Currently, the debate over taxation is intensifying. A wide spectrum of the populace, from business people to the general public, are voicing their concerns related to the tax arrangements set by the federal and local governments. Basically, haphazard introduction of taxes by local governments, which in many cases have been leading to double taxation, a rapidly increasing tax burden and abolishment of tax concessions to certain businesses are among the major concerns at the moment. After six months as the Minister for Finance, Dr Yuba Raj Khatiwada finds himself in the hot seat with criticism growing from different quarters of Nepali society in terms of the government’s new tax arrangements and other problems in taxation.
Nevertheless, Dr Khatiwada, who led Nepal Rastra Bank as the governor and the National Planning Commission as vice-chairman in the past, is confident that the new tax arrangements announced in the budget for FY2018/19 are pragmatic in terms of tax policy reform and the problems seen at the local level will be resolved through the central government’s help. In an interview with Ranju Kafle of New Business Age, Dr Khatiwada talks about the government’s tax policy reforms, the changing scenario of taxation in Nepal and ways to resolve taxation problems at the local level, among other issues. Excerpts:
The government has received criticism from several quarters for the tax arrangements in the first federal budget. What do you have to say on this?
The tax provisions incorporated in the first federal budget were discussed in parliament comprehensively and were approved. I don’t see any reason behind criticising the government for the new tax provisions. This is also because there have not been upward revisions in the taxes which adversely affect the masses.
As changes in indirect tax rates can hit the consumers hard, the rate of Value Added Tax (VAT) wasn’t changed. But the arrangement of VAT rebate to businesses has been repealed. This action is aimed at telling the businessmen that they cannot enjoy the taxes paid by the people from now onwards.
As far as direct taxes are concerned, there is a provision in the federal budget under which taxpayers from low income groups are taxed proportionately less than the higher income groups. It is in fact a progressive tax system which provides fair treatment to the people. Anyway, direct tax like on income does not adversely affect general consumers.
The activities of consumers are affected by the changes in the rates of indirect taxes. The indirect tax rates haven’t been changed much. The rates of some non-tax revenue and customs duties on some goods and commodities have been raised. The general people won’t be affected by the tax rate adjustments on luxury items and goods that can negatively impact human health and the environment. The adjustments to customs duties have been made only on the import of such items which can help in import substitution and tame the widening trade deficit. We believe this approach will enable us to sustain the external sector imbalances and achieve economic self-reliance.
The tax burden people are feeling right now is not due to the federal budget. The ongoing disputes over taxation are due to the taxes levied by the local governments. Most people haven’t paid such taxes in the past. So it is quite obvious that the initiative of the local governments in implementing tax provisions for the first time will receive wider attention. The federal government will work towards with drawing the unlawfully imposed taxes and review the exorbitant rates even if lawfully levied, in a bid to make the local governments more accountable.
Taxes levied by local governments can be repealed if such taxes are found not having legitimacy. But it is very hard to repeal tax provisions implemented by the federal government. It is said that complications in the tax system have been created by the federal government. Is it so?
I don’t disagree with the first argument. But I do not agree with the later statement. We have been flexible in fine tuning taxes if they distort the production and consumption by the general public.
However, the federal government studies different aspects before changing tax provisions and the issues related to taxation are discussed in parliament before their implementation. We have introduced the principles of “equal tax for equal income” and “unequal tax for unequal income” for the people based on equity and ability to pay taxes. So, there won’t be a situation to roll back the major tax provisions implemented by the federal government. But, the local governments are recently formed and the representatives of the people are excited to works they have been elected from polls held after a long time. We are practicing an entirely new system of governance and there is a lack of resources. So the present situation appears a bit difficult for managing the expectations of the people with limited resources. The central government has facilitated both provincial and local governments though revenue transfer and equalization grants to address such difficulties.
Birgunj and Biratnagar metropolitan cities have rolled-back their decisions to hike taxes. What does this indicate?
The repeal came because the taxes imposed by the metropolitan cities were not according to the tax laws. Also, some taxes with a high tax burden on the taxpayers have been suspended despite being lawfully imposed. We need to be clear that the rates of the lawfully imposed taxes can be revised but the taxes won’t be repealed. Only the taxes which are against the law will be repealed.
A single-point tax collection mechanism is being used to collect taxes to avoid double taxation for the same goods and services. It is the responsibility of all tiers of the government to collect tax and provide services and protection to the taxpayers in the spirit of the laws and social justice.
