VAT 99-2/final - empcom.gov.in

60 VAT MONITOR Vol. 10 No. 2, March/April 1999 

1. BACKGROUND 

Nothing has become as popular as VAT in the field of taxation 

in the 20th century. The tax generated interest in both 

the academic and the non-academic world as soon as it 

was invented in the first quarter of this century. Wilhelm 

von Siemens recommended VAT for Germany in 1919 to 

replace the German Umsatzsteuer (multi-stage sales tax) 

to avoid the problems of the latter tax, including cascading 

and vertical integration. 2 The German Government seriously 

considered introducing VAT but due to the fear of 

administrative complications involved with this tax, it 

decided to lower the rate of Umsatzsteuer instead, in order 

to minimize negative effects of this tax. 3 Professor 

Thomas S. Adams proposed VAT for the United States of 

America in 1921. 4 The Shoup Mission 5 designed a detailed 

structure of VAT (Fuka-Kachi-Zei) for Japan in 1949. The 

tax was recommended to replace enterprise and turnover 

taxes. VAT law was passed by the Japanese diet but the 

implementation of VAT was postponed several times due 

to fear of its complicated nature. 6 

France introduced VAT for the first time in 1954. Ivory 

Coast and Senegal introduced VAT in 1960 and 1961 

respectively while Denmark and Brazil adopted it in 1967. 

VAT became popular as it was accepted as the model tax 

system for the European Union (EU) (then European Economic 

Community) countries in the late 1960s. Of the six 

original member countries of the EU, Germany introduced 

VAT in 1968 and others in the following years. Non-EU 

countries also followed suit for various reasons. For example, 

Korea introduced VAT in 1977 to simplify the 

indirect tax system, to promote exports and capital formation 

and to preserve neutrality of indirect taxes by amalgamating 

various commodity-based taxes into one broadbased 

VAT. 7 New Zealand introduced VAT in 1986 in 

order to shift reliance from direct taxes to indirect taxes. 8 

Singapore introduced VAT “to shift the burden of tax from 

direct tax to indirect tax, to make Singapore’s economy 

internationally competitive and to develop a broad based 

and more stable source of tax revenue”. 9 Many developing 

countries introduced VAT to mobilize additional 

resources as well as to avoid the problems of other types of 

sales taxes such as import/manufacturing level sales tax. 

PREPARATION AND 

IMPLEMENTATION OF VAT IN 

NEPAL 

Rup Khadka 1 

© 1999 International Bureau of Fiscal Documentation 

By now, many rich and poor countries, developed and 

developing countries, small and big countries, and socialist 

and capitalist countries have adopted VAT. This tax is 

under active consideration in many other countries. 

2. NEED TO INTRODUCE VAT IN NEPAL 

Nepal introduced VAT in 1997 for several reasons. One of 

the important reasons was to develop a stable source of 

revenue by broadening the tax base. It must be noted that 

Nepal had been generating the bulk of its tax revenue from 

import duties. This became possible because of the restrictive 

economic policies adopted by India until the beginning 

of the 1990s. Indian tourists were attracted to buy 

goods imported from the third countries in the Nepalese 

market. These goods also used to be deflected to India by 

both the Indian and Nepalese traders. The scope of this 

type of trade, however, has been decreasing due to the 

opening up of the Indian economy since the early 1990s. 

There has been a drastic reduction in the import tariff, 

quantitative restrictions and a licensing system in India 

since 1991. As a result, the volume of the third country 

import in the Nepalese market meant for the Indian buyers 

has been shrinking. Further, Nepal has reduced its import 

1. Dr Rup Khadka is a consultant to the VAT Project Nepal. He 

would like to express his gratitude to Mr Nick Lawrence for his comments 

on an earlier draft of this article. 

2. John F. Due, Sales Taxation, University of Illinois Press, Urbana, 

1957, p. 138. 

3. Ibid., p. 66. 

4. George N. Carlson, Value Added Tax European Experience and 

Lessons for the United States, Office of Tax Analysis, Department of 

Treasury, 1980, p. 6. 

5. A tax mission led by Professor Carl S. Shoup designed a comprehensive 

tax reform plan for the reconstruction of the Japanese economy 

in 1949. 

6. Rup Bahadur Khadka, “Focus on Japan”, 2 International VAT 

Monitor 9 (1991), at 12. 

7. Kwang Choi, “Value Added Taxation: Experiences and Lessons of 

Korea”, 2 Asian-Pacific Tax and Investment Bulletin 6 (1984), at 231. 

8. John Prebble, “Tax Reform in New Zealand”, Tax Reform in the 

Asian-Pacific Countries, Asia-Pacific Tax and Investment Research 

Center, Singapore, 1986, p. 24. 

9. Glenn P. Jenkins and Rup Khadka, Value Added Tax Policy and 

Implementation in Singapore, Working Paper Series 1001, International 

Tax Program, Harvard Law School, October 1997, p. 6.

Vol. 10 No. 2, March/April 1999 VAT MONITOR 61 

tariff in line with the liberal economic policies adopted 

since 1992/93 and in line with the customs duties reform 

taking place around the world generally but in particular in 

India. Consequently, import duties will be less important 

in the future than they were in the past. The process has 

already begun as the relative position of import duties 

decreased from 37% in 1990/91 to 34% in 1996/97. Furthermore, 

Nepal will not be in a position to levy import 

duties on trade that takes place within the South Asian 

Association for Regional Co-operation (SAARC) region 

after the implementation of the South Asian Free Trade 

Agreement (SAFTA). This means that Nepal will have to 

become less dependent on international trade taxes for its 

revenue, which is also desirable from an economic 

resource allocation point of view. 

The base of the domestic trade taxes has been narrow as 

well since the share of the total economy that flows 

through market channels is relatively small. The potential 

tax base became even smaller as sales tax used to be collected 

at the import/manufacturing point. The large number 

of exemptions granted on socio-political grounds and 

weak tax administration only aggravated the problem. The 

narrow tax base had been eroded further due to compliance 

weaknesses that have tolerated the understatement of 

Table 1: Fiscal position of HMG/N 


import value/ex-factory price and/or smuggling. Since the 

sales tax was not levied at stages beyond the import/manufacturing 

point, there was no possibility of capturing the 

evaded tax at a point further down the trade channels. 10 It 

has also been necessary to transfer some of the national 

level taxes such as land revenue, house and land tax and 

vehicle tax to the local bodies in order to make them financially 

more autonomous. This means that there is no 

choice but to introduce VAT in Nepal to generate revenue 

required to improve its deteriorating macro-economic performance. 

As indicated in Table 1, the budgetary position 

of His Majesty’s Government of Nepal (HMG/N) is very 

weak. In 1983/84 prices, the development expenditure was 

NPR 7,459 million in 1996/97 compared to NPR 8,087 

million in 1990/91. The decrease in development expenditure 

may be due to the frequent changes in the government 

that hampered development activities considerably. This 

is not a desirable situation in a developing country like 

Nepal. On the other hand, regular expenditure has been 

increasing due to the increasing debt services, national and 

local elections, and other administrative activities. While 

revenue growth was encouraging until the mid-1990s, it 

has been deteriorating since then. This trend needs to be 

reversed in order to avoid a possible fiscal crisis. 

(NPR in million in 1983/84 prices) 

Description 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 

total expenditure 11918 11049 11866 11842 12790 14095 14255 

regular 3831 4143 4410 4374 6308 6530 6797 

development 8087 6906 7455 7468 6482 7565 7459 

receipts 6526 6339 7274 7936 9336 9909 10246 

revenue 5430 5652 5817 6902 8047 8447 8537 

foreign grants 

overall surplus (+) 

1096 688 1457 1034 1289 1461 1709 

or deficit (–) 

sources of financing 

– 5392 – 4710 – 4592 – 3906 – 3454 – 4187 – 4010 

foreign loans 3166 2851 2658 3230 2394 2866 2523 

internal loans 2304 870 622 642 622 666 843 

cash balance (–) 

Source: Calculated by using CPI. 

79 – 989 – 1312 – 35 – 437 – 654 – 643 

A VAT system is needed for revenue purposes as an alternative 

tax system to import tariffs. At the same time, the 

VAT system promotes the interchange of information 

between the other tax systems, particularly trade taxes as 

customs information is required to determine the validity 

of input tax credits claimed. The VAT should not only be 

an effective instrument to generate substantial revenue at 

customs points, but also help streamline tax policy in general. 

VAT has a natural link with the income tax. Currently, 

the main basis of the income tax assessment in the 

case of importers is the information supplied by the customs. 

But only a fraction of such information reaches the 

tax administration. VAT will provide the information on 

imports, local sales and input costs that can be used to 

assist in the effective implementation of the income tax. 

Furthermore, it is necessary to introduce VAT for several 

other reasons. The import/manufacturing level sales tax 

discriminated against the domestic products vis-à-vis 

imports because the profit margin of the manufacturers 

were included under the base of this tax but not the profit 

margin of the importers. Further, there was chronic undervaluation 

in the case of imports. This means that the effective 

rate of import/manufacturing level sales tax became 

10. For details, See Rup Bahadur Khadka, “A Review of the Nepalese 

Sales Tax”, 4 International VAT Monitor 2 (1993), at 8-14.


higher on domestic products than on imports although the 

nominal tax rate was the same for both sets of goods. A 

VAT system puts an equal burden on both imports and 

domestic products since the burden of this tax depends 

upon the final price irrespective of the proportion of value 

added at different stages in the process of import/production 

and distribution. Further, VAT can be applied anywhere 

in the economy without leading to a cascading/ 

pyramiding because it employs a credit mechanism. It also 

relieves exports completely free from the burden of taxation 

through the zero-rating of exports and the refund system 

for excess credit. 

The implementation of a VAT in Nepal was also expected 

to establish an account-based modern transparent tax system. 

The import/manufacturing level sales tax was not 

levied on the actual selling price but on the notional sale 

value which included the ex-factory price/import value 

and the amount of excises/import duties. This means that 

the determination of the sales tax base invited the problems 

associated with the determination of the base of the 

excises or import duties. In the case of domestic products, 

sales tax registered manufacturers were also required to 

get their prices approved by the tax officials. In the case of 

excisable items, manufacturers have not only to get their 

ex-factory prices but also dealer, wholesale and retail level 

prices approved by the excise authorities. There was a possibility 

of either collusion or prices negotiated by harassment 

between tax officials and taxpayers. There was a 

general lack of administrative capability to determine the 

taxable value in a realistic way. So the prices were fixed 

arbitrarily. Taxpayers also used to complain that tax officials 

give their approval only when prices had to be raised, 

but not when they had to be reduced, meaning that manufacturers 

had to pay tax on previously determined high 

prices even if the actual prices had fallen due to the reduction 

in the prices of raw materials and other market conditions. 

As VAT is based on transaction value, there is no 

need to fix arbitrary or artificial values for tax purposes 

under this system. 

For the above-mentioned reasons, HMG/N decided to 

introduce VAT. The Eighth Plan (1992/93-1996/97) 

adopted a policy to introduce a VAT in place of several 

minor commodity taxes in order to establish a sustainable 

source of government revenue. 

3. VAT PREPARATION 

VAT preparation began in September 1993 when a VAT 

task force was created in order to make necessary preparation 

for the introduction of VAT. A VAT Steering Committee 

was also set up to evaluate and monitor VAT 

preparatory activities. 11 The United States Agency for 

International Development (USAID) provided financial 

assistance in order to support the VAT preparation and 

implementation process in Nepal. Under this project, the 

technical assistance of the Harvard Institute for International 

Development (HIID) began in the fall of 1993. 


Members of the VAT task force and the HIID consultants 

worked together. USAID/HIID assistance was supposed 

to last until August 1996. 

However, a change of government took place in late 1994 

when a minority government was formed. The new government 

did not show the same commitment in the beginning 

to implement VAT. Consequently, the USAID activity 

was suspended at the beginning of 1995. The new 

government, however, kept the idea of VAT alive. This 

government appointed a Tax System Review Task Force 

in order to review the overall tax system and recommend 

measures for the reform of the tax system and tax administration. 

The task force strongly recommended VAT for 

the rationalization of the Nepalese tax system. There was 

again a change in the government in late 1995 when a new 

coalition government was formed. This government 

decided to introduce VAT at the earliest date. As a consequence, 

the USAID/HIID technical assistance resumed in 

February 1996 for a period of about 8 months. The 

USAID/HIID assistance was later extended and continued 

until the end of September 1997. Assistance for the implementation 

of the VAT was continued beyond September 

1997 through financing provided by the Danish Government. 

The DANIDA assistance, which was originally 

meant for 2 years, is likely to be extended for another 2 

years. 

3.1. Design of VAT law and VAT system 

The VAT law was drafted in 1994. It was discussed in 

depth at several stages within the VAT task force, with the 

Secretary of the Law Reform Commission and with various 

business groups. It was reviewed by the VAT Steering 

Committee. The draft was sent to various business groups, 

including the Federation of Nepal Chamber of Commerce 

and Industry (FNCCI) and Nepal Chamber of Commerce 

for their comments. While this was a good beginning to 

seek the opinion of the private sector on the proposed 

VAT law before its passage by the parliament, no written 

comments were received from the private sector on the 

draft VAT Act. 

The VAT Bill was presented to the parliament on 3 

December 1995. It was referred to the Finance Committee 

where it was discussed on 24, 25, and 26 December 1995. 

The Finance Committee sent the Bill to the parliament on 

27 December 1995 together with its report for amendments 

to a few provisions. The Lower House of Parliament 

passed the VAT Bill on 30 December 1995 and the 

Upper House of Parliament on 4 January 1996. The VAT 

Act received the Royal seal on 20 March 1996. 

The VAT regulations were drafted in July 1996. Like the 

VAT Act, the regulations were discussed at different 

stages. They were sent to the FNCCI for comments. As in 

11. Since then VAT task forces and steering committees were formed 

or reorganized several times in connection with the preparation and 

implementation of VAT.


the case of the VAT Act, no comments were received from 

the private sector on the VAT regulations. Cabinet 

approved the regulations on 27 January 1997. 

The Operational Manual was initially drafted in 1996 and 

was finalized in the fall of 1997. HMG/N approved the 

operational manual on 21 September 1997. The manual 

has been prepared in nine volumes covering all aspects of 

VAT from the law through to investigation of offenses. 

They are: (1) Organization and management, (2) Charging 

and accounting for value added tax, (3) VAT registration, 

(4) Collection and enforcement, (5) Payment of claims for 

refund, (6) Verification and audit, (7) Fraud investigation, 

(8) The VAT computer system, and (9) VAT Act and 

rules. 

The Manual is expected to facilitate day-to-day administration 

and reduce the risk of varying interpretations of the 

tax laws by different officials. In addition, a number of 

computer user manuals have been produced. 

VAT law has stipulated a consumption type VAT using 

the credit method, which is based on a destination principle 

and extended right through the retail level. It is levied 

with a single rate of 10%. Exports are zero-rated while 

several items such as unprocessed food, live animals, and 

livestock feed, medicine and books are exempt. Taxpayers 

are allowed to take immediate credit of the tax paid on 

their inputs. However, only 40% of the input tax is 

deductible on automobiles and aeroplanes. The corresponding 

figure is 60% for computers. No credit is given 

for the tax paid on petrol. Excess credit is to be carried forward 

for 6 months. A VAT refund arises under the following 

situations: 

– where a person exports more than 50% of his total 

sales in any one month; 

– where a person is in credit for a continuous period of 6 

months; 

– to accredited diplomats, foreign agencies and foreign 

funded projects. 

Taxpayers are required to issue tax invoices and collect 

VAT on their sales. There is a provision for abbreviated 

invoices in the case of low value sales of less than NPR 

500. Taxpayers are required to keep a record of their purchases 

and sales and submit a monthly return within 25 

days of the end of that month. Voluntarily registered taxpayers 

can submit quarterly returns. Taxpayers are 

required to pay the tax within 25 days of the close of the 

month. VAT is based on the principle of self-assessment. 

Official assessment is made only in the following circumstances: 

– where a return is not submitted on time; 

– where an incomplete or incorrect return is identified; 

– where a VAT return is found to be fraudulent; or 

– where a tax officer has reasons to believe that the 

amount of VAT has been understated or is otherwise 

incorrect. 


Taxpayers can file an appeal at the Revenue Tribunal 

against a tax assessment or a penalty order by the tax 

office within 35 days of receipt. 

3.2. Taxpayer education programme 

As VAT is a tax based on the self-assessment of taxpayers, 

their cooperation is essential for the success of this tax. It 

was, therefore, planned to educate the potential taxpayers 

before the tax was introduced. It was also necessary to dispel 

some of the fears of VAT held by business communities 

and to give them and others some idea of the structure 

and operation of VAT and its possible effects on their particular 

businesses. 

To this end, a comprehensive VAT education programme 

was launched. Information was disseminated on a large 

scale through the media. Seminars and public speeches 

were organized at various places for various groups. For 

example, VAT interaction groups were held with the 

FNCCI, many district chambers of commerce and industry, 

commodity associations and professional organizations. 

Similarly, VAT presentations were made at programmes 

arranged by different organizations, including 

various training centres, universities, campuses, schools, 

and rotary clubs. 

General brochures for all, and special brochures for particular 

groups (such as hotels, travel agencies, importers and 

exporters, consumers) were developed and distributed. 

Most of the brochures were produced in both English and 

Nepali versions. 

In addition to the above, many articles on aspects of VAT 

were written and published in national newspapers. Different 

posters were also prepared. Similarly, three VAT 

videos have been produced and broadcast. They are: “A 

brief introduction to VAT”, “The impact of VAT on 

prices”, and “VAT registration”. Similarly, many TV and 

Radio programmes were organized on aspects of VAT. An 

information service was provided to callers from business 

and the general public. 

In the middle of 1997 it was decided to hire a local advertising 

company to create and carry out the overall information 

strategy through television, radio, newspapers, 

posters, brochures, etc. Information relating to activities 

such as the date of the introduction of VAT, the period 

within which taxpayers must register, the date of submission 

of returns and payment of tax, VAT accounting systems, 

penal provisions, etc. were advertised widely 

through the media. 

The taxpayer education programme continued even after 

the introduction of VAT. Through the advertisements, taxpayers 

were invited to participate in VAT training programmes 

in the VAT Department as well as VAT offices. 

