Foreign Tax Credit in Nepal — Section 71 Guide

Foreign Tax Credit / Foreign Tax Adjustment

but the credit is subject to an important ceiling.

The calculation must be made: separately for each foreign country

and the foreign tax credit cannot exceed the Nepal tax attributable under the statutory average Nepal tax rate limitation.

Therefore:

Foreign tax paid abroad is not automatically credited in full.

Who Can Claim Foreign Tax Credit?

The Section 71 credit is available to a: resident person for foreign income tax paid in relation to that person's:

assessable foreign income.

This is consistent with Nepal's broader residence principle:

• residents can be taxed on foreign income according to the Income Tax Act;

• foreign tax already suffered can then potentially be adjusted.

A non-resident ordinarily does not use Section 71 simply because it paid tax in another country.

What Is Assessable Foreign Income?

For Section 71, assessable foreign income broadly includes income included in the Nepal-resident person's assessable income from:

• employment;

• business;

• investment

where the income has a foreign source.

It can also include specified deemed income from a controlled foreign entity under the international-tax provisions.

Credit Is Country-by-Country

This is fundamental.

Section 71 requires a: separate foreign tax credit calculation for each source country.

Example

Nepal Co earns income from: India → NPR 5 million
China → NPR 3 million

Foreign tax suffered: India → NPR 800,000
China → NPR 900,000

Do not simply combine: Foreign income = NPR 8 million
Foreign tax = NPR 1.7 million

and perform one global credit test.

The credit limitation should be calculated separately for:

• India; and

• China.

Nepal Average Tax Rate

The Section 71 ceiling uses the person's:

Average Rate of Tax of Nepal

broadly calculated as: Nepal tax payable before foreign-tax adjustment

÷

taxable income

× 100.

The exact computation should follow the statutory taxable-income and tax calculation for the year.

Credit Ceiling

For each source country, the maximum foreign-tax credit is effectively constrained by:

Assessable foreign income from that country × Nepal average tax rate

subject to the amount of qualifying foreign income tax actually paid.

Therefore the allowed credit is broadly the lower of:

A

Qualifying foreign income tax paid.

or

B

Nepal statutory Section 71 credit ceiling.

Example

Nepal-resident company has: Total taxable income:

NPR 20,000,000

Nepal tax before FTC: NPR 5,000,000

Average Nepal tax rate: 25%

Foreign-source taxable income from Country A: NPR 4,000,000

Foreign tax paid: NPR 1,400,000

Nepal FTC ceiling: NPR 4,000,000 × 25% = NPR 1,000,000

Therefore: Foreign tax paid = NPR 1,400,000

Current-year Nepal FTC =

NPR 1,000,000

The excess NPR 400,000 cannot simply reduce Nepal tax in the current year.

Excess Foreign Tax Can Be Carried Forward

Section 71 expressly provides that foreign tax that cannot be credited because of the statutory ceiling may be: carried forward

and treated as foreign income tax paid in respect of future assessable foreign income sourced from the: same country.

Therefore excess Country A tax cannot automatically be used against income from Country B.

Country Tracking Is Essential

CMA recommends maintaining a foreign-tax-credit ledger by:

• country;

• income type;

• income year;

• foreign taxable income;

• foreign tax assessed;

• foreign tax actually paid;

• Nepal FTC utilised;

• excess carried forward;

• closing balance.

Do not maintain only one global:

“Foreign Tax Credit”

account.

Option to Claim Foreign Tax as Expense Instead

Section 71(4) permits a taxpayer to give up the foreign-tax-adjustment claim for a year and instead claim the qualifying foreign tax as an: expense/deduction

where the statutory conditions are satisfied.

This creates a choice that should be modelled rather than automatically assuming credit is always preferable.

Credit vs Deduction

Suppose: Foreign tax = NPR 1,000,000.

Tax Credit

Potentially reduces Nepal tax by up to NPR 1,000,000, subject to Section 71 limit.

Tax Deduction

Reduces taxable income by NPR 1,000,000.

If corporate rate is 25%, the cash-tax impact could be only: NPR 250,000.

Normally a full tax credit is economically more valuable than a deduction.

However, the actual optimal treatment depends on:

• FTC ceiling;

• losses;

• foreign-income profile;

• carry-forward prospects.

Foreign Tax Must Be Income Tax

Section 71 deals with: foreign income tax.

Do not automatically include every foreign Government charge.

Examples requiring separate analysis:

• VAT/GST;

• customs duty;

• municipal tax;

• payroll contribution;

• withholding that is refundable;

• penalty;

• licence fee.

The foreign levy should first qualify as income tax for Section 71 purposes.

Foreign Withholding Tax

Foreign tax collected through withholding can potentially qualify where it is genuinely foreign income tax on assessable foreign income.

Maintain:

• withholding certificate;

• foreign tax return;

• payment confirmation;

• tax assessment;

• treaty documentation.

An invoice showing a deduction is not always sufficient evidence.

Exchange Rate

Foreign income and foreign tax must ultimately be incorporated into the Nepal tax computation in NPR.

The company should apply the proper accounting/tax foreign-currency conversion basis consistently and retain:

• foreign-currency amount;

• exchange rate;

• NPR equivalent;

• payment date.

DTAA Interaction

A DTAA may also provide double-tax relief.

The process is generally: determine Nepal domestic taxable income

↓ check treaty taxing rights

↓ determine foreign tax legally payable

↓ apply Nepal Section 71 foreign-tax adjustment.

Do not claim credit for foreign tax that should not legally have been imposed under the applicable treaty without first reviewing whether refund/treaty relief is available.

Example — Excess Foreign Withholding

Nepal company earns foreign service revenue: NPR 10,000,000.

Foreign country deducts: 20% = NPR 2,000,000.

Nepal average tax rate: 15%.

Maximum current Nepal Section 71 credit: NPR 1,500,000.

Excess: NPR 500,000 is potentially carried forward to future qualifying foreign income from that same country under Section 71.

The business should also ask:

Was the full foreign 20% legally payable under an applicable DTAA?

A foreign tax credit should not become a substitute for treaty compliance.

Foreign Loss

Where a foreign jurisdiction produces a tax payment but the corresponding Nepal computation produces different assessable foreign income because of:

• timing;

• depreciation;

• source rules;

• expense deductibility;

the credit should follow Nepal's Section 71 computation rather than simply copying the foreign tax return.

Change in Control

The Income Tax Act contains restrictions associated with a qualifying change in ownership/control.

Among those restrictions is the ability to carry forward certain foreign-tax balances arising before the change.

Companies facing:

• acquisition;

• majority share transfer;

• restructuring

should therefore review unused foreign-tax credits before closing the transaction.

Advance Tax

Section 71 foreign-tax adjustment can also affect estimated/instalment tax calculations.

The Income Tax Act permits relevant foreign tax paid or estimated to be payable for the year to be considered in calculating the foreign-tax adjustment for estimated tax purposes.

Documents to Maintain

• foreign income invoice/contract;

• proof of foreign income;

• foreign tax return;

• foreign withholding certificate;

• tax assessment;

• tax-payment evidence;

• tax-residence certificate where relevant;

• DTAA analysis;

• country-wise FTC working;

• exchange-rate working;

• prior-year FTC carry-forward schedule.

Foreign Tax Credit Checklist

• Confirm taxpayer is Nepal resident

• Identify foreign-source income

• Identify source country

• Determine foreign income tax paid

• Verify tax is qualifying income tax

• Check DTAA

• Compute Nepal taxable income

• Calculate Nepal average tax rate

• Calculate country-specific ceiling

• Claim lower allowable credit

• Track excess country-wise

• Carry forward qualifying excess

• Compare credit vs expense treatment

• Reconcile foreign-currency conversion

• retain supporting tax evidence

Common Errors

Pooling foreign income from all countries into one FTC calculation

Claiming foreign VAT/customs duty as Income Tax credit

Crediting foreign tax above Nepal's Section 71 ceiling

Losing unused country-wise FTC records

Ignoring a DTAA and accepting excessive foreign withholding

Assuming foreign tax credit and tax deduction are the same

Further guidance and practical checks

Foreign tax credit is fundamentally a country-by-country limitation calculation. Businesses earning from several jurisdictions should maintain the FTC schedule as part of the annual tax provision rather than reconstructing it after year-end.