Nepel: Transfer Pricing Provisions in Nepal

Globalization and economic growth have driven the level of inter-company transactions to new heights. In 2004, Nepal became the member of World Trade Organization which has brought major changes and significances in business in the country. Although the concept of Transfer Pricing has been introduced in Income Tax Act, 2058 (2002), the drastic changes with inflow of Foreign Direct Investment and entry of foreign company in Nepal started only after 2004. 

There are couple of provisions in Income Tax Act of Nepal related to Transfer Pricing, however, there is no practice to cover the arm’s length principle that neutralizes the adverse effect of transfer pricing. Transfer pricing concept is very necessary to have fair taxation practice in Nepal. Currently there is a practice of taking reference of Organization for Economic Cooperation and Development (OECD) in matters related to transfer pricing and the arm’s length principle. 

Transfer pricing refers to the setting of prices for transactions between associated enterprises involving the transfer of property or services. Associated enterprises are the component parts of a multinational group such as companies. These transactions are also referred to as controlled transactions, as distinct from uncontrolled transactions between companies that are not associated and can be assumed to operate independently (on an arm’s length basis) in setting terms for such transactions. 

Section 33 of Income tax act, 2058 contains provision related to Transfer pricing and other arrangements between associates. As per the act, in any arrangement between associated persons: Inland Revenue Department (IRD) may, by notification in writing, distribute, apportion or allocate the amounts to be included or deducted in the income between the persons as to reflect their taxable income or tax liability when the arrangements are operated by them according to general market practices (at arm’s length) 

IRD may, in the process of the notification: 

1. Re characterize the source and type of any income, loss and amount of payment or 
2. Allocate costs, including the head office expenses, incurred by one person in conducting a business that benefits an associate or associates in conducting their businesses based on the comparative turnover of the businesses. 

Associated persons means two or more persons or group of such persons where one may reasonably be expected to act in accordance with the intentions of the other associated persons. 

As per the Rule 15 of Income Tax Rules, 2002, where one or more persons make an application in writing for the clarification in respect of distribution, apportionment or allocation of the amounts to be included or deducted according to general market practices (at arm’s length) where transfer pricing between associates is necessary, IRD may issue a written notification as follows: 

1. The term of the written notice shall not exceed five years at a time and 
2. The written notice may be renewed every, five years 

The written notice is a compulsion to both tax payer and tax authority. However, it may be made inoperative if the IRD agrees with the written notice for the same by tax payer. 

The provision in the Income Tax Act, 2058 (2002) does not go further in suggesting how the arm’s length principle may be met in specific cases. This is complex and has not been appropriately dealt with separate regulations or practice notes. Although, there is no filing requirement or requirement to prepare a detail Transfer Pricing Study Report in Nepal, it is advisable that the company maintain adequate document to justify the arm’s length nature of the transactions with associated person taking in the reference of OECD principle. Seeing the business transaction with cross border transactions among associate enterprise by foreign company in Nepal, the tax authority has very limited tax provisions, and practice to identify the issue of transfer pricing cases in the country.

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