Tax Audit Process in Nepal

Tax audits are an essential part of Nepal’s tax administration system, helping ensure compliance with tax laws and regulations. This article provides a comprehensive overview of tax audits in Nepal, including the types of audits, procedures, requirements, and key considerations for taxpayers.

What is Tax Audit?

A tax audit is an examination of an individual or organization’s tax returns and financial records to verify that the information reported is accurate and complies with tax laws. In Nepal, tax audits are conducted by the Inland Revenue Department (IRD) to assess whether taxpayers have correctly reported their income, claimed appropriate deductions and credits, and paid the proper amount of tax.

The main objectives of tax audits in Nepal are to:

• Verify the accuracy and completeness of tax returns and financial statements
• Detect and deter tax evasion and fraud
• Ensure compliance with tax laws and regulations
• Recover unpaid taxes and impose penalties for non-compliance
• Educate taxpayers on proper record-keeping and reporting requirements

Tax audits play a crucial role in maintaining the integrity of Nepal’s self-assessment tax system by promoting voluntary compliance and identifying cases of underreporting or non-payment of taxes.

Types of Tax Audit in Nepal

Desk Audit

A desk audit is a preliminary review of a taxpayer’s returns and records conducted at the tax office without direct contact with the taxpayer. Tax officers examine the submitted returns, compare them with third-party information, and look for any discrepancies or red flags. