Foreign Tax Credit

The taxability of an income of a person in Nepal is based on two broad principles. In case of non-resident person generating income or receiving any payment from various income heads viz. employment, business, investment or win fall gain, it is taxed in Nepal on the basis of ‘Source Principle’. Similarly, any resident person generating income or receiving any payment from outside Nepal is taxed on the basis of ‘Residence Principle’. If any resident person pays income tax from income generated outside Nepal, he can claim the amount of tax paid in the foreign country while assessing his income tax in Nepal.

The taxability of an income of a person in Nepal is based on two broad principles. In case of non-resident person generating income or receiving any payment from various income heads viz. employment, business, investment or win fall gain, it is taxed in Nepal on the basis of ‘Source Principle’. Similarly, any resident person generating income or receiving any payment from outside Nepal is taxed on the basis of ‘Residence Principle’. If any resident person pays income tax from income generated outside Nepal, he can claim the amount of tax paid in the foreign country while assessing his income tax in Nepal.

Section 71(1) of Nepalese Income Tax Act, 2002 provides the following provision.

A resident person may claim a foreign tax credit for an Income Year for any foreign income tax paid by the person to the extent to which it is paid with respect to the person’s assessable foreign income for the year

Process of Claiming Foreign Tax Credit

There are two methods of claiming Foreign Tax Credit.

(1) Credit Method

(2) Expense Method

Under Credit Method, Foreign Tax Credits (FTC) claimed shall be calculated as follows

• FTC calculated separately for assessable foreign income sourced in each country; and
• With respect to each calculation, FTC shall not exceed the average rate of Nepal Income Tax of the person for the year applied for the person’s assessable foreign income.

This can be clarified with following example

Mr. Handsome has a source of income in Nepal and also in more than one foreign country. During the Fiscal Year 2016/17, income and tax paid in each foreign country is given below;

Name of the Country                         Income (NPR)                    Tax Paid (NPR)

USA                                                     100,000                              30,000

Australia                                               75,000                               15,000

UAE                                                     125,000                               2,500

Nepal                                                   300,000                                  -

Let us assume that he is a resident natural person and selected for the couple as tax payer during the year. His tax liability shall be as follows

Particulars                             Amount (NPR)

from USA                                   100,000

from Australia                             75,000

from UAE                                   125,000

Total Income                              600,000

Tax Calculation (NPR)

First 400,000                                          4,000

Next 100,000                                         15,000

Remaining 100,000                                 25,000

Total Tax                                                44,000

Average Tax Rate
(44,000/600,000*100)   =7.34%

Tax credit for the year available for

Country

Income (NPR)

Tax Paid (NPR)

Tax Calculated at Av. Rate (NPR)

Tax Credit Available for the Year (NPR)

Unabsorbed tax credit to be Carried forward (NPR)

USA

100,000

30,000

7,340

7,340

22,660

Australia

75,000

15,000

5,505

5,505

9,495

UAE

125,000

2,500

9,175

2,500

0

Total

15,345

32,155

Total tax payable during the year = NPR 44,000 – NPR 15,345 = NPR 28,655

Under Expense Method, following is the provision

Notwithstanding anything contained in credit method, with respect to any Income Year, a person may elect to relinquish a FTC for the year and claim a deduction for foreign income tax for which the credit is available.

In the above example, if Mr. Handsome follows expense method the following is the calculation

Gross Income Less Foreign Tax = Taxable Income

NPR 600,000 – NPR 47,500 = NPR 552,500

Total                                Tax Calculation (NPR)

Upto 400,000                               4,000

Next 100,000                              15,000

Remaining 52,500                       13,125

Total Tax                                    32,125

It is beneficial to take credit method as tax payable is lesser.