Taxation in INGOs

A debate is raging of late whether International Non-Government Organizations (INGOs) should be provided with Tax Exemption Certificate or not. Various tax offices seem to have different opinions. Some INGOs did receive their exemption certificate for the fiscal year 2017/18 while many others were denied. Income Tax Act 2058 was first enacted on April 1, 2002.The debate started after some tax officials questioned the eligibility of INGOs for tax exemption. INGOs have been contributing a huge amount of withholding tax and have been submitting financial statements to tax offices all these years. But why is this issue raised now? Why do INGOs need tax exemption certificate? If they are not provided one, does this mean that they have to pay tax on whatever amount remain unspent in the year end?

The Act has defined certain social organisations as tax exempt organisations. Those organizations that meets the definition criteria should apply to their nearest Inland Revenue Office in order to obtain tax exemption certificate. According to Rule 5 of Income Tax Rule 2059, those organisations that have received tax exemption certificate should only submit their audited financial statements of a particular fiscal year within three months from the end of that fiscal year. They need not submit separate income tax return. Earlier INGOs were receiving the “tax-exempt status” and it was just to submit audited financial statements each year. But if organization has not obtained tax exemption certificate they are required to file separate income tax return with their tax office. And in doing so, many INGOs are facing issues. Because the existing tax return form (Schedule 5 of D 03 form) does not have a clear provision to include any grants income and related expenditure, some of them have submitted a zero return, others have submitted it showing equal amount of income and expenditure. And there are some which have even shown surplus and it has been taxed by the taxation authority. Tax officers across various offices are not consistent and clear about the correct procedure to file a return and taxpayers are confused.

Fundamentally speaking, tax is levied only when a person (natural person or entity) generates some sort of income. Income Tax Act 2058 provides facilities for reducing certain expenses that meets the defined criteria in accordance with Section 13 and 21 of the Act. Therefore income that is subject to tax will normally be a profit or residual income i.e. income less allowed expenses.

INGOs in their existing legal structure in Nepal as such should not have their own income with some exception. Whatever amount they receive from their head quarter for office operation or as grants from donors, it is either a liability to their headquarter or towards their donor respectively. Looking at this scenario it seems like they do not have any taxable income and INGOs demand to get the exemption certificate might seem logical. However, if we go through the definitions and legal provisions of Income Tax Act 2058, INGOs are not categorized under tax-exempt entity.  According to Section 2(s) of the act, “Organisations entitled to enjoy exemption” means a social, religious, educational, or benevolent organization of public nature established with non-profit motive. This however excludes any amounts given as benefit to any person from the assets of the entity, and any amounts derived by the entity except in pursuit of the entity’s function as per its objectives.

From the definition, it is clear that in order to avail tax-exempt facility an entity should be registered as an organization of either social, religious, educational or charitable nature without having a profit motive. Though it may be argued that INGOs are of course established without having a profit motive in their home country, they do not have any legal registration status in Nepal. All INGOs in Nepal run their activities based on “General Agreement” (which normally runs for a period of five years and is renewable after that) and project specific “Project Agreement” with Social Welfare Council. Further, after the general agreement is concluded they also get registered with the tax authority and obtain Permanent Account Number (PAN) Certificate. Except for these, they do not have any other legal registration identity like NGOs who are registered in District Administration Office and have a unique registration number. Because of this, they do not fall under the criteria of eligible organization to obtain tax exemption certificate. Recently the finance bill also provided waiver of all tax, fines, additional fees and interest of all previous fiscal years to all those social organizations registered under Institution Registration Act 2034 who shall submit their income tax return for fiscal year 2017-18 by 14 January 2019. This also does not include INGOs as they are not registered under Institution Registration Act 2034. This also adds to this discussion that even the government is trying to bring INGOs under tax net.

Now does this means that INGOs should pay tax irrespective of nature of their income? No. However, some cases have been noted where some INGOs paid tax in the surplus amount in last fiscal year 2016/17. First of all it is necessary to understand how this surplus arises. If such INGOs are engaged in profit making activities, no doubt that this will be taxable. In addition to their engagement in profit making activities if any INGO receives grant from a competitive bidding process where profit making entities also participate in equal terms and condition then such income is also taxable. Except these two cases all other funds they receive is a liability towards the donor or their head quarter. Some INGOs, even if they do not have any taxable income, are showing surplus or deficit in their income statement. This is because of the erroneous accounting of grant. Any restricted/unrestricted funds whenever received should be booked as liability to the donor/headquarter respectively unless this has been spent and approved by the donor. The moment such expenditures are approved; equivalent amount should be recognized as income in the books making the total of income and expenses equal. Hence, there will be neither any surplus nor deficit. Any amount remaining in the restricted/unrestricted funds will be represented as a liability in the balance sheet.

Though some organizations have been practicing this system of accounting, they are also facing difficulty in obtaining tax clearance certificate. This is because tax officials themselves have differing opinions on how the income tax return should be filed. Some argue that entire amount of grants should be shown as taxable income and entire expenditure be reported as allowed expenditure making the difference zero and therefore no tax liability remains with the entity. While others argue that, it is not logical to include grants as income even if it is not taxable.

To conclude from this discussion, there are four main points that will clear the confusion. First is that INGOs are not eligible to get tax exemption certificate and going forward no tax office will issue or renew it. Second, because no tax exemption certificate is provided, all INGOs are required to file income tax return within three months after the expiry of a fiscal year or within another three months if extension is granted. Third, that INGOs should account for their grant income according to matching concept i.e. equivalent amount of expenses should only be booked as income and remaining amount should be shown as a liability. And the last one is that return should be filed as a zero return in the existing D 03 form, provided it doesn’t have any taxable profits.  

This issue has also been acknowledged by the Inland Revenue Department and it is now considering to revise the existing D 03 form. This will allow INGOs to include their grant income and expenditure separately in the return. We expect that this will be addressed soon and relieve taxpayers from the present hassles and confusions. This would also encourage taxpayer to submit their return in a timely manner thereby avoiding any fines and penalties.

A portion of this article appears in print on June 26, 2018 of The Himalayan Times.