The local governments are being blamed for imposing new taxes under different headings. What is the Ministry of Finance doing to check such acts?
The local governments are autonomous bodies. The federal government cannot challenge the bodies which have the authority to levy taxes lawfully. The ministry has been requesting the local governments to introduce and levy taxes by following the established laws, rules and regulations and making them aware to repeal the taxes that are not in accordance with the law. The confusion seen at the moment is related to the tax base areas mentioned in the Concurrent List. The collection of taxes and distribution of revenue through the single-point mechanism has been agreed to resolve the issues. The ministry has prepared and forwarded a model of tax laws related to the collection and distribution of taxes to the provincial and local governments. Under this, 60 percent of the collected tax will go to the collecting government and the remaining 40 percent to the receiving government. Regardless of the type of taxes or the collecting bodies, all taxes will be collected through the single point. The collection of taxes related to international trade such as customs duty, Value Added Tax (VAT) and excise duty fall under the jurisdiction of the federal government. We’ve started the distribution of the revenue collected from excise duty and VAT to the provincial and local governments.
There has been a major change in terms of expansion of the tax net as many village development committees (VDCs) of the past have now become municipalities. People who used to simply pay land tax and those who haven’t paid land and house tax have now come under the property tax net. The tax liability has increased along with new evaluation of urban property than due to tax rate hike. In the meantime, the newly formed local and provincial governments also need money to build physical and institutional infrastructures. This is why the local bodies are levying taxes in a free manner. It is our request to all governments to levy taxes evaluating the taxpaying capacity of the people. They need to be aware that tariffs should not erode the productive capacity of taxpayers. There should be coordination between the people and the elected representatives at the local level to resolve the taxation related issues.
During your visit to the United States in early August, you said that Nepal has one the most competitive tax rates in South Asia. What is the basis of your statement?
As per the existing arrangements, investors here are required to pay 20 percent corporate tax for industries, while it is 25 percent for other businesses. Fewer other South Asian nations offer such competitive institutional income tax rates. Meanwhile, customs duties on import saver age at 11 percent. Customs duties for almost three-fourths of goods and commodities are less than 10 percent.
Don’t you think that increasing the tax burden will have more disadvantage than advantage without increasing the taxpaying capacity and readiness of the taxpayers?
Earlier, the effective income tax rates were 15, 25 and 35 percent, which has now been set at 10, 20 and 36 percent respectively. Only individuals with an annual income of over Rs 2 million are required to pay the 36 percent income tax. We have just raised maximum income tax rate by 1 per cent, with 35 per cent effective tax rate being the maximum for a long time.
VAT, One of the major sources of government revenue, has been left unchanged. So, the current issues are not about the tax burden. The main challenge for the tax collectors is related to identifying the groups to tax or exempt and finding appropriate evaluation methods and procedures for taxation.
Some people fear that new tax provisions will increase the gap between the rich and the poor. Do you agree?
The salient feature of the progressive tax system is to reduce income inequality. Not only taxes but government expenses also need to be evaluated while asking if the taxation system increases income inequality or not. The beneficiary social classes of the revenue distribution system need to be looked at closely. The gap in income inequality will widen if the distribution of the national budget makes the rich richer. The federal budget has programmes geared to social security, employment generation, basic education and health and expenses on programmes like these reduce the income inequality.
The federal budget has set a revenue growth target of 35 percent. The major sources of government revenue are customs duties, VAT and indirect taxes. Don’t you think the increase in indirect taxes will affect the low-income people living around the poverty line?
There is no consideration of rich and poor when it comes to indirect taxes. But the people responsible for taxation should be aware to avoid levying indirect taxes on the goods used by the poor to the largest possible degree. At the moment, the tax base has not widened to such an extent that we could rely only on direct taxes.
Earlier, there was no tax on agricultural income which will now be taxed by the provincial governments. It has become important because the agriculture sector makes up one-third of the country’s GDP. It will also help us to gradually formalise the large-sized informal economy. This situation necessitates levying indirect taxes for the short and midterms. At the moment, there is also a compulsion to finance the government activities from the limited sources of revenue.
When our economic development gathers significant pace, direct taxes will have the largest share in the total government revenue and the net of indirect tax can be narrowed down gradually. There can also be adjustments to customs and excise duties. For this to happen, the income tax net should be wider and stronger. This shows the state first needs to have a good source of income coming from high and inclusive economic growth.