Participants did not have to pay any fee for these courses. 

Thus an extensive taxpayer education programme was 

launched to educate potential taxpayers and others in most


aspects of VAT. The focus of these programmes was on 

the business community. It was a right approach to explain 

to them the rationale and working of VAT and to get input 

for the refinement of the draft law. The business community, 

however, did not care about the rationale of VAT and 

were not serious in learning VAT formalities. Instead they 

have been opposing VAT strongly even since its introduction. 

The government was criticized for organizing interaction 

programmes mainly for the business community 

that was not serious and ready to accept VAT. Consequently, 

the taxpayer education programme intended for 

the business community was not that effective. The business 

community did not believe in the introduction of 

VAT. 

Attempts also have been made to educate consumers on 

different aspects of VAT. To this end, posters and 

brochures have been prepared and distributed. Similarly, 

television programmes have been developed and broadcast. 

The business community, who tried their best to turn 

consumers against VAT by making propaganda that VAT 

is inflammatory, could not lure them. This was assumed to 

be the result of the VAT education programme launched 

for the consumers. 

3.3. Administrative reorganization 

The sales tax and excise administration was made responsible 

for the administration of VAT. The Sales Tax 

Department, which was established only in 1992, was in 

its infancy. The unification of the Excise and Sales Tax 

Department in 1993 had expanded the scope of this administration 

regarding the number of tax officials and tax 

offices. This administration had 18 field offices and 471 

officials, and of these officials, 47 were gazetted (officer 

level) and 424 non-gazetted (assistant level). The number 

of non-gazetted level posts was very large. Most of these 

officials had previously worked in the excise administration. 

They were not familiar with the sales tax administration. 

The organization of the sales tax and excise offices was 

not functional; the same officer was responsible for registration, 

assessment and collection. Such a system was corruption-prone. 

Further, under this organization, there was 

a lack of inspection, audit and enforcement. Furthermore, 

sales tax and excise administration had been viewed as the 

least important part of the total revenue administration. 

Revenue officials used to prefer to work either in the tax or 

the customs departments. In general, officials who could 

not be accommodated in the tax or customs departments 

used to be transferred to this department. Thus the sales 

tax and excise administration, which collected more than 

40% of total tax revenue, was very much neglected. 

Such an administration was not appropriate or adequate 

for the implementation of VAT. It was, therefore, necessary 

to revamp and reorient this administration due to the 

modern nature of VAT. In this context, a study of the sales 

tax and excise administration was conducted. This estab- 

lished that the sales tax and excise administration was not 

functional and unsuited for VAT. A revised organizational 

system based on functional requirements and setting out a 

hierarchy of personnel responsibility was drawn up and 

recommended. 12 This had been largely accepted and the 

new system was approved and implemented in July 1996. 

Under the new structure sections and subsections were 

created on the basis of the function of VAT administration. 

Large taxpayer, tax refund, taxpayer services, tax 

audit and investigation, internal monitoring, collection 

and registration are important sections of VAT administration. 

The number of gazetted officers was increased substantially 

while the number of non-gazetted personnel was 

reduced drastically. 

The total number of staff positions within the VAT organization 

is 494, out of which 120 are gazetted, 261 are 

non-gazetted, including accountants and computer operators 

and 113 are peons/drivers. The Public Service Commission 

could not recommend required officials on time. 

Consequently, not all positions were filled by 16 November 

1997, i.e. the date of VAT introduction. While almost 

all gazetted positions in district offices were filled, 16 out 

of 37 gazetted positions were not filled in the Department. 

Out of the 261 non-gazetted positions, 82 positions were 

vacant. Due particularly to the vacancy of the high level 

positions, some tasks like internal monitoring and analysis 

of computer output could not be done on time. Similarly, 

the lack of non-gazetted staff has created problems at the 

district offices whose work has increased substantially 

after the introduction of VAT. 

3.4. Training 


It was necessary to train officials recruited for VAT 

administration on various aspects of VAT before they 

were assigned particular jobs. To this end, various training 

programmes were organized in order to familiarize tax 

officials with VAT. These programmes were mounted not 

only for VAT Department and VAT District office personnel, 

but also officials of the Customs Department, Tax 

Department, Ministry of Finance, Revenue Investigation 

Department, Revenue Administration Training Center, the 

Accountant General’s Office, and the Auditor General’s 

Office. 

Training of tax officers continued even after the introduction 

of VAT. Training programmes organized before the 

introduction of VAT were more general. After the introduction 

of the VAT, the concentration was on specific 

training programmes. In this connection, special training 

programmes on specific issues such as refunds, collection, 

accounting and auditing were organized. Similarly, a system 

was established to organize workshops for the chiefs 

of VAT offices every 2 months to share experience. With 

12. It was very difficult to get approved the new organizational and 

personnel system from the Ministry of General Administration that was 

blocking the work without any reason.


finance from the Dutch Government, the International 

Bureau of Fiscal Documentation (IBFD) organized a 3week 

training programme in Amsterdam beginning on 18 

November 1996. IBFD also organized another training 

programme of 2 weeks in Kathmandu from 30 November 

to 11 December 1998. 

Training has been provided in the field of computerization 

as well. First computer training was provided to data entry 

clerks on the use of the registration module. Training has 

also been provided on the manual procedures needed for 

the operation of a computer system. VAT officials were 

also trained on batching procedures, with emphasis on the 

importance of registration controls. Now computer training 

is being provided on various aspects of VAT application. 

3.5. Computerization 

An attempt has been made to set up a computerized VAT 

administration. Initially, it was planned to computerize the 

whole VAT administration in one go. But this was 

changed at a later date due to the budget constraints and 

other problems, including personnel problems. It was 

decided to computerize the VAT Department first and 

extend it to the VAT offices in a phased manner. 

A local area network (LAN) has been established in the 

Department and is running well. Several modules such as 

registration, returns, payments and refunds were developed 

before the introduction of VAT. However, only the 

registration module was tested before the introduction of 

VAT. Other modules relating to returns, payments, 

refunds, computerized accounting systems, computer generated 

assessments for taxpayers that failed to file tax 

returns, and computer selection of taxpayers for verification 

and audit were tested after the introduction of VAT 

and a few changes have been made and a few facilities created. 

Such changes were expected when this new system 

was introduced and implemented. 

Under the centralized data processing system, documents 

such as application for VAT registration, VAT returns, 

payment vouchers, etc. are received first by the VAT 

offices and batched to the VAT Department. Data entry 

and processing is done at the computer section in the VAT 

Department and necessary printouts are sent to the VAT 

offices. 

Now the VAT Department is fully computerized regarding 

registration, returns, collection, payment, audit and penalties. 

The computer system provides such outputs as registration 

certificates, a registrants’ list, a non-filers list, posting 

reports, outstanding reports, audit trial reports, refund 

claims, revenue reports, suspended reports, and closing 

reports. These are generated by the taxpayer and the VAT 

office. 

The VAT administration has now gained some experience 

in computerization at Department level. After this experience, 

attempts have been made to computerize VAT 

offices. Decentralized data entry and processing began on 

an experimental basis in September 1998. First Lalitpur 

VAT office was selected. The reasons for the selection of 

Lalitpur office was that it was easier to monitor it closely 

by the computer experts located at the VAT Department 

since it is only a few hundred meters away from the VAT 

Department. For similar reasons, Kathmandu VAT office 

was selected next. These two offices constitute about 47% 

of total taxpayers and they collect more than half of total 

domestic VAT revenue. The decentralized data processing 

has been running smoothly in both of these offices. In the 

second phase, VAT offices located outside the Kathmandu 

Valley were selected for decentralized data entry and processing 

systems and it was planned to computerize all 

VAT offices by the end of 1998. 

Unlike the centralized system, VAT offices will not batch 

such documents as applications for registration, VAT 

returns, payment vouchers, etc. for the VAT Department 

under the decentralized system. Instead, VAT offices will 

enter data themselves and transmit it to the Department, 

which in turn will validate the batches transmitted before 

posting to taxpayers accounts. 

The decentralized data processing system is expected to 

save time and provide data on time since the computerization 

will be done at the VAT offices, which are much 

closer to the taxpayers. It will be easier for the tax officers 

to correct errors since they can obtain data by telephoning 

or visiting the concerned taxpayers under their area of 

jurisdiction. It will help to give more correct information 

on time since it will save the postal time that takes 2 weeks 

or more in some cases. It is also expected to improve taxpayer 

services and help accelerate collection and reporting 

systems. 

3.6. Manual system 


A manual system was set up in all VAT offices to keep 

track of at least large taxpayers. The purposes of this manual 

system are: 

– to make the tax officers familiar with VAT procedures; 

– to compare output from the computer with calculations 

made manually; 

– to ensure that large taxpayers submit returns and pay 


The tax offices have been asked to inform the Department 

in case of differences between manual calculations and 

computer printouts. This information was used to analyse 

the function of the computer system. 

The Department selected companies to be handled under 

the manual system parallel to the computer system. Total 

taxpayers selected for the manual system covered 6% of 

the total number of registered businesses and 20% of total 

transactional value.


