
- They are easy to collect but can be passed on to consumers in the form of higher prices
- They affect all consumers regardless of income level
Major Indirect Taxes in Nepal:
i. Value Added Tax (VAT) VAT is the most important indirect tax in Nepal. It is a consumption tax levied on the value added at each stage of production and distribution. Ultimately, the entire VAT burden falls on the final consumer.
According to the Value Added Tax Act, 2052 BS of Nepal, VAT is levied at a standard rate of 13% on the supply of taxable goods and services in Nepal, and on imports.
How VAT works:
- A manufacturer buys raw materials worth Rs. 100, paying Rs. 13 VAT (total Rs. 113)
- The manufacturer processes them into a product worth Rs. 200 and charges Rs. 26 VAT (Rs. 200 × 13%)
- The manufacturer pays the government Rs. 13 (Rs. 26 collected minus Rs. 13 paid as input tax credit)
- The chain continues until the final consumer pays VAT with no further recovery
This input tax credit mechanism prevents cascading (tax on tax) and ensures that VAT is ultimately borne only by the final consumer.
VAT registration is compulsory in Nepal for businesses whose annual turnover exceeds Rs. 50 lakhs (Rs. 5,000,000) for goods, or Rs. 20 lakhs (Rs. 2,000,000) for services. VAT-registered businesses must file monthly VAT returns with the Inland Revenue Department (IRD).
ii. Customs Duty Customs duty is levied on goods imported into or exported from Nepal. It serves dual purposes — revenue generation and protection of domestic industries. Import duties are specified in Nepal’s Customs Tariff, which categorizes thousands of products with different duty rates.
Given Nepal’s landlocked geography, customs duty collection at border points (primarily Birgunj, Biratnagar, Bhairahawa, and Kakarbhitta) is a major source of government revenue. Nepal’s trade with India is governed by the India-Nepal Trade Treaty, which provides for preferential treatment of many products.
iii. Excise Duty Excise duty is levied on the production of specific goods within Nepal — particularly alcohol, tobacco, petroleum products, vehicles, and other specified items. Manufacturers pay excise duty at the factory gate before goods enter the distribution chain.
According to the Excise Duty Act, 2058 BS of Nepal, excise serves both revenue and regulatory purposes — high excise on tobacco and alcohol is intended to discourage consumption of these harmful products.
iv. Entertainment Tax Levied on cinemas, concerts, sports events, and other entertainment activities. Collected by local governments.
Comparison: Direct Tax vs. Indirect Tax
| Basis | Direct Tax | Indirect Tax |
|---|---|---|
| Definition | Levied on income/wealth | Levied on goods/services |
| Impact & Incidence | Same person | Different persons |
| Shifting | Cannot be shifted | Shifted to consumers |
| Nature | Generally progressive | Generally regressive |
| Collection | Annual returns | At point of transaction |
| Examples in Nepal | Income tax, corporate tax | VAT, customs, excise |
| Visibility | Clearly visible | Often hidden in price |
| Effect on equality | Reduces inequality | May increase inequality |
3. PAN: Concept, Registration Process in Nepal
3.1 Concept of PAN
PAN stands for Permanent Account Number. It is a unique numerical identifier assigned by the Inland Revenue Department (IRD) to every taxpayer — individual, business, organization, or other entity — in Nepal. The PAN is the foundation of Nepal’s tax administration system: it links all of a taxpayer’s economic activities, tax filings, and payment records in a single, traceable identity.
According to the Income Tax Act, 2058 BS and the Value Added Tax Act, 2052 BS of Nepal, every person or entity conducting business in Nepal is required to obtain a PAN before commencing operations.
According to the Inland Revenue Department of Nepal (IRD), “The Permanent Account Number is a unique identification number that enables the tax authority to maintain a comprehensive record of all taxable transactions, income, and compliance activities of each taxpayer.”
The PAN system in Nepal was introduced as part of the broader tax reform agenda to widen the tax base, improve compliance, and bring more of Nepal’s large informal economy into the formal tax system.
