Nepal: Brief analysis on ‘Transfer Pricing’ and ‘Income Splitting’ provisions of Nepal

‘Transfer Pricing’ means any arrangement among the related parties or group of related companies/entities/ persons or any enterprises while dealing in international transaction and any foreign branch of such enterprises or any foreign permanent establishment, with the objective to reduce tax liability. Any arrangement among the related parties with the objective of reducing tax incidence or planning of the transaction in such a way that the price of asset or service shifted to another related party resulting into tax liability, is ‘Transfer Pricing’. 

Income Tax Act, 2002 of Nepal has following provisions with respect to ‘Transfer Pricing’ and ‘Income Splitting’. 

1.1 Transfer Pricing 

Section 33(1) 

In any arrangement between persons who are associates, the Department may, by notice in writing, distribute, apportion, or allocate amounts to be included or deducted in calculating income between the persons as is necessary to reflect the taxable income or tax payable that would have arisen for them if the arrangement had been conducted at arm’s length. 

Section 33(2) 

In making any adjustment under Section 33(1), the Department may.

(a) re-characterize source and type of any income, loss, amount, or payment; or 

(b) allocate costs, including head office expenses, incurred by one person in conducting a business that benefit an associate or associates in conducting a business to the associates based on the comparative turnovers of the business. 

Key Points 

1. If there is any arrangement between the associate persons, the department or the offices may distribute, apportion or allocate the amount to be included or deducted in calculating income between the persons as is necessary to reflect the taxable income or tax payable that would have arisen for them if the arrangement had been conducted at arm’s length. 

2. ‘Arrangement’ means any arrangement or provision of any agreement, any deal in business among each other, promise, transaction, understanding, or any other provision, directly or indirectly, by a person himself or through more than one persons. ‘Arm’s length’ means any purchase or sale of asset or service or business transaction or business deal among unrelated persons in market value. ‘Market Value’ means value on any transaction for the asset or service among unrelated person under general business transactions. In other words, ‘market value’ means any value as determined by market under normal circumstances among the unrelated parties for the purchase/sale of asset or service. 

1.2 Income Splitting 

Section 34(1) 

Where a person attempts to split income with another person that is likely to cause reduction in tax, the Department may, by notice in writing, adjust amounts to be included or deducted in calculating the amount of each person to prevent any reduction in tax payable as a result of the splitting of income. 

Section 34(2) 

As reference in Section 34(1) to a person having attempted to split income includes, but is not limited to, a reference to a transfer of the following amounts so as to lower the total tax payable by the person or an associate, either directly or indirectly through one or more interposed entities, between the person and the associate; 

(a) amounts to be derived or costs to be incurred; or 

(b) an amount received or enjoyed by the transferee of an asset that is derived from the asset; or an amount paid or expenses incurred in owning the asset. 

Section 34(3) 

In determining under Section 34(2) whether a person is seeking to split income, the Department shall consider the market value of any payment made for the transfer.

Key Points 

If any person makes an arrangement to reduce the current or future tax by establishing an establishment of possibility of reducing tax is called ‘Income Splitting’. Transfer Pricing is also one of types of ‘Income Splitting’ which happens only between related persons but ‘Income Splitting’ can happen even in other situations as well. Followings are the possibilities of ‘Income Splitting’ – 

• By making inter-adjustment of progressive rates of taxes 

• By making an adjustment of social or family establishment and tax base • By making inter-adjustment of tax rebate or industrial rebates 

• By making transfer of expense or income, which is not in reality 

• By making transfer of expense of tax rates incentives income to general tax rates income 

• By transforming business transactions to final withholding income transactions 

• Any other arrangement with a view to reduce tax

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