4. VAT IMPLEMENTATION 

The VAT Act came into force on 16 November 1997 13 

when the Sales Tax Act 1966 14 was repealed. The 

import/manufacturing level sales tax was converted into 

VAT on this date. 

4.1. Registration 

As per the gazette notification of the government, all sales 

tax registered firms15 were supposed to be converted into 

VAT registrants by 16 November 1997. Other firms, 

which were not registered under the sales tax, were 

required to be registered within 90 days from 16 November 

1997. A number of taxpayers registered under the sales 

taxes were found not to have converted to VAT by 16 

November 1997. VAT officers visited some of these. 

Some of them assumed that since they were already in the 

tax net, they would be automatically converted to VAT. A 

list of these firms was sent to each VAT office for further 

action. A few more firms were converted into VAT registrants 

after action by the VAT offices. 

The trend of the number of VAT registrants is given in 

Table 2. As shown in this table, the total number of VAT 

registrants on 9 December 1997 was 2,320. The number 

increased to 2,596 on 2 January 1998, 2,870 on 2 February 

1998 and 3,025 on 13 February 1998, the last date for 

compulsory registration for VAT. Despite the strong 

opposition to VAT from the business community, the 

number of VAT registrants increased gradually, reaching 

about 5,000 by the end of the fiscal year 1997/98 (i.e. 15 

July 1998) and around 6,500 by the end of 1998. 

Table 2: Trend of VAT registrants 

Date Number Change percentage 

09.12.97 2320 – 

02.01.98 2596 11.90 

02.02.98 2870 9.55 

03.03.98 3543 23.45 

02.04.98 4290 21.08 

17.05.98 4699 9.53 

17.08.98 5618 13.29 

18.09.98 5920 5.38 

Source: VAT Department 

The VAT administration has already gained experience in 

the field of registration. The registration process has been 

running smoothly at both VAT offices and the VAT 

Department. The computer module dealing with registration 

has been working well. An updated list of VAT registrants 

is sent to each VAT office every month. 

4.2. Return submission/Non-filers 

The first VAT return was to be submitted on 9 January 

1998. A large number of taxpayers since then have submitted 

returns by the due date. Until now, the number of 

credit returns has been higher than the debit returns. VAT 

returns are being scrutinized on a regular basis. 

Not all taxpayers, however, submit returns on time. The 

status of non-filers is given in Table 3. About 12% of registrants 

have been non-filers in the recent months. Non-filers 

are mainly small taxpayers, particularly small contractors, 

whose turnover is lower than the threshold but have 

been registered for VAT due to the requirement to submit 

a copy of the VAT registration certificate in order to bid 

for government contracts. These non-filers have been 

reminded to file their returns and have been visited since 

February 1998. 

Table 3: Status of non-filers 

Month Number 

mid-Nov. to mid-Dec. 1997 560 

mid-Dec. to mid-Jan. 1998 709 

mid-Jan. to mid-Feb. 1998 603 

mid-Feb. to mid-Mar. 1998 843 

mid-Mar. to mid-Apr. 1998 535 

mid-Apr. to mid-May 1998 771 

mid-May to mid-June 1998 579 

mid-June to mid-July 1998 630 

mid-July to mid-Aug. 1998 740 


4.3. Revenue position 


VAT is expected to generate NPR 9,420 million in 

1998/99. Out of this NPR 6,500 million is expected to be 

collected on import at customs points and the rest from 

VAT registrants. This means that almost 70% of total 

VAT revenue will be collected from imports and about 

30% from VAT registrants. The trend of VAT revenue 

collected from VAT registrants in various months of fiscal 

year 1997/98 and the first few months of fiscal year 

1998/99 is given in Table 4. 

13. 1 Marg 2054 according to the Nepali calendar. 

14. The Hotel Tax Act 2018, the Contract Tax Act 2023, and the 

Entertainment Tax Act 2016 were also repealed on 16 November 1997. 

The entertainment tax, however, continued to be levied under the 

Finance Act 1997 even after the introduction of VAT and the abolition 

of the Entertainment Tax Act. Similarly, as per the Finance Act 1997, 

contractors were given an option to pay the contract tax or to come 

under the VAT regime in the case of contract signed before the introduction 

of VAT. 

15. In the middle of November 1997, 2045 firms were registered for 

the sales tax.


Table 4: Status of VAT collection 

Month Amount 

(per thousand NPR) 

Change percentage 

mid-Nov. to mid-Dec. 1997 79,958 – 

mid-Dec. to mid-Jan. 1998 230,494 188.27 

mid-Jan. to mid-Feb. 1998 168,636 – 26.84 

mid-Feb. to mid-Mar. 1998 148,928 – 11.69 

mid-Mar. to mid-Apr. 1998 161,924 8.73 

mid-Apr. to mid-May 1998 189,849 17.24 

mid-May to mid-June 1998 200,216 5.46 

mid-June to mid-July 1998 205,498 2.64 

mid-July to mid-Aug. 1998 


235,257 14.48 

It was expected that the VAT revenue might fall in the first 

few months due to the credit claims by registered taxpayers 

on their stock. Taxpayers have claimed about NPR 400 

million as input tax credit in place of sales tax credit. It 

affected total collection in the first few months. The reduction 

in the rate of tax from 15% to 10% has been another 

reason for the shortfall in revenue. 

Besides, due to the resistance of the business community, 

not all potential taxpayers have been registered for VAT 

and not all registered taxpayers have submitted returns and 

paid tax on time. Also, the government did not take firm 

action due to the political situation. Further, since not 

many potential vendors are registered, cross-checking has 

not been possible and undervaluation and dummy sales by 

VAT registrants have been common. VAT has not been 

able to run properly. 

However, the tax will generate more and more revenue in 

the days to come when it is fully operational. It will provide 

a stable base of revenue for the government since it is 

a tax based on consumption. 

4.4. VAT visits 

Many taxpayers were visited during the initial stages of 

VAT implementation. The idea of these visits was to introduce 

taxpayers to VAT formalities. Priority was given to 

those taxpayers that phoned and asked questions and in 

this connection wanted to have a visit from the VAT 

administration. The tax officer has to prepare a report of 

each visit and keep it in the taxpayer’s file maintained in 

the district office. 

VAT officials also visited several taxpayers after a few 

months of VAT implementation. This time the visits were 

focused on both education and verification of the records. 

They discovered several errors in the records maintained 

by the taxpayers for VAT purposes. For example, some 

taxpayers had not maintained purchase and sales books as 

required while some taxpayers had not got their purchase 

and sales books certified by the tax officers. Some taxpayers 

had used computer accounting systems without prior 

approval from the tax office; some had not prepared 

invoices as specified by the VAT regulations; some had 

not printed or stamped the words “tax invoice” on the top 

copy; some had claimed tax credit on the basis of the second 

copy of the invoices; some had claimed for the full 

credit even when they used a part of their inputs in producing 

exempt supplies; some had not charged VAT on 

goods which are exchanged using the barter system and 

had not recorded such purchases or sales in the purchase 

and sales books; some had even claimed import duties as 

credit; some had not shown tax paid on telephone bills; 

some had recorded total purchase and sales figures instead 

of the purchase and sales figure for each invoice. Taxpayers 

were informed about these mistakes, consequently the 

number of errors decreased after a few months. 

4.5. Tax audit 

Tax audits by tax officials are a new concept in Nepal. It 

has been, however, an important aspect of VAT administration. 

The VAT Department has set up an audit core 

group of six tax auditors in order to discuss and review 

audit procedures on a regular basis. They have developed 

criteria for the selection of taxpayers for audit. A couple of 

firms have been selected for a detailed audit after 1 year of 

VAT implementation. Auditors have already found some 

cases of tax avoidance or evasion. For example, a Coke 

producer has been splitting the prices of Coke and bottles 

and crates and was charging VAT only on the price of 

Coke. Similarly, a company based in India has appointed a 

stockist in Nepal that has, in turn, appointed dealers 

around the country. The buying prices and the selling 

prices of the stockist have been the same and all expenses, 

including taxes on the stockist’s transactions are met 

directly by the Indian supplier. Under this arrangement the 

tax is being levied in the following way: 

purchase price of stockist 

NPR 

100 

transportation cost 5% 5 

total (base of import duty) 105 

import duty, suppose 10% 10.50 

total (base of VAT) 115.50 

VAT on import 10% 11.50 

selling price of stockist 100 

VAT on sales 10% 10 


input tax credit 1.50 (10 – 11.50) 

The stockist remains always in the credit position. His 

dealers, who may be related persons, escalate profit margins 

and sell goods at higher prices to the consumers. 

The third interesting case discovered by the auditors concerns 

a tyre dealer who also has a retail shop selling tyres 

in the name of his son. As per his records, he issues 

invoices understating the prices to different firms, other 

than his son’s firm, which are difficult to identify. The tax


auditors suspect that the tyre dealer might, in practice, be 

selling tyres through the retail outlet owned by his son. 

These are some of the cases discovered by the tax auditors 

during the course of an audit. As the auditors gain experience, 

the audit programme is expected to detect complicated 

cases of fraud, and generate more revenue. 

4.6. Tax refund 

The tax refund is the basic essence of VAT. So it must 

function properly. The credibility of the VAT system will 

be questioned if refunds are not processed timely. On the 

other hand, the tax refund system will be abused if the 

refund claims are not scrutinized properly. So a proper 

balance needs to be maintained between the two. 