What people pay as service charges for public services are generally considered taxes. Isn’t there a contradiction in the government’s interpretation and general understanding about taxes and service charges?
The service charges and taxes are different by their benefits. When anyone pays tax, there is no such specific thing so as to look whether he or she will get proportionate public service. However, service charge is paid immediately for certain goods or services. It is intended to benefit the fee payers. On the other hand, when tax money goes to the revenue system, it gets distributed to various sectors. Direct and indirect taxes are the source of government revenue which is used to develop infrastructure and provide services to the people. The taxpayers’ money benefits people in large numbers.
The number of non filers is said to be large. So, it is alleged that the government is trying to squeeze those who are already in good compliance and leave those who aren’t under the net or have not complied even being under the net?
Maybe it was like that in the past. But it won’t be like this anymore. We have been reminding and providing additional timeto those who are yet to clear their tax dues and the ones who haven’t submitted their tax details. The trend of non-filing of tax details will decline. We are bringing more companies, non-government organisations and other institutions under the taxnet.
Hasn’t repealing the VAT rebate on the sale of some items and customs duty exemption on the import of some daily essentials and raw materials made the taxation system regressive?
The repeal came because the tax rebate lacked clarity on its purpose and its benefit to the taxpayers. Also, there was not any clear accounting of the paid amount and rebated amount of such taxes. VAT rebate on items such as vegetable ghee, cooking oil, flour, sugar, mobile phone sets, textile and dairy products have been abolished. According to the new arrangement, sugarcane farmers and tea producers are to receive direct subsidies, while the tax concessions granted to sugar producers and tea distributors have been withdrawn. Similarly, producers of farm products like ghee, oil, cattle and livestock and oilseed crops are also entitled to receive government subsidies.
We are in the phase of building the national economy. Now what needs to be looked at is, how long we are going to keep operating agricultural industries based on imported raw materials. It won’t be sustainable to run industries by importing soybean, mustard, maize, rice and sunflower. This is why subsidies are provided to raw material producers of agri-based industries in order to become self-reliant. There will be no concessions on VAT. Other kinds of supports or subsidies, including to the textile industries, can be given after considering their specific problems.
Won’t the withdrawal of tax exemptions cause divestments?
There is no such possibility. The issue of tax exemption is not a big deal in itself. Also, not all goods and services are entitled to 100 percent tax concessions. For entrepreneurs, the availability and smooth flow of capital and secured market are the main concerns at present. Business activities will be much easier if bank loans are available at reasonable interest rates and if markets remain buoyant.
Earlier, the government had said that the taxation related issues at the local level would be resolved through the National Natural Resource and Fiscal Commission (NNRFC). Now, minister and secretary level committees have been formed. Is it an attempt to weaken the role of NNRFC?
NNRFC has been set up for the distribution of grants and revenues. It has no role in determining the tax rates and deciding on taxable goods and services. The commission has the responsibility of establishing a mechanism to distribute revenue collected by the federal government among provincial and local governments and formulate standards for equalisation, and conditional and special grants. For now, it has been completed during the budget formulation process.
Now NNRFC is preparing criteria for royalty sharing of natural resources and determining the beneficiaries. The commission can work towards resolving the issues at the local level regarding the distribution of natural resources. Rest, provincial and local governments have all the rights.
As a constitutional body, the role of NNRFCis not weak. But the commission should not seek rights beyond its areas. The Ministry of Finance has been working closely with NNRFC in administrative manner until the commission is fully formed. It is not that the formation of the commission will resolve all taxation related problems. The local bodies should introduce and levy taxes in a rational way. At the moment, people are not used to in terms of paying taxes.
How is NNRCF operating?
NNRFC has prepared a formula for tax distribution as mentioned in the Intergovernmental Fiscal Arrangement Act. It has used indicators such as population, geographical area, inaccessibility, remoteness and human development index. The formula is expected to yield satisfactory results. It can be changed according to the need.
You have said that the allocated budget for the current fiscal year will be spent in a timely manner and the targeted economic growth will also be achieved. What do you base this statement on?
The first basis is that the budget was presented on May 29 (Jestha 15) and the work procedure for budgetary operations was prepared on July 11 (Asar 27), that is even before the new fiscal year started. Earlier, this used to take a significant period of time after the start of the fiscal. The preparation of work procedures in a timely manner ensures that public procurement and the work related to contracts will move ahead continuously from the very first day of the fiscal year. At the moment, the risk related to the adjustment of government employees needs to be addressed at the earliest.
