Chapter 4 Solutions: Introduction to Tax
Answers to the Chapter 4 exercises. Each answer is as long as its marks call for: a sentence or two for 1 mark, and five marks’ worth of explained points, tables or working for 5 marks.
Group A: Very Short Answer Questions (1 Mark Each)
1. What is indirect tax?
An indirect tax is a tax levied on the production, import, export or consumption of goods and services whose burden the producer or seller shifts to the final consumer by adding it to the price, such as VAT, Customs Duty and Excise Duty.
2. What is the current rate of Value Added Tax (VAT) in Nepal?
Nepal levies VAT at a single standard rate of 13%; exports are taxed at 0%, and basic agricultural, medical and educational items are exempt.
3. Write the full form of PAN and VAT.
PAN: Permanent Account Number. VAT: Value Added Tax.
4. Who propounded the four classical canons of taxation?
The classical economist Adam Smith propounded the four canons of taxation (Equality, Certainty, Convenience and Economy) in The Wealth of Nations (1776).
Group B: Short Answer Questions (5 Marks Each)
1. What is tax? Explain any four major objectives of levying tax by the government.
Tax is a compulsory financial charge imposed by the government (Federal, Provincial or Local) on individuals, businesses and goods or services under prevailing law, without any direct personal return or benefit to the taxpayer in exchange. In the words of Prof. Seligman, “A tax is a compulsory contribution from a person to the government to defray the expenses incurred in the common interest of all, without reference to special benefits conferred.” In Nepal, domestic taxes are administered by the Inland Revenue Department (IRD) under the Ministry of Finance.
Four major objectives of levying tax are:
- Collection of public revenue: Tax is the primary source of government income. It pays for administrative expenses, the salaries of public employees, defense and the public services the government provides every year.
- Infrastructure and economic development: Tax revenue finances roads, bridges, hydropower, schools, hospitals and drinking water projects. Such infrastructure raises production and employment and speeds up the country’s economic development.
- Reduction of economic inequality: Under progressive taxation, people with higher incomes pay at higher rates: the first Rs. 10,00,000 of an individual’s yearly employment income is taxed at only 1%, while the rate rises through 10%, 20% and 27% to a top rate of 29%. The revenue is then spent on social security, scholarships and subsidies for low-income citizens.
- Protection of domestic industries: Higher customs duty on imported luxury and competing goods makes them costlier than domestic products. This shields domestic manufacturers from foreign competition and encourages local production.
The chapter lists a fifth objective: control of harmful consumption and inflation, through heavy excise duties on tobacco, alcohol and luxury items.
2. Differentiate between Direct Tax and Indirect Tax in five points with suitable examples.
A Direct Tax is levied directly on the income, profit or wealth of a person or institution, and the same person bears its burden. Examples in Nepal are Income Tax, Remuneration Tax, Property (House and Land) Tax and Vehicle Tax. An Indirect Tax is levied on the production, import, export or sale of goods and services, and its burden is shifted to the final consumer through the price. Examples are Value Added Tax (VAT), Customs Duty and Excise Duty. They differ as follows:
| Basis of Difference | Direct Tax | Indirect Tax |
|---|---|---|
| Meaning and basis | Levied directly on the income, profit or property of a person or institution, e.g., income tax on a salary or on business profit | Levied on the production, import, export or sale of goods and services, e.g., customs duty on imported goods |
| Impact and incidence | Impact and incidence fall on the same person, so the burden cannot be shifted, e.g., an employee bears the remuneration tax deducted from their own salary | Impact falls on the importer, manufacturer or seller, but incidence falls on the final consumer, who pays the tax in the price, e.g., a shopkeeper adds 13% VAT to the customer’s bill |
| Nature of equity | Progressive: higher incomes are taxed at higher rates, e.g., employment income is taxed from 1% up to 29% | Regressive: rich and poor pay the same rate on the same commodity, e.g., 13% VAT |
| Civic consciousness | High: taxpayers directly feel the payment and demand accountability from the government | Low: the tax is hidden inside the retail price, so consumers hardly notice it and resist it less |
| Manner of payment | Paid by the taxpayer to the government on income earned or property owned, often deducted at source (TDS) from salary | Paid by the consumer in small amounts, as part of the price, each time taxed goods or services are bought; the importer, manufacturer or seller deposits it with the government |
3. What is Value Added Tax (VAT)? Explain the features and importance of VAT in Nepal’s revenue system.
Value Added Tax (VAT) is a multi-stage consumption tax levied on the value added to goods and services at each stage of production and distribution. In Nepal it is governed by the Value Added Tax Act, 2052, administered by the Inland Revenue Department and charged at a single standard rate of 13%. At each stage, a registered business charges VAT on its sales and deducts the VAT it has already paid on its purchases, so in effect it pays tax only on the value it has added. For example, a trader who buys goods for Rs. 1,000 (+ Rs. 130 VAT) and sells them for Rs. 1,500 (+ Rs. 195 VAT) pays 195 - 130 = 65 to the government, which is 13% of 500 = 65 on the Rs. 500 of value added.
Features of VAT in Nepal:
- Multi-stage tax: VAT is collected at every stage, from the manufacturer or importer to the wholesaler and retailer, but each business pays only on its own value added. Tax is therefore not charged again on tax already paid at an earlier stage.
- Single standard rate: All taxable goods and services carry one rate of 13%. Exports are taxed at 0%, and basic agricultural, medical and educational items are exempt.
- Indirect consumption tax: Businesses collect and deposit it, but its burden is shifted forward to the final consumer as part of the price.
- Registration and VAT invoice: Businesses dealing in taxable goods with an annual turnover above Rs. 50,00,000 (Rs. 30,00,000 for services or mixed transactions) must register for VAT and issue VAT invoices that show the 13% tax separately.
Importance of VAT in Nepal’s revenue system:
- Major source of revenue: VAT is charged on most goods and services consumed in the country, so its base is broad and it brings in a large and steady share of government revenue.
- Control of tax evasion: A business can deduct only the VAT shown on proper invoices, so buyers ask for VAT invoices and sales get recorded at every stage. This leaves a trail of transactions that the Inland Revenue Department can check.
- Promotion of exports: Since exports are taxed at 0%, Nepalese goods are sold abroad without VAT, which makes them more competitive in foreign markets.
- Simplicity and transparency: One standard rate, shown separately on every invoice, makes the tax easy to calculate for businesses and clear to consumers, which fits the canons of certainty and simplicity.