3.2 Importance and Uses of PAN
PAN is not merely a tax identifier — it serves as a universal business and financial identity number:
i. Tax Filing and Payment: All income tax returns, VAT returns, and tax payments are filed and tracked under the PAN. Without PAN, a business cannot formally submit tax documents.
ii. Business Registration: PAN is required for company registration at the Office of the Company Registrar (OCR), registration of firms and partnerships, and licensing by sector-specific regulators.
iii. Banking and Financial Transactions: Banks and financial institutions require PAN for opening business accounts, applying for loans, making large transactions, and issuing financial instruments.
iv. Government Procurement: All businesses bidding for government contracts must have a valid PAN. The PAN ensures that contractor payments are linked to the tax system.
v. Customs and Import/Export: Importers and exporters must present PAN at customs clearance. This links trade data to tax records.
vi. Property Transactions: Sale and purchase of land, buildings, and other immovable property requires PAN registration of both parties — linking real estate transactions to the tax system and preventing undisclosed wealth accumulation.
vii. Employment: Employers in the formal sector record employees’ PAN numbers and use them to remit salary withholding tax on behalf of employees.
viii. Prevention of Tax Evasion: The PAN system creates an auditable trail of transactions, making it significantly harder for businesses and individuals to conceal income or engage in tax evasion.
3.3 PAN Registration Process in Nepal
PAN registration in Nepal is administered by the Inland Revenue Department (IRD) through its offices (Tax Service Offices — TSOs) located in major cities and district headquarters across Nepal. Online registration is also available at irdonline.gov.np.
Documents required for PAN registration:
For Individual / Sole Trader:
- Citizenship certificate of the applicant
- Passport-size photographs
- Business registration certificate (if a registered firm)
- Proof of business address (rental agreement or land ownership document)
- Contact details (phone number, email address)
For Partnership Firm:
- Partnership Deed (registered with the Department of Industry)
- Citizenship certificates of all partners
- Firm registration certificate
- Proof of business address
For Private/Public Limited Company:
- Certificate of Incorporation from the Office of the Company Registrar (OCR)
- Memorandum of Association (MOA) and Articles of Association (AOA)
- Citizenship certificates of directors/shareholders
- Board resolution authorizing PAN application
- Proof of registered office address
For Cooperative:
- Cooperative registration certificate
- By-laws of the cooperative
- Citizenship certificates of office bearers
Step-by-Step PAN Registration Process:
Step 1: Collect and prepare all required documents as listed above.
Step 2: Fill in the PAN Registration Form (Form IR-1 for individuals/firms, Form IR-2 for companies and organizations). This can be done online at irdonline.gov.np or in person at the nearest Tax Service Office (TSO).
Step 3: Submit the completed form along with all supporting documents to the relevant TSO (generally, the TSO of the district where the business is located).
Step 4: The IRD verifies the submitted documents. If all documents are in order, the PAN is issued — typically within the same day or within a few working days.
Step 5: The applicant receives a PAN Certificate containing:
- The unique PAN number (a 9-digit number in Nepal)
- Name of the taxpayer
- Business address
- Nature of business
- Date of registration
Step 6: For businesses that are VAT-eligible (turnover exceeding VAT threshold), a separate VAT Registration (Form VAT-01) must also be completed. In many cases, PAN and VAT registration are processed simultaneously.
Step 7: Maintain the PAN certificate and use the PAN number in all tax filings, business registrations, banking, and formal transactions.
3.4 Renewal and Modification of PAN
PAN in Nepal is a permanent number — once assigned, it does not expire and does not need to be renewed. However, taxpayers must:
- Update the IRD if there are changes to business address, nature of business, or ownership
- File annual tax returns using the PAN even in years where no taxable income is earned (nil returns may be required)
- Cancel the PAN with the IRD when the business ceases operations (deregistration)
3.5 Consequences of Not Having PAN
Operating a business without a PAN in Nepal is a violation of the Income Tax Act and VAT Act. Consequences include:
- Inability to access formal banking facilities
- Exclusion from government procurement and contracts
- Legal penalties and fines imposed by the IRD
- Potential criminal prosecution for persistent non-compliance
- Inability to legally import or export goods
- Exclusion from formal investment opportunities and credit markets
4. Tax Administration in Nepal
4.1 Inland Revenue Department (IRD)
The Inland Revenue Department (IRD) under the Ministry of Finance is Nepal’s primary tax authority responsible for the administration, assessment, collection, and enforcement of direct and indirect taxes at the federal level. The IRD manages income tax, corporate tax, VAT, and excise duty.
4.2 Customs Department
The Customs Department under the Ministry of Finance administers customs duties on imported and exported goods at border points and international airports.
4.3 Provincial and Local Tax Authorities
Under Nepal’s federal structure established by the Constitution of Nepal, 2072 BS, provinces and local governments (municipalities and rural municipalities) have independent powers to levy certain taxes — house and land tax, entertainment tax, vehicle tax, and advertisement tax, among others.
4.4 Tax Treaties
Nepal has signed Double Taxation Avoidance Agreements (DTAAs) with several countries — India, China, Norway, Sri Lanka, Austria, and others — to prevent the same income from being taxed twice (once in Nepal and once in the other country). DTAAs are important for businesses engaged in international trade, investment, and cross-border services.
5. Tax Planning, Tax Avoidance, and Tax Evasion
Understanding the distinction between legitimate tax planning, legal tax avoidance, and illegal tax evasion is important for business students:
Tax Planning: The legal arrangement of business affairs to minimize tax liability within the letter and spirit of the law. According to the Supreme Court of India in CIT vs. A. Raman & Co. (1968), “A taxpayer is entitled to arrange his affairs so as to reduce his liability to tax as much as possible.” Tax planning is not only legal — it is prudent financial management.
Tax Avoidance: The legal but aggressive use of tax rules to reduce tax liability in ways that technically comply with the law but exploit loopholes or inconsistencies in a manner not intended by lawmakers. While technically legal, aggressive tax avoidance is increasingly seen as ethically problematic. According to the OECD, Base Erosion and Profit Shifting (BEPS) — used by multinational companies to avoid tax in high-tax countries — represents “a serious risk to tax revenues, tax sovereignty, and tax fairness.”
Tax Evasion: The illegal non-payment or underpayment of tax through concealing income, falsifying records, or misrepresenting transactions. Tax evasion is a criminal offence in Nepal under the Income Tax Act, 2058 BS and the VAT Act. It deprives the government of revenue needed for public services and is fundamentally unethical — violating the social contract.
According to Keynes, “The avoidance of taxes is the only intellectual pursuit that still carries any reward.” This witty observation captures the reality that tax minimization is rational economic behaviour — but there is a crucial ethical and legal line between minimization (planning and avoidance) and evasion.
6. Taxation in the Nepali Business Context
Nepal’s tax system has undergone significant reform over the past two decades, driven by revenue mobilization needs and the transition to federalism:
i. Revenue Dependence: Nepal’s government budget relies heavily on tax revenue — particularly VAT, customs duties, and income taxes — supplemented by foreign aid and loans. Improving tax compliance is a national priority.
ii. Informal Economy Challenge: A large proportion of Nepal’s economic activity — particularly in agriculture, small trade, and domestic services — occurs in the informal sector outside the tax net. Expanding PAN registration and bringing informal businesses into the formal tax system is a major challenge for the IRD.
iii. Federal Tax Structure: Nepal’s 2072 BS Constitution established a federal structure with three tiers of government — federal, provincial, and local — each with defined taxing powers. This has created both opportunities (local revenue mobilization) and challenges (coordination and preventing double taxation across levels).
iv. Digital Tax Administration: The IRD has been progressively introducing digital systems — online filing, electronic payment, and data analytics — to improve efficiency, reduce corruption, and widen the tax base. The IRD Online portal (irdonline.gov.np) is central to this effort.
v. Tax Incentives for Priority Sectors: Nepal’s tax laws provide incentives — reduced rates, exemptions, and deductions — for investment in priority sectors: manufacturing, hydropower, tourism, export industries, Special Economic Zones (SEZs), and businesses operating in remote areas. Understanding these incentives is important for entrepreneurs making investment decisions.
Conclusion
Taxation is the financial backbone of every modern state. Without tax revenue, governments cannot build roads, run schools, operate hospitals, maintain security, or administer justice. For businesses, tax is both a cost and a civic duty — a contribution to the society that provides the infrastructure, legal system, educated workforce, and stable governance that makes business possible.
According to Oliver Wendell Holmes Jr., Associate Justice of the US Supreme Court, “Taxes are what we pay for a civilized society.” This insight holds as true for Nepal as anywhere else. A business that honestly pays its taxes is not merely complying with the law — it is investing in the social and physical infrastructure on which its own prosperity depends.
For NEB Grade 11 students, Chapter 7 equips them not just with exam knowledge but with practical financial literacy. Understanding direct and indirect taxes, the VAT system, and the PAN registration process are skills that every Nepali entrepreneur, employee, and citizen needs to navigate the formal economy successfully and responsibly.
Prepared for NEB Grade 11 Business Studies — Chapter 7: Taxation Aligned with the National Curriculum Framework 2076, Curriculum Development Centre, Sanothimi, Bhaktapur