The second basis is the end to unaccountability. As all tiers of the government are now run by elected representatives,they will immediately point out any substandard work and low-quality construction materials used in development work. Third, the government has also stepped ahead to make the private sector more responsible. Making proper revisions in the Public Procurement Act, we will be rewarding those who complete work on time by maintaining quality. Those failing to comply will be penalised. Also, we will be strengthening the inspection mechanism.
How will fiscal discipline be maintained?
Fiscal discipline is about the mobilisation of government revenue which is presented as the national budget to achieve intended results. Our understanding of fiscal discipline is to end the tradition of mismatch between programmes, spending and results. We are committed to establishing fiscal discipline also through proper work procedures, budget release and payment system, and expenditure tracking.
The Nepali manufacturing sector has weakened considerably over the last 15 years. What are its future prospects like?
There are some reasons for the shrinkage in the manufacturing output. First, many of the industries in the past were based on import substitution and could not sustain themselves after the 1990 era of economic liberalisation. Second, the industries based on the quota system could not expand because of the conflict and political transition. Third, insufficient supply of power hampered industrial activities severely for a considerable period of time. Investors were also not left assured due to the prolonged political instability. The combination of all these factors has weakened the foundation of the Nepali industrial sector. Lately, industrial activities have been gathering momentum and the situation in the sector will improve eventually.
The international community is seemingly not convinced with the strongest government in the history of Nepal that was formed after the parliamentary elections held last year. It is said they are seeking clarity on policies and assurances in the implementation aspect. How is the government moving ahead in this situation?
This is not true at all. The donor agencies and foreign diplomatic missions have told us that this time offers tremendous opportunities to invest in and to mobilise support in Nepal.
The World Bank has pledged to double its investment and the Asian Development Bank is also positive about utilising the investment opportunities in the country. Similarly, the Asian Infrastructure Investment Bank (AIIB) has asked for projects to invest in. Nepal is amongst the few countries to receive the Compact of Millennium Challenge Corporation (MCC) of the United States government which will be implemented soon. The Department for International Development (DFID)of the United Kingdom has been increasing its support to Nepal. India and China have been extending their support and assistance to us like never before. So are other bilateral donors.
Donors do not decide to help on the basis of the symbols printed on the flags of the ruling parties. Basically, their parameters are democratically elected government, level of transparency in spending money and strengths/weaknesses in governance. Many socialist governments in the world have been receiving good levels of foreign assistance.
The government’s spending capacity is still weak. Will the increased foreign financial assistance be fairly utilised?
Primarily, our focus is on improving the capacity to design the projects and move ahead with the implementation. The donors are convinced about the government’s spending capacity which has been reflected in their support pledges. Donors become ready to lend their support when there is appropriate institutional infrastructure and the government has a long-term vision for development.
At the moment, the private sector seems to be hesitant. It may be because their high expectation from the new government and the expert finance minister hasn’t been realised yet. Has the government failed to win the private sector’s confidence?
We have no magic wand and structural reforms take time to deliver results. But, rest assured, our efforts would deliver result for sustained growth of the private sector. The private sector’s expectation from the government is obvious. Being in the public post for a long time, I have some responsibilities. It is my duty to keep the parts of the economy intact. I would like to request the business community not to lose patience so quickly. We will institute all the fundamental rights guaranteed by the constitution. The first year of this government is all about course correction. Improvements will be visible from next year. The umbrella associations of Nepali businesspersons are collaborating with the government. We are positive about their requests for amendments to some laws and processes. The budget is private sector friendly and they are satisfied with it. Collaboration is the key to achieving the current need of sustainable economic development by standing on a strong foundation.
You are often blamed of being intolerant of the stock market. What is your comment?
I have always been dedicated to developing a strong and organised capital market. In the history of Nepal Rastra Bank, probably I am one of the earliest researchers to engage in an in-depth study of the capital market. I know both positive and negative aspects of the stock market and will take measures to see that this market mobilizes the much needed equity and debt capital for industrial and infrastructures development.
At the moment, Nepali stock market needs more investors. The size of the capital and share transactions needs to be increased gradually. There is also a need to ease transactions. Meanwhile, several institutional improvements are ongoing and the capital structure of the institutions listed in the stock market has changed. This is the major reason for the current fluctuation in the Nepali stock market. The national economy will be built with the development of the capital market. Investors can be assured that the government is committed to developing the capital market to enhance national capital formation and to strengthen the national economy.