Under the Nepalese VAT system, the first refund claim 

was expected in early January 1998. No refund claim was 

made until March 1998. Now some refund claims have 

been made. For example, the number of refund claims was 

35 amounting to NPR 57 million by the first week of 

December 1998. Out of this, 16 claims have been 

approved and NPR 31 million has been refunded. 

The number and amount of refund claims made so far is 

still very low compared to the potential. This might be for 

the following reasons: 

– taxpayers do not have confidence in the refund system 

due to past experience where it used to be a Herculean 

task to get money back from the government; 

– taxpayers are scared of having their records audited 

which might not be maintained properly; 

– tax officers discourage taxpayers from claiming 

refunds; 

– taxpayers do not know enough about the VAT refund 

system. 

Whatever may be the reason, it is not a good situation 

because taxpayers’ money is unnecessarily blocked. This 

leads to an increase in the cost of the economy and reduction 

in economic activities and ultimately brings contraction 

in the tax base, leading to a lower amount of tax collected. 

So tax officials should facilitate, not discourage tax 

refunds. The VAT administration must make an effort to 

run the refund system properly but this certainly does not 

mean that tax officials should not scrutinize fraud cases. 

5. VAT: SUCCESS OR FAILURE? 

Since experience of VAT is brief, it is too early to make an 

assessment. While VAT went live on 16 November 1997, 

the businesses that were not registered were allowed 90 

days to register. This means that full operation of VAT 

was postponed until 14 February 1998. However, due to 

the strong resistance from the business community, many 

big vendors did not register by the due date. Since the 

business community strongly opposed VAT, the government 

also did not take action against those businesses that 


did not register. Exemptions granted under the sales tax 

continued. The government has made several compromises 

in response to strong opposition and the tax has not 

been fully implemented yet. Not all potential taxpayers 

have been registered for VAT. Consequently, some buyers 

are registered but not the sellers. In other cases, sellers are 

registered but buyers are not. This means, there is no possibility 

of cross-checking, which is one of the important 

aspects of VAT. Several VAT registered vendors have 

been in a credit position for several months, indicating that 

they grossly understate their sales prices. Some vendors 

also issue invoices in the name of bogus firms. 

In some lines of business, a few sellers are registered while 

the majority are not. In such a situation, the registered one 

has been considering that he has been at a disadvantage. 

Registered sellers would not have been at a disadvantage 

due to the credit mechanism had all their suppliers been 

registered. But this is not the case today. In some lines of 

business, some firms do not want to buy goods from VAT 

registered suppliers due to the fear that the record of such 

purchases will be available to the VAT administration. As 

a result, VAT registrants have been finding difficulty in 

selling their goods to some firms. Some registrants are 

also subject to high penalties while their unregistered 

counterparts are free from any VAT formalities. Such a 

situation discourages new vendors to come under the VAT 

net. 

Further, due to the provision that HMG/N, constitutional 

bodies, government-owned corporations, etc. should make 

purchases exceeding NPR 25,000 from VAT registrants, 

some small suppliers such as contractors have been registered 

for VAT while other big firms are still outside the tax 

net. This does not seem good from several point of views, 

including justice. 

The implementation of VAT, however, has been improving 

gradually. The number of VAT registrants has been 

increasing slowly. Despite the huge sales tax credit carried 

forward and undervaluation, the revenue collection is not 

bad. The computer system is running well. The VAT 

administration is now in a position to generate information 

on VAT registrants, returns, non-filers, revenue collection, 

due amount, refund claims, credit tax, debit tax, etc. The 

tax administration has already gained some experience in 

the area of registration, collection, audit and refund. Technically 

speaking, the tax system is in good order. The 

implementation, however, has not been smooth due to the 

following reasons: 

5.1. Opposition from the business community 

The private sector has been divided on VAT issues from 

the outset. FNCCI, the apex body of the private sector, 

which is represented mainly by the industrialists, has been 

advocating the introduction of VAT with full preparation. 

The business community, particularly importers, has been


very hostile to VAT from the very beginning16 . While they 

could not challenge the principle of VAT, they were 

repeatedly saying that this tax could not be implemented in 

Nepal for several reasons. They raised several issues such 

as VAT is not suitable for Nepal, it is inflationary, it is 

complicated and it will encourage corruption. But these 

charges could not catch the sentiment of the mass, which 

was informed on different aspects of VAT through an 

extensive taxpayer education programme. Finally, the 

business community demanded that VAT be introduced 

from the beginning of the next fiscal year (i.e. from 16 July 

1998 instead of 16 November 1997) and the sales tax rate 

prescribed for the imports by non-registered persons 

should be reduced from 20% to 15%. They also demanded 

the continuation of all exemptions granted under the sales 

tax system. 

On 18 November 1997 government officials and the 

FNCCI representatives reached an agreement on VAT 

issues, including the creation of a technical committee in 

order to identify different problems met in the course of 

implementing VAT, to form a permanent revenue board, 

and continue with the facilities granted under the sales tax 

for 3 months. Under this agreement, all tax exemptions 

and incentives granted under the sales tax system were 

granted under VAT as well for 90 days and a technical 

committee was created on 15 December 1997. Representatives 

of the business community presented to the committee 

for discussion several issues such as the customs 

valuation, VAT and income tax treatment of stock, the 

time period for the declaration of stock, a review of the 

exemption list, the possibility of limiting VAT only to 

imports or the wholesale stage, reform of customs duties 

and income tax, partial VAT, penal provisions and creation 

of a permanent Revenue Board. 

Some of these concerns were genuine while others were 

ridiculous. For example, the demand for the improvement 

in the customs valuation system was genuine. This is 

because the Customs Department fixes values for customs 

purposes. These values are lower than the actual values of 

some commodities while higher than the actual values of 

others. In the case of overvaluation, taxpayers have to pay 

more VAT than actually required, while in the case of 

undervaluation they have to pay less VAT than actually 

required. Such an unrealistic valuation system has made it 

difficult to maintain proper accounts. This is because in 

the case of undervaluation, importers have to show a lower 

value than the actual purchase price in the purchase book. 

The importer fixes his selling price on the basis of the 

actual price he has paid, not on the basis of the value fixed 

for customs purposes. This leads to an artificially high 

value added and high profit and hence high income tax liability. 

Because of this importers did not issue an invoice 

showing actual selling prices, rather they stated much 

lower prices on invoices than they actually charged. On 

the other hand, in the case of goods subject to overvaluation, 

importers had to pay high tax and later on claim a 

refund. This created not only a cash flow problem but also 

difficulty in getting a refund since tax officials treat cases 


of tax credit with suspicion. Because of this problem, 

traders tried not to come under the VAT net. So customs 

valuation has been an impediment to the smooth and transparent 

running of VAT. The business community 

demanded the abolition of the customs valuation system. 

Another problem was the VAT and income tax treatment 

of stock. According to the VAT regulations, only the sales 

tax paid on purchases made within 1 year remaining in 

stock at the commencement of the VAT Act was allowed 

to be deducted in the case of the following goods: 

– on goods bought by taxpayers for resale; 

– on goods and services partially produced or ancillary 

goods for the business; 

– on raw materials, auxiliary raw materials, and packing 

materials. 

A taxpayer may submit an application to the tax officer in 

the prescribed form to have a deduction of sales tax paid 

by him on his stock of goods at the time of registration. 

These goods must have been purchased during the last 

year. He is also required to submit invoices of payment of 

sales tax and other documentary evidence within 15 days 

of registration. There is no provision allowing input tax 

credit in the case of goods that were in stock but did not 

meet these criteria. In such cases there was a possibility of 

double taxation and consequent price rises. 

Treatment of stock was a problem from the point of view 

of income tax also. This is because in the case of imports 

from third countries, income tax is also assessed on the 

basis of import documents. This means that importers 

have to pay income tax on the stock of imported 

goods. The business community demanded that they 

should not be asked to pay income tax again on such 

income tax paid stock. 

The business community also demanded a reduction in the 

customs and income tax rates. This was particularly 

important in the context that taxpayers would have to pay 

full tax in the post-VAT regime through the availability of 

the information on the business transactions of taxpayers 

under the VAT system. The business community at large 

was also scared of the transparency to be generated by the 

VAT system. This was also of concern to many tax collectors. 

Another concern of the business community was penal 

provisions. They considered that the penal provisions 

under the VAT law were very stringent and the tax officials 

would threaten them with such severe penalties. 

The business community also demanded an unusual type 

of VAT system, i.e. that for some selected commodities, 

VAT should be levied at each stage in the process of production 

and distribution without any threshold; for others, 

VAT should be limited to the import/manufacturing point, 

other items should be exempted from VAT and the tax 

should be levied only in some parts of Nepal, not every- 

16. The Nepal Chamber of Commerce set up an Anti-VAT Action 

Committee, which called for strikes several times.


where. It is difficult to think of such a VAT system. The 

business community also demanded the continuation of all 

exemptions and incentives granted under the sales tax system. 

They did not bother to consider the rationale of VAT. 

The technical committee discussed different issues. However, 

the decisions were not made on time by the government. 

