Determination of permanent establishment

Foundation for Imposing Tax

The basis of taxation in any country depends upon “Residence Rule” and “Source of Income Rule”. In both of the rules determination of “Permanent Establishment” (PE) plays a vital role.

The concept of Permanent Establishment is necessary to avoid administrative difficulties and simplify the tax assessment of non-resident entity having business transaction in Nepal. Inland Revenue Department (IRD) has recently issued Permanent Establishment (PE) Directive 2077 (2021 AD). An excerpt from such Directive is discussed below.

Base for determination of PE

Explanation

Supply alone will not create Permanent Establishment

Supply and Business are treated separately for tax purpose. Business transaction pertaining to supply only does not constitute of Permanent Establishment of foreign entity. Income Tax Law of Nepal prescribes the creation of Permanent Establishment based on circumstances under which such business activities take place

Natural Person will not be Permanent Establishment

The income of natural person having source in Nepal is taxed on the same individual so, natural person does not constitute Permanent Establishment

Non-resident entity should be established in Nepal

Non-resident entity should have establishment in Nepal. Any of the companies, partnerships, limited liability partnerships, government bodies, universities, unit trusts, family groups or any other corporate body registered outside Nepal can have Permanent Establishment in Nepal

An entity not registered in foreign country shall not constitute Permanent Establishment even after having management in Nepal

Such unregistered body of foreign individuals having management in Nepal shall be treated as Entity similar to normal company

Business of Non-resident person and its operation

Business of Non-resident person and its operation is compulsory in order to constitute Permanent Establishment

 

Nature of Business and Permanent Establishment

  • Business includes conversion of goods, trading of goods and rendering of Services

  • Preparatory works related to industry, trade or business does not mean business

  • Supply alone is not a business. Business should involve continuation to some extent or habitual transaction.

  • One-time service such as installation at the place of importer or training provided for operation as well as occasional repair is not considered as continuous business for this purpose. Further, if installation or repair on call is a main task then it should be classified as business.

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Business in general includes purchase, conversion and sale.

  • Purchase includes both domestic purchase and import. Purchase without conversion and sale is not business.

  • Conversion means industry or factory transforming the goods. If manufacturing or conversion activities are carried out in Nepal, whether or not purchase or sale is done within Nepal, or transfer or utilization is done to main company or associated entity after manufacturing in Nepal; it is business.

 

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  • Sales within or outside Nepal is business. Sales also includes:

  • Sales of manufactured goods – sales from factory

  • Trading of goods

  • Transfer of manufactured goods

  • Sale of professional services

  • Sale of services

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  • Sales activity in Nepal is business irrespective of place of purchase or manufacture.

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  • Sales shall not be deemed to be done in Nepal merely on the ground of sale to a Nepali importer. So, it is not business in Nepal.

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  • Sale of goods kept in warehouse or goods kept in custody of some other person in Nepal or goods purchased in Nepal made available to the Nepali Importer within Nepal is sale within Nepal, hence constitutes a business within Nepal.

Permanent Establishment in context of Investment, Employment or Special Business

  1. Business is compulsory factor to constitute Permanent Establishment and any type of investment of non-resident entity in Nepal shall not constitute Permanent Establishment.

    1. Interest income as a result of debt funding shall not constitute Permanent Establishment but interest income of Permanent Establishment is its business income.

    2. Return from investment in securities or immovable assets shall not constitute Permanent Establishment, however, such return of Permanent Establishment is its business income.

    3. Profit on sale of debt bonds, securities or immovable assets shall not constitute Permanent Establishment however such profit of Permanent Establishment is its business income.

  2. Since only an entity can have Permanent Establishment; employment or business of foreign natural person does not constitute Permanent Establishment.

  3. In case where tax law or tax treaty to which Nepal is a party, provides for separate basis for imposition of tax on a business; such business can not constitute Permanent Establishment. Taxation on gain on sale of major investment of such business shall be as prescribed in such tax law or tax treaty.

  4. Flight income of International flights as per Sections 67 and 70 of Income Tax Act, 2058 (2002) and article 8 of tax treaties, is not income of Permanent Establishment.
  5. Income earned out of communication equipment established in Nepal as per section 67 and 70 of Income Tax Act of Nepal, 2058 (2002 AD) and article 8 of tax treaties, is not income of Permanent Establishment. Since the equipment of telecommunication operator self are used for roaming service in Nepal it shall not constitute Permanent Establishment.

  6. Receipt of royalty only does not constitute Permanent Establishment but such royalty income of Permanent Establishment is its business income.

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