-This article was originally published by Ashesh Shrestha in The Himalayan Times on April 2, 2017.
Tax regime plays a crucial role in an enterprise’s decision regarding formalization of business. The more complex the tax system, the more difficult it is to comply with tax laws. Thus, tax regime plays an important role in determining the size of the informal economy. Nepal itself houses large informal micro enterprises; and a look into the Nepalese tax regime can provide us some insight to understanding why it is such. Recognizing this, the new Industrial Enterprise Act, 2016 also has provisioned to provide an income tax exemption to the micro enterprises for a period of five years starting from the date of operation to incentivise them to come into the formal sector. It is however also crucial that the tax regime be simple and facilitative post any kind of grace period. It seems that we need to do some more homework still, on this end.
Various forms of income based taxes
There exist three types of income based taxes in Nepal. The first one is the income tax to be paid on installment basis. This system of taxation requires the micro entrepreneurs to deposit the tax amount of a fiscal year in three installments. The entrepreneurs have to estimate their annual income and deposit prescribed tax amount in installments. The other system of income tax is Presumptive tax system under which a sole-proprietor has to submit the details of his/her annual transaction and income at the end of the fiscal year, and upon meeting the criteria, s/he has to pay certain amount depending on location of business. Another system of tax is the turnover tax where an entrepreneur’s tax liability is ascertained on the basis of annual turnover of business.
Problems within each tax system
First of all, let us look into the installment based tax system. The problem with this system of taxation is that it requires the entrepreneur to visit the tax office multiple times. The entrepreneur has to submit the estimated amount of income and tax amount every time through self-assessment. Additionally, auditor examined Balance sheet, Profit & Loss statement, Business cash-flow, Accounting policy and Audit report are also mandatorily required during tax filing installments. All these works are cumbersome and require time and a lot of effort. Often times, micro entrepreneurs lack the required skill sets to comply with these regulations. These can therefore easily discourage micro entrepreneurs.
The presumptive and turnover taxes are relatively easy to comply with, compared to the installment-based tax system. The entrepreneur only has to submit the details of the transaction and income annually in the case of presumptive tax and semi-annually in the case of turnover tax by filling up a prescribed form. No other documents such as audit report, Balance sheet, Profit & Loss statement etc. are required. However, these systems of tax are only applicable to sole-proprietor enterprises. If the micro enterprises are of partnership category, they will mandatorily have to go for installment-based tax. Therefore, even though the aim of these tax systems has been claimed to facilitate the compliance and payment of taxes to the micro and small enterprises, the partnership enterprises of this category have been ostracized, thus breaching their main purpose.
Problems with the tax system as a whole
Due to the existence of various forms of income taxes and systems of payment, it is difficult for micro entrepreneurs to comprehend the tax regime wholly. They might not be able to figure out the tax system that they have to comply with. Furthermore, it is not tenable for them to spend time to read and understand all these laws as it increases their cost (by way to having to forgo business while they spend time trying to understand the laws).
Also, as the enterprises get bigger, they will have to move to the installment-based tax system, requiring them to pay taxes on three installments and requiring them to submit all necessary documents as aforementioned. This works as an additional burden to the enterprises and might work as a disincentive to grow as well.
The Industrial Enterprise Act, 2016 has provision of providing income tax exemption to the micro enterprises for a period of five years. However, the authority responsible for implementation of this provision is the tax authority, which follows the Finance Act and Income Tax Act, and implements the provisions as per these Acts. As there is no provision of providing income tax exemption to the micro entrepreneurs in these Acts till now, it is very unlikely that micro entrepreneurs will get the income tax exemption. This type of disharmony in laws can create confusions among the micro entrepreneurs. The result, oftentimes, then is that informal micro-entrepreneurs choose to stay that way, instead to formalizing and increasing the compliance burden for themselves.
Firstly, it would be much easier for the entrepreneurs if there were a single system of taxation that is easy to understand. A flat income system can be a very effective measure to do so as it is easier to calculate the tax to be paid by the enterprises of any income category. Furthermore, a flat tax system also does not discourage the entrepreneurs from growing. It will also be much more efficient from administrative perspective as the administrator will not have to look into all details of the enterprises, categorize them and make them understand these different systems of taxation and the category in which they fall. Thus, it will be efficient and easy for both entrepreneurs and the administrators.
Policy harmonization is another current necessity. The cause of this disharmony is the lack of co-ordination among concerned government agencies; in the case of income tax exemption, the lack of co-ordination between the Ministry of Industry and Ministry of Finance. This has hindered smooth and proper implementation of the policy.