In the meantime, FNCCI decided on 4 February 

1998 that it would not sit for negotiations with the government 

regarding the implementation of VAT unless the 

government abolished octroi, a local tax levied on goods at 

the city gates. 

After some time discussion took place again between the 

government and the private sector representatives and 

there was an agreement between them on 18 March 1998 

regarding the modalities of the implementation of VAT. 

They decided to continue some exemptions including the 

exemption of industrial machinery and tractors, to adopt a 

lenient approach regarding the implementation of VAT at 

the retail level, accept the bill value of imports for tax purposes, 

to set up a committee in order to review the VAT 

law and to establish a permanent revenue board. 

Since most of the points of the agreement were not implemented, 

the business committees continued to oppose 

VAT. Again negotiation began between the private sector 

and government after the formation of the new government 

in April 1998. A series of discussions took place 

before the presentation of the 1998/99 budget. The main 

points agreed by both parties were as follows: 

– in the case of VAT registrants, the bill value of 

imported goods will be accepted as its face value; 

– only VAT registered persons will be allowed to make 

commercial imports; 

– special provision will be made to avoid double taxation 

on goods in stock. Income tax will also not be 

levied on goods in stock if they are supported by proof 

of tax payment; 

– the threshold will be reviewed; 

– penalties imposed so far will be waived; 

– a committee representing both the government and the 

private sector will make recommendations for amendments 

to the law; 

– a permanent Revenue Board will be set up; 

– agreement made between the public and the private 

sectors will be advertised widely. 

The business community avoided signing the agreement. 

The government introduced some of the above-mentioned 

points in the 1998/99 budget which was presented to the 

parliament on 10 July 1998 together with the Finance Bill 

1998. Important legal changes introduced through the 

Finance Bill relating to VAT are outlined below: 

– The VAT threshold was increased from NPR 2 million 

to NPR 3 million. 

– All importers of commercial imports other than cottage 

industries are required to register for VAT. 

– Interest and penalties imposed in the fiscal year 

1997/98 will be waived when a taxpayer submits tax 


returns and pays tax and additional charges imposed 

under section 19 of the VAT Act. 

– A special arrangement will be made to allow taxpayers 

to claim an input tax credit on stock. Under this system, 

it will be assumed that taxpayers have paid 10% 

as sales tax/VAT of the declared value of stock. They 

will have to collect 10% VAT on such sales and claim 

75% of the collected VAT as an input tax credit. 

– The rate of interest was reduced from 18 to 15%. 

– The tax officer will make a tax assessment under Section 

13 of the VAT Act when a taxpayer cannot establish 

the reasons for the undervaluation (selling price is 

lower than purchase price) or discriminatory discounts 

(different rate of discount to different buyers). 

– In the case of late filing of tax returns, the rate of 

penalty is fixed at 0.1% per day instead of 100%. 

– Industries, companies, etc. with the approval of the 

department, will be allowed to claim an input tax 

credit equivalent to the amount of tax paid on the 

machinery and equipment imported or purchased in 

the name of a bank or financial institution under collateral 

arrangements. 

– HMG/N, or associations, organizations or offices 

owned by HMG, or constitutional bodies should purchase 

goods or services only from registered persons 

when making purchases of more than NPR 25,000 of 

taxable goods at one time. This figure was NPR 

10,000 before the change. 

– Firms, companies and industries are required to issue 

serially numbered invoices with their names and 

addresses. The VAT administration may inspect, with 

prior approval of the Director General of the VAT 

Department, the books of accounts of unregistered 

vendors in connection with VAT and may penalize if 

the books of accounts are not maintained properly. 

– Agricultural equipment such as tractors, cultivators, 

levellers, threshers etc., vaccines, printing and publications, 

battery operated tempos, their chassis and batteries, 

plant and main equipment required producing 

energy from bio-gas, solar power, and air on the recommendation 

of the alternative energy centre, aeroplanes, 

helicopters, fire fighters and ambulances, 

domestically produced recycled goods with iron 

scrapes, used plastics, and paper as their inputs, cotton 

textiles, jute goods, birds and animal feed, industrial 

machinery mentioned in section 84 of the customs tariff, 

weaving, carding, carpet washing, and feed supplement 

were already exempt from VAT. Similarly, 

unprocessed muster oil, cotton thread, woollen yarn to 

be used in handmade sweaters (other than synthetic 

and acrylic), aluminum, copper, bronze, scrap, circles, 

and sheet, gold ornaments, and domestically produced 

cotton and other textiles were included in the list of 

exempt items of the Finance Bill 1998 on 24 August 

1998. 

In addition to the above mentioned provisions, the government 

introduced several new measures in the field of 

VAT, customs duties, income tax and other taxes and rev-


enue investigation, including an increase in the rates of 

import duties and income tax, introduction of the tourism 

services fee, the motion picture development fee and erection 

of barriers on the highways. In response to these 

measures, the business community went on strike and 

closed their businesses for several days. Negotiations took 

place at different stages between the government officials 

and the representatives of the private sector in order to 

resolve the problems. First, both parties agreed not to 

implement newly introduced proposals until they reached 

an agreement. Finally, both parties agreed on 39 points on 

1 September 1998 when they agreed not only to reverse 

some proposals introduced through the 1998/99 budget 

but also to provide more exemptions and concessions and 

review the tariff structure. These provisions were related 

to VAT, income tax, customs duties, tax administration 

and revenue investigation. On the basis of the recommendations 

made by the representatives of both the government 

and the private sector, HMG/N made the following 

decision on 24 September 1998. The decision again did 

not conform fully to the agreement. VAT-related provisions 

under the 39 points are as follows: 

– The VAT threshold will be increased from NPR 3 million 

to NPR 4.5 million. 

– Importers will be allowed to import commercial goods 

from India and Tibet up to NPR 1.2 million per annum 

without a VAT registration certificate. They cannot, 

however, import goods of more than NPR 200,000 at 

one time. They will have to pay 5% advance tax at the 

customs point. 

– Vendors who are not registered for the purpose of 

income tax will be allowed to import commercial 

goods up to NPR 3,000 at a time from India and Tibet 

without being registered for VAT. 

– In the case of old stock, self-declared value would be 

accepted provided that the vendor has paid 1% income 

tax on the declared value. 

– The burden of proof will rest with the tax officers 

while establishing penalties relating to discriminatory 

discounts and undervaluation. 

– In the case of mobile sales, a taxpayer has to send 

goods together with a dispatch paper with the vehicle 

number on it and must issue tax invoices in the case of 

sold goods. 

– Vendors having transactions below the threshold will 

be required to issue serially numbered invoices and 

maintain their records. 

– A committee representing both the government and 

the private sector will be set up to resolve the problems 

relating to VAT and other tax procedures. The VAT 

office will coordinate this committee. 

– The VAT office will register new taxpayers as per the 

recommendations of the above-mentioned committee 

and the FNCCI representatives will help the registration 

of new taxpayers. This will not be applicable in 

the case of those vendors who voluntarily register. 

– In the case of those districts where there is no VAT 

office, representatives of the concerned district chamber 

of commerce and Industry will be included in the 

committee in order to resolve the problem relating to a 

taxpayer residing in such a district. The person nominated 

by the FNCCI will be included in the committee 

if the concerned district chamber of commerce and 

industry does not nominate its representative. 

– A committee of government officials and representatives 

of the private sector will be set up in order to recommend 

measures for the improvement of VAT law. 

– Mid-December 1998, this agreement has still not been 

implemented. Businessmen are dissatisfied and the tax 

administration has not been able to work properly. 

5.2. Weakness of the government 


There were some weaknesses on the government side as 

well. There was a lack of coordinated approach and longterm 

strategy. Several tax measures were introduced in 

1997/98 without any consideration of their possible 

effects. While VAT was scheduled to be implemented 

from 16 November 1997, the sales tax system was 

changed drastically in mid-July 1997, only for 4 months. 

Under the new system, in addition to manufacturers, dealers 

and wholesalers, retailers having an annual turnover 

exceeding NPR 2 million were required to register. Similarly, 

importers with annual commercial imports exceeding 

NPR 100,000 were also required to register. Taxpayers 

were required to get their prices approved by the sales tax 

officers or publish their prices from the manufacturing 

point to the retail point in the national daily newspaper 

except in the case of sales by a registered person to another 

registered person. Taxpayers were given a registration 

number, meaning that those manufacturers who were 

already in the sales tax net were provided a new registration 

number in place of the existing sales tax number. 

Since the tax administration and taxpayers were not 

informed about the new system, both parties were confused. 

Taxpayers did not comply with the new system, 

which remained almost unenforced. Taxpayers thought 

that VAT was introduced by the back door, which was not 

good for confidence building. 

There was a lack of coordination with other tax measures 

as well. The rate of sales tax was reduced from 15% to 

10%. However, the sales tax rate was fixed at 20% on 

imports by non-sales tax registered vendors. Customs 

valuation and income tax assessment procedures, which 

were obstacles to the implementation of VAT, were not 

handled properly. While the government reduced the rate 

of customs duties from 40% to 30% and the income tax 

rate from 33% to 25%, they were not closely linked with 

the implementation of VAT. These rates were lowered in 

July 1997 whereas VAT was introduced from November 

1997. Taxpayers had already forgotten these reductions in 

rates by the time VAT was introduced. 

The business community called for a strike at a time when 

the government had reduced the rate of all major taxes 

drastically. This was due to the introduction of some 

administrative procedures that were influenced by the tra-


ditional administrative mentality and which were not in 

line with the broader transparent tax reform measures. On 

the other hand, due to a large cut in tax rates, the government 

had to forgo a substantial amount of tax revenue that 

was reflected in the collection of about NPR 26 billion 

against the original estimates of about NPR 30 billion in 

1997/98. This was a lose-lose situation, indicating mishandling 

of tax matters. 

A similar story occurred in 1998/99 although for different 

reasons. Instead of introducing the measures that help 

soothe the opposition to VAT from the business community, 

the government introduced several new measures, 

including an increase in the rate of import duties, a 10% 

surcharge on income tax, export duties on a few items, 

new taxes such as the tourism services fee and motion picture 

development fee. These measures were not appropriate 

at a time when the government had planned to implement 

a fully fledged VAT. International experience 

indicates that governments do not propose any new taxes 

and do not increase the rates of existing taxes during the 

initial stages of VAT implementation. Rather there is a 

common practice to lower the rate of income tax and customs 

duties at the time of the implementation of VAT. 

Nepal chose another way. Further, tax barriers were 

erected on different highways at the time VAT was introduced. 

The business community considered it as also a 

part of the VAT implementation. Several proposals 

seemed to have been introduced to trap as many taxpayers 

as possible without broader consideration of revenue 

mobilization and/or tax rationalization. Because of all 

these reasons, the business community went on strike. 

They closed the market continuously for 11 days. The 

government could not enforce new proposals. It became 

necessary to amend the finance bill, which was done perhaps 

for the first time in Nepal. The situation did not 

improve much even after this amendment. Tax proposals 

were opposed perhaps more strongly in the recent 2 fiscal 

years than ever before. This has also affected the implementation 

of VAT. 

5.3. General environment 

It has become difficult to move to a fully fledged VAT 

system from sales tax due to other reasons also. Many 

exemptions and tax incentives were granted under the 

sales tax system. VAT was supposed to abolish them 

which was necessary to broaden the tax base and rationalize 

the tax system. Further, many businessmen are 

required to register for VAT and maintain proper books 

and accounts that could make their transactions transparent. 

It must also be noted that tax compliance is very poor 

in Nepal and different taxes are not being fully paid in 

accordance with the law. There is a lack of transparency 

and both taxpayers and tax collectors took undue advantage 

of the situation. They thought that VAT would 

deprive them of this opportunity, and opposed this tax 

strongly. These were the main reasons for the opposition 

to VAT and the government has made several compromises 

in response to the strong opposition. 

VAT has not been effectively implemented yet due also to 

the fragile political situation. There was a change in the 

government five times in a period of about 4 years 

(November 1994, September 1995, April 1997, October 

1997 and April 1998). In such a situation, it is difficult to 

implement any broad measure effectively. The period 

from now to the election is critical for VAT. Some politicians 

may oppose VAT to attract votes. Businessmen can 

try to put maximum pressure on the government not to 

make this tax effective and try to destroy the VAT system 

indirectly. After the election, the government of any party 

is likely to implement VAT more effectively. 

Further, the tax administration is still weak. Many positions 

are vacant even after 1 year of VAT implementation. 

Turnover of personnel which is not in the interest of the 

VAT organization is rather high. Most tax officials are not 

well motivated. The VAT administration is considered the 

least attractive administration in the revenue administration. 

Tax officials prefer to work in customs or the tax 

administration. There is a lack of incentive to work in the 

VAT administration. There is also a lack of a proper physical 

working environment. The budget for VAT offices 

has not been increased even after the manyfold increase in 

their activities since the introduction of VAT. There is a 

common feeling amongst businessmen that VAT officers 

lack proper understanding of VAT and ability to implement 

it. There is a problem of retaining well-qualified staff 

particularly in the computer field where remuneration can 

be higher in the private sector than in the government. Due 

to the lack of computer personnel, the government has 

decided to hire private computer technicians to provide 

technical support to the computerized information system 

by means of a 2-year contract. 

5.4. Teething problems 


As expected, some teething problems appeared after the 

introduction of VAT. Taxpayers have to maintain purchase 

and sales books for VAT purposes. In the case of 

some taxpayers, these books are in addition to their other 

books showing similar information. Recording of each 

and every purchase and sales invoices has also created 

additional work for those taxpayers that were not doing it 

before the introduction of VAT. As explained earlier, 

some accounting problems also occurred due to the customs 

valuation system. 

Some taxpayers that had already printed invoices in large 

quantities had to destroy them after the introduction of 

VAT since they were not in line with the VAT law. Some 

taxpayers continued to use old invoices. The VAT administration 

adopted a liberal approach by allowing them to 

use old invoices and supply information required for VAT 

purposes, such as the TPIN of both seller and buyer, if the 

buyer is registered for VAT, and the VAT amount. Hotels 

were allowed to issue separate invoices with separate


serial numbers for the restaurant, bar, laundry, etc. as per 

their business practice. Some departmental circulars were 

issued in response to queries from taxpayers. 

Some foreign businesses, which were not registered under 

any organization in Nepal, could not be registered for 

VAT since they were required to attach a copy of a business 

registration with the VAT registration application. 

Similarly, abolition of several exemptions granted under 

the sales tax system also created havoc in the business 

community. Some unscrupulous people spread rumours in 

the market to give VAT a bad name. 

Some confusion has been created due to compromises 

made in response to opposition from the business community. 

As a result, VAT law has not been implemented 

effectively. Tax officers who were trained in different 

aspects of VAT law are not in a position to implement it 

strictly. Some provisions introduced through the Finance 

Acts have also created confusion. For example, the applicability 

of 10% or 20% sales tax/VAT rate has created a 

lot of confusion throughout the 1997/98 fiscal year. The 

government has introduced some new taxes such as the 

motion picture development fee and tourism services fee 

in 1998/99. Since these taxes were introduced without 

proper preparation, they created considerable confusion 

and VAT was unnecessarily blamed for this too. 

6. THE TASK AHEAD 

The formulation and passage of the VAT Act, design of 

VAT regulations and its final approval, preparation of the 

VAT operational manual, creation of a functional VAT 

organizational structure and creation and recruitment of 

VAT officials have all been done in a short time by Nepali 

standards. The VAT Act, Regulations, Manual and 

Brochures have been in line with international standards. 

Preparations for VAT in Nepal have been comprehensive 

and much more detailed than for the introduction of any 

other tax. This preparation has contributed towards creating 

a favourable environment for the implementation of 

VAT and gaining gradual acceptance by taxpayers as well 

as the people at large. 

Since the implementation of VAT is a great jump from the 

traditional tax system to a modern one, several things still 

need to be done for the successful implementation of VAT 

in Nepal. 

6.1. Political commitment 

Strong political commitment is the key to the success of 

VAT. In many countries the politicians at the highest level 

support VAT. For example, in Singapore, the Prime Minister, 

Deputy Prime Minister and many ministers, including 

the Finance Minister defended VAT on various occasions. 

In Nepal, however, only the Finance Minister has 

advocated VAT frequently. This was also the case in the 

past. Since implementation of VAT is one of the major 

tasks of the government, other members of the cabinet 

should support it as well. One important point from a political 

point of view is that no major political parties have 

opposed VAT so far. Since several governments of various 

parties have been involved in one way or another in 

the implementation of VAT, major political parties are 

unlikely to oppose it. 

6.2. Administration 


An effective and efficient administration is crucial for the 

proper implementation of VAT. Although in view of this 

VAT organization has been reorganized in the functional 

line and several positions have been created, many positions 

are still vacant and VAT administration is still weak 

and least attractive for personnel. So the tax administration 

should be strengthened significantly. It must be noted that 

under the sales tax system taxpayers were subject to several 

controls, such as, renewal of registration, approval of 

prices by tax officials, certification of tax invoices by the 

tax authorities and submission of copies of invoices to the 

tax offices. Rightly or wrongly, tax officials used to have 

an effective control over taxpayers due to these formalities, 

which were used as a lever for the payment of tax. In 

addition, tax officials insisted taxpayers should pay tax in 

such a way that they fulfil their revenue targets. Tax officials 

do not have any of these leverages or controls under 


VAT is based on the principle of self-assessment by the 

taxpayers that are required to pay tax on transaction values. 

Tax officials have to monitor taxpayers from a distance. 

For this, the tax administration has to be more efficient 

and well equipped than under the sales tax. This is 

because under the sales tax system tax officials can easily 

reject prices declared by taxpayers and can increase taxable 

values arbitrarily. VAT law does not permit them to 

do so. Now tax officials have to establish facts. Their job 

requirements have changed from physical control to an 

audit-based control system. This means that the VAT 

administration demands a large number of qualified and 

trained officials. VAT officials have to conduct a survey 

of potential taxpayers from time to time so that potential 

taxpayers may not remain outside the tax net. It is equally 

necessary to detect non-filers. The VAT administration 

must process the returns submitted by taxpayers on a continuous 

basis and should notify taxpayers if they have 

made any mistakes. Books of account must be audited on 

a sample basis. For this, officials must have advanced 

accounting and auditing skills. Tax auditing, which is necessary 

in order to prevent abuse of the credit mechanism, 

to detect fraudulent refund claims, and to enhance tax 

compliance, is not carried out by the sales tax administration. 

