Transfer Pricing in Nepal — Arm's Length, Documentation, Safe Harbour & APA

Arm's Length / General Market Practice

rather than an artificial related-party price.

Section 33 authorises IRD to:

• distribute;

• apportion;

• allocate

income or deductions between associated persons where necessary to reflect the tax result that would arise under normal market behaviour.

IRD has issued detailed:

Transfer Pricing Directives, 2024 (2081 BS)

for cross-border associated-person transactions.

For FY 2083/84, Finance Act 2083 has also introduced statutory:

Safe Harbour — Section 33 A

and

Advance Pricing Agreement — Section 33 B

frameworks.

What Is Transfer Pricing?

Transfer pricing concerns prices/terms used in transactions between related persons.

Examples: Nepal subsidiary buys goods from foreign parent.

Nepal company pays royalty to foreign group company.

Nepal company receives IT support from foreign affiliate.

Foreign parent lends money to Nepal subsidiary.

Nepal company exports software to related foreign distributor.

The question is:

Would independent parties have agreed comparable pricing and terms?

Transfer Pricing Is Not Automatically Tax Avoidance

A related-party transaction is not automatically improper.

Transfer pricing law requires the transaction to reflect an appropriate: arm's-length result.

The IRD directive describes transfer pricing as pricing of transactions between associated enterprises and focuses on ensuring that cross-border controlled transactions are comparable with transactions between independent parties.

International Transactions

IRD identifies international related-party transactions including matters such as:

• sale of finished goods;

• raw-material purchase;

• fixed assets;

• machinery;

• intangibles;

• expense reimbursement;

• IT-enabled services;

• software-development services;

• support services;

• technical services;

• management fees;

• guarantee fees;

• loans.

This means transfer pricing is much broader than imports of physical goods.

Associated Persons

The associated-person test should be performed before preparing the analysis.

Finance Act 2083 has expanded/specified the relevance of Sections 33, 33 A and 33 B for relationships involving matters including:

• ownership/control;

• financing dependence;

• intellectual-property/technical dependence;

• significant supply dependence.

The exact current statutory associated-person test should be taken from the Finance Act 2083 overlay until IRD publishes a fully consolidated Income Tax Act incorporating the 2083 amendments.

Do not rely solely on a pre-2083 ownership test when assessing the current associated-person definition.

Functional Analysis

A transfer-pricing analysis should determine what each party actually contributes.

The standard analysis examines:

Functions

What does each party do?

Assets

What tangible/intangible assets does each party use or own?

Risks

Who actually assumes:

• market risk;

• credit risk;

• inventory risk;

• currency risk;

• product liability;

• development risk?

The IRD Directive treats this FAR analysis as central to comparability.

Five Transfer-pricing Methods

IRD's current Directive identifies five arm's-length methods:

1. Comparable Uncontrolled Price (CUP)

2. Resale Price Method

3. Cost Plus Method

4. Transactional Net Margin Method (TNMM)

5. Transactional Profit Split Method

The method should be selected according to the actual transaction and availability/reliability of comparable information.

CUP

CUP compares the controlled transaction price against a comparable independent transaction.

It can be highly persuasive where genuinely comparable:

• products;

• contractual terms;

• market;

• volume;

• geography

exist.

Cost Plus

Cost Plus can be relevant where one group company provides:

• manufacturing;

• routine services;

• support services

and an arm's-length markup over an appropriate cost base can be established.

The difficulty is often determining:

• correct cost base;

• shareholder costs;

• pass-through expenses;

• comparable markup.

TNMM

TNMM compares an appropriate net profit indicator.

It is frequently useful where exact price comparables are not available but comparable profitability data can be established.

Potential indicators can include:

• operating margin;

• cost-plus margin;

• return on assets

depending on the tested party and transaction.

Intercompany Service Charges

For management/support services, do not stop at:

“The parent issued an invoice.”

The Nepal entity should demonstrate:

• service actually received;

• business benefit;

• no duplication;

• allocation key;

• cost base;

• markup;

• arm's-length character.

Transfer pricing, withholding tax and tax deductibility are three separate tests.

Royalty

Royalty should be supported by:

• actual IP ownership/control;

• licence rights;

• benefit to Nepal entity;

• approved TTA where required;

• comparable royalty analysis;

• transfer-pricing support.

DOI approval of a royalty agreement does not by itself establish arm's-length pricing for Income Tax.

Intercompany Loan

Review:

• principal;

• currency;

• tenure;

• security;

• borrower's credit risk;

• benchmark interest;

• parent support;

• NRB approval.

An NRB-permitted interest ceiling is a foreign-exchange rule.

It does not automatically equal the arm's-length interest rate for Income Tax purposes.

Guarantee Fee

Where a parent guarantees a subsidiary's borrowing, determine:

• whether a real economic benefit exists;

• whether independent parties would charge a fee;

• appropriate pricing.

Do not create a group-company guarantee fee purely as a mechanism to transfer profit offshore.

Documentation

CMA recommends contemporaneous documentation covering:

• organisational structure;

• related parties;

• controlled transactions;

• agreements;

• industry/business analysis;

• FAR analysis;

• tested party;

• selected method;

• comparables;

• financial analysis;

• adjustments;

• conclusion.

IRD's Transfer Pricing Directive forms the core current administrative framework for this analysis.

Documentation Should Be Prepared Before Audit

Transfer-pricing documentation prepared only after IRD issues an audit query is weaker than contemporaneous analysis.

The relevant economic facts should be documented when:

• agreement is entered;

• price is set;

• transaction occurs;

• year-end tax return is prepared.

Section 33 Adjustment

If IRD concludes that associated persons did not transact under normal market behaviour, Section 33 allows IRD to reallocate:

• income;

• expenses;

• deductions

to reflect the appropriate taxable result.

This can lead to:

• additional taxable income;

• tax;

• interest;

• penalties.

Safe Harbour — New for FY 2083/84

Finance Act 2083 introduced:

Section 33 A — Safe Harbour

into Nepal's transfer-pricing framework.

A safe harbour allows qualifying controlled transactions satisfying prescribed statutory conditions to use an accepted arm's-length benchmark instead of completing the full ordinary pricing dispute process.

This does not abolish Section 33.

Transactions outside the statutory safe-harbour conditions remain subject to the ordinary arm's-length regime.

Safe Harbour — Source and scope

Section 33A identifies specified safe-harbour transaction categories, including:

• IT/IT-enabled service exports;

• qualifying related-party foreign-currency financing;

• low-value-added services.

Apply the exact section 33A conditions and confirm the operative IRD implementation and election procedure before using safe harbour. The statutory category alone does not establish that a particular taxpayer or transaction qualifies.

Retain the eligibility calculation and election evidence with the transaction file.

Advance Pricing Agreement — Section 33 B

Finance Act 2083 also introduced:

Section 33 B — Advance Pricing Agreement

providing a statutory framework for advance certainty on pricing of qualifying international associated-person transactions.

An APA can be particularly useful for recurring material transactions such as:

• royalty;

• contract manufacturing;

• captive service centre;

• intercompany financing;

• distribution structures.

APA vs Safe Harbour

Safe Harbour

Taxpayer follows prescribed statutory conditions.

APA

Taxpayer and tax administration agree in advance on an appropriate transfer-pricing methodology/outcome for covered transactions.

Ordinary TP

Taxpayer prices at arm's length and supports the result under Section 33 and the Directive.

These are three different compliance mechanisms.

Existing Rule 15 History

Before the new statutory APA framework, Income Tax Rule 15 already contained a transfer-pricing arrangement mechanism, and IRD's Directive discussed advance pricing arrangements under Section 33/Rule 15.

Finance Act 2083 has now given APA a more explicit statutory foundation through Section 33 B.

Current Rules/fees/procedural requirements should be checked when an APA application is actually contemplated.

Tax Return

Related-party transactions should be reconciled to:

• financial statements;

• tax computation;

• withholding returns;

• customs values where relevant;

• foreign-exchange records;

• DOI/NRB agreements.

A transfer-pricing report that does not reconcile to the ledger has limited practical value.

Customs vs Transfer Pricing

An import transaction can face two different valuation perspectives:

Customs

Is import value acceptable for customs duty/VAT?

Transfer Pricing

Is price arm's length for Income Tax?

A low import value might reduce customs duty but increase Nepal profit.

A high import value might reduce Nepal taxable profit but increase customs exposure.

Groups should maintain a defensible consistent valuation position.

Example

Nepal subsidiary provides software-development services to foreign parent.

Annual operating cost: NPR 50,000,000.

Intercompany revenue: NPR 53,000,000.

Operating profit: NPR 3,000,000.

Margin on cost: 6%.

The company cannot conclude:

“6% is arm's length”

without determining:

• functions;

• assets;

• risks;

• comparable independent margins;

• applicable ordinary/safe-harbour rule.

Transfer Pricing Checklist

• Identify related persons

• Identify all cross-border transactions

• Reconcile to ledger

• Obtain agreements

• Perform FAR analysis

• Determine tested party

• Select TP method

• Search comparables

• Calculate arm's-length result

• Consider Safe Harbour

• Consider APA for recurring material transactions

• Review withholding

• Review VAT

• Review DOI/NRB

• Prepare contemporaneous documentation

• Reconcile with annual tax return

• Update analysis annually

Common Errors

Believing group invoices automatically establish arm's-length price

Using NRB-approved interest as automatic tax arm's-length rate

Paying royalty without proving IP benefit

Preparing TP documentation only after an IRD audit begins

Using one method for every transaction

Applying Safe Harbour without satisfying statutory conditions

Treating Safe Harbour as replacement for the entire TP regime

Further guidance and practical checks

Transfer pricing should be built into the transaction before the invoice is issued. Agreement → economic substance → pricing → withholding → accounting → TP documentation should remain consistent.