Income Tax Act, Rules & Current Finance Act

At a Glance

This Highlight explains how Nepal’s income-tax framework applies to employment income, employee benefits, and payroll withholding. It outlines key compliance considerations for HR, payroll, finance, and management teams, including tax deductions, recordkeeping, and cross-border employment. It should be read together with related labour, tax, social-security, immigration, corporate and sector rules where applicable.

Why This Matters

Understanding payroll tax requirements helps employers ensure accurate tax deductions, maintain proper records, and meet their legal obligations while supporting employees in understanding their tax responsibilities.

Major Provisions / Issues to Understand

1. Employment income and taxable benefits (Section 8)

Section 8 computes employment income as the remuneration a person derives from employment in the income year, and Section 8(2) sweeps in cash and non-cash benefits beyond base salary — allowances, facilities and benefits-in-kind are generally taxable unless a specific exclusion applies. HR should treat any new pay component (housing, vehicle, insurance top-up, etc.) as taxable by default and confirm an exclusion applies, rather than assuming it is tax-free because it isn’t called “salary.”

2. Allowances, perquisites and reimbursements (Section 8(3))

Section 8(3) lists amounts excluded from computing taxable remuneration — broadly, genuine reimbursement of actual expenses the employee incurred on the employer’s business (not a fixed allowance) falls outside taxable income, while a flat allowance paid regardless of actual spend generally does not. HR should keep the distinction in the expense policy itself: reimbursement against receipts is treated differently from a fixed monthly allowance, and the payroll system needs to tag each pay component accordingly rather than lumping all non-salary payments together.

3. Resident/non-resident employee analysis (Section 3)

Section 3 sets the residency test (commonly a 183-day-in-a-12-month-period presence test for individuals, among other criteria) that determines whether an employee is taxed on worldwide income (resident) or only Nepal-source income (non-resident). HR should run this test per employee per tax year, not once at hire — an expatriate’s residency status can change mid-assignment and shift both the applicable rate schedule and the withholding treatment.

4. Nepal-source employment income (Section 67)

Section 67 defines what counts as Nepal-source income; for a non-resident employee, only the Nepal-source portion of employment income is taxable in Nepal (Section 3 read with Section 67). This matters most for cross-border arrangements — a secondee who performs part of the role outside Nepal needs the Nepal-source portion isolated for withholding purposes, which is a payroll-apportionment exercise HR should build into any secondment or dual-employment contract from the outset (see Weeks 11 and 19).

5. PAYE/TDS withholding and PAN (Sections 87, 78)

Section 87 makes every employer a withholding agent, obliged to deduct income tax from salary and remuneration each pay cycle at the individual’s applicable slab rate and remit it to the Inland Revenue Department; Section 78 requires a Permanent Account Number for the taxpayer. Failure to withhold correctly makes the employer personally liable for the shortfall, plus interest and penalty — this is an employer risk, not just an employee one, so HR/payroll should not treat PAYE as a pass-through administrative task.

6. Annual payroll tax reconciliation (Section 4(3), Section 96)

Section 4(3) allows a resident individual whose only income is employment income, and who meets specified conditions, to treat the total Section 87 withholding for the year as their final tax liability — meaning many employees do not need to separately file an income return under Section 96. HR should still issue each employee an annual withholding statement reconciling gross pay, exemptions applied and tax withheld, since an employee outside that simplified treatment (multiple income sources, for instance) will need it to file their own return.

7. Termination/exit payments (Sections 65)

Sections 65 govern the tax treatment of retirement payments and retirement-fund interest; provident fund and gratuity paid out of an approved retirement fund attract a reduced final withholding rate (commonly cited as 5%, per Section 83 (1)) rather than being taxed as ordinary employment income. HR should confirm at exit whether the paying fund is “approved” under Section 63 — an unapproved fund payout is taxed differently — and apply the correct rate rather than defaulting to the standard salary withholding table for a final settlement.

8. Foreign employees and cross-border payroll (Sections 3, 67, 71)

A foreign employee’s Nepal tax exposure runs through the same residency test (Section 3) and source rules (Section 67) as any employee, with Section 71 allowing a foreign tax credit where a Double Taxation Avoidance Agreement applies (see Week 07 for Nepal’s DTAA network). HR should not assume a foreign employee’s home-country tax settlement satisfies their Nepal obligation — withholding, PAN registration and, where relevant, work-permit/immigration compliance (Weeks 11–12) all sit alongside the tax analysis rather than substituting for it.

9. Annual Finance Act changes (Schedule 1 rates)

The Income Tax Act, 2058’s parent text is comparatively stable; the individual tax slabs, exemption limits and specific withholding rates that HR applies in payroll live in Schedule 1 and are updated by that year’s Finance Act, typically effective from the new fiscal year (mid-July). HR’s payroll configuration should be re-validated against the current fiscal year’s Finance Act every year, not carried over from the prior year’s settings by default — this is the single most common source of a stale-rate payroll error.

Employer Should Know

• Classify salary, allowances, and benefits correctly for tax purposes.

• Apply current tax rates and withholding requirements.

• Maintain supporting documents for reimbursements and exemptions.

• Reconcile payroll deductions with tax payments and records.

• Review tax residency and cross-border payroll where applicable.

Employee Should Know

• Understand how salary, allowances, and benefits are treated for tax purposes.

• Review payslips and verify tax deductions.

• Keep employment contracts, payslips, and annual tax statements.

• Provide accurate information required for payroll tax calculations.

• Check whether additional tax filing or payment obligations apply to their circumstances.

International Employer Alert

Employers managing foreign employees, cross-border assignments, or international payroll should review applicable tax residency, income-source, withholding, and treaty requirements. Tax compliance should be assessed alongside relevant labour, immigration, and social-security obligations.

HR Check — Evidence to Maintain

☐ Employee and payroll records

☐ Salary, allowance, and benefit classifications

☐ Supporting documents for reimbursements and exemptions

☐ Tax deduction, payment, and filing records

☐ Current tax rates and payroll calculations

☐ Annual payroll reconciliation and review records

☐ Corrective actions for identified compliance gaps

Myth vs Law

MYTH: “Non-cash employee benefits are not subject to income tax.”

LAW: Non-cash benefits may form part of taxable employment income under the applicable law. Employers should assess each benefit and verify whether any specific exemption applies before calculating payroll tax.

FAQs

1. Who is responsible for deducting payroll tax?
Employers generally have withholding responsibilities for employment payments. They should apply the rules and rates relevant to the applicable fiscal year.

2. Does tax deducted from salary mean an employee has no further tax obligations?
Not always. Additional filing or payment obligations may depend on the employee’s circumstances and applicable requirements.

3. How should employers handle tax for foreign employees?
They should assess the employee’s tax residency, income source, withholding requirements, and any applicable tax treaty provisions.

4. Are bonuses and incentives included in employment income?
Bonuses and incentives may be treated as employment income. Their tax treatment should be assessed under the applicable rules.

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