It is a critical aspect of VAT control. 

It is equally important to reorient the tax administration in 

the light of this modern tax. Officials should be mentally 

prepared to accept the prices declared by taxpayers at face 

value. Tax investigations and audits should be effective in


order to make taxpayers more careful in fulfilling their 

duties. Changes in the mentality of VAT officials would 

not be enough. It is equally necessary to teach the basics of 

VAT to officials working in other organizations such as 

the Revenue Investigation Department, the Special Police 

Department, the Auditor General’s Office and the Authority 

Abuse Investigation Commission who are also 

involved in VAT administration in one way or another. 

This process has already started, now it is time to accelerate 

it. It must be remembered that in the case of a tax based 

on self-assessment, a service minded attitude of tax officers 

is very important. Moreover, the commitment of staff 

to solve all problems must be increased significantly. 

6.3. Overall tax reform 

Since VAT and other tax systems and procedures are so 

closely related, it is necessary to reform the overall tax 

system and tax administration. As the 39-points agreement 

encompasses all major taxes and administrative procedures, 

it should be implemented immediately and effectively. 

6.4. VAT law 

VAT law needs to be reviewed on the basis of experience 

gained so far. It is worthwhile considering the following 

points. 

(a) Several provisions have been introduced through the 

Finance Act and departmental circulars. Of them, those 

provisions that are in line with the principle of VAT 

should be included in the VAT law while others should be 

abolished. 

(b) The existing exemption list is rather long. While some 

exemptions are unavoidable for administrative reasons, 

most are politically motivated and given under some pressure. 

Exemptions have an impact not only on revenue but 

also on economic efficiency and administration. So the list 

must be shortened gradually. 

(c) There has not been a provision for group registration. 

As a result, companies within a group are required to register 

separately. Registered companies are required to levy 

VAT on inter-company transactions and fulfil all VAT 

requirements, leading to an increase in both compliance 

and administrative costs. There is also the possibility of 

cascading. 

There should be a provision for group registration under 

which related companies would be allowed to register as a 

single entity. Inter-group transactions would not be subject 

VAT. This would reduce both compliance and administrative 

costs by reducing the number of registrants. It 

would not encourage groups of companies to restructure 

and it would avoid the cascading effect of irrecoverable 

VAT where one group member sells exempt goods or services 

to another. The VAT administration would be given 

power to withdraw the provision if it is abused. 


(d) For VAT purposes, taxpayers are required to keep a 

record of their purchases and sales. The original idea was 

to demand specific information relating to sales and purchases 

and not to ask them to maintain records in a specified 

manner. That is why a description of a purchase and 

sales book was included in the VAT regulations as an 

example. However, as per the Ministry of Law and Justice, 

anything included in the Regulations is mandatory. Therefore, 

taxpayers are now required to maintain purchase and 

sales books as specified in the Regulations although a taxpayer 

can maintain records with the approval of the VAT 

Department according to a prescribed method. 

This type of recording system has created problems, particularly 

for taxpayers required to maintain a detailed 

record of their purchases and sales for other purposes, 

including income tax. It seems that now they have to keep 

two sets of records: one for VAT and one for income tax 

and personal reasons. This increases their compliance 

costs to some extent. 

This problem could be mitigated by allowing taxpayers to 

record a summary of transactions in purchase and sales 

books. Under this system, it would not be necessary to 

record all low value sales and purchases separately. Only 

the total value of several invoices up to a certain amount 

would be recorded. The summary sheet, however, should 

indicate the total as well as the breakdown of each purchase 

or sales invoice, which must be attached to it. From 

a longer-term perspective, it is desirable to amend VAT 

law in such a way that taxpayers are required to submit 

specified information, but not maintain records in a prescribed 

manner. 

(e) A tax period of 2 months could be introduced to 

reduce both costs of collection and compliance costs. This 

will also partly solve the problem of credit sales. 

(f) Currently, there is provision for the carry-forward of 

excess credit for 6 months. This was designed to maintain 

a control of credit in the initial stage of VAT implementation. 

But this is a slight deviation from the basic principle 

of VAT. It puts at a disadvantage those firms that cannot 

take full input tax credit immediately. Further, it may put 

local companies at a disadvantage compared to their international 

counterparts that can claim all input tax credit 

immediately. Due to the non-availability of immediate 

input tax claims, foreign companies may be discouraged 

from setting up their subsidiaries in Nepal. So from a 

longer term perspective it is necessary to allow immediate 

credit of input tax. 

(g) As stated earlier, government bodies, constitutional 

organizations, public enterprises, etc. are required to buy 

goods and services exceeding NPR 25,000 at a time from 

VAT registered businesses. Because of these provisions, 

even small vendors who have to make their supplies to 

such bodies are registered for VAT. Some vendors registered 

due to this provision, such as contractors, are small 

and do not comply with the VAT system properly. They


are not important from a revenue point of view. So this 

provision needs to be reviewed. 

(h) It is necessary to draw clear provisions relating to 

debit and credit notes which should be issued only in 

genuine cases. For example, credit could be issued in such 

cases as return of goods, reduction of prices due to damages 

or broken goods but not when buyers do not pay tax. 

(i) Unless bad debt provision is carefully handled it opens 

up loopholes for tax avoidance. So no provision has been 

made for bad debt relief. For the same reason, no relief is 

provided for insolvencies. But in the long term, it is desirable 

to introduce a policy of providing relief for bad debts 

and insolvencies. 

(j) Penal provisions need to be reviewed and an efficient 

appeal system established. For the latter a revenue consideration 

board should be set up. It must give its decisions 

within 1 year of the application or day on which the taxpayer 

submits required documents; otherwise decisions 

should be considered in favour of the taxpayer. 

6.5. Computerization 

Although VAT can be implemented even in the absence of 

computerization, as was the case in parts of Europe, it is 

essential to computerize the VAT administration for its 

effective implementation. For example, while tax audit is 

an integral part of VAT administration it is not possible to 

audit all taxpayers. So some criteria must be developed for 

the selection of audits. Computerization makes it possible 

to select suspect cases for audit, which would be very difficult 

to do manually. Similarly, computerization also 

makes it possible to detect non-filers and non-payers. Considering 

this, a comprehensive computerization system 

has been developed in Nepal but the successful implementation 

of such a system is yet to be seen which may cause 

serious problems due to the shortage of skilled manpower, 

frequent power interruption and the lack of a suitable 

physical environment. So special attention must be paid to 

the proper running of the computer system, especially data 

entry and processing at VAT offices. 

6.6. Taxpayer education 

Since VAT is not fully implemented yet and many potential 

taxpayers are still outside the tax net, it is necessary to 

continue with the taxpayer education programme which is 

important for both traders and consumers once it is applied 

effectively up to the retail level. 

6.7. Lack of confidence 

There is a lack of confidence between the private and public 

sectors. As stated earlier, government officials and private 

sector representatives agreed on several points 

recently but they were not implemented in practice. Taxpayers 

do not believe that tax officials will follow the 

basics of VAT. They believe officials will rather run VAT 

in a similar way to other taxes. Tax officials, on the other 

hand, think that taxpayers would abuse liberal VAT policies. 

They suspect, for example, that taxpayers would 

grossly understate taxable values and pay less tax since 

they would not have to get their prices approved by tax 

officials. It would result in a considerable loss of revenue. 

Now is the time to break this lack of confidence. It is also 

time to make persistent efforts to make VAT succeed. 

Adequate measures must be taken so that both taxpayers 

and tax officials do not fail in performing their new 

responsibilities. 

7. CONCLUDING REMARKS 


The introduction of VAT in Nepal was inevitable for several 

reasons, including broadening the tax base and creating 

a transparent and fairer tax system. That is why no 

major political party has opposed it so far. While some 

politicians may be influenced by the business community 

that is against VAT and might oppose it in the first quarter 

of 1999 since an election is expected in April 1999, the 

government of any party is likely to implement VAT 

effectively after election. A detailed preparation was made 

for its introduction. Despite taxpayers’ resistance, the government 

has gone ahead with implementation without second 

thoughts although it has made several compromises in 

response to opposition from the business community. 

VAT has survived and its implementation has been gradually 

improving. 

VAT implementation could have been even better had the 

government adopted an integrated approach and a proper 

strategy and coordinated all tax measures in a proper way. 

Past experience indicates that there is a need to develop 

professionalism both at policy and implementation levels 

in the revenue administration so that there are people who 

understand the overall tax system, are familiar with the 

main stream of the current tax policy and tax development 

taking place around the world, who can analyse the intricacies 

of tax measures and who can think in a longer-term 

perspective. It is also equally necessary to motivate personnel. 

Similarly, it is necessary to minimize, if not eliminate 

the lack of confidence between the government and 

the private sectors on tax matters, which has been in an 

increasing trend. 

Effective and proper implementation of VAT is necessary 

in order to streamline the overall tax system. Since the collection 

of both the customs duties and income tax depends 

to a great extent upon the effectiveness of VAT, every 

effort must be made to strengthen this tax that will help 

enhance revenue collection and avoid a possible fiscal crisis.

VAT 99-2/final - empcom.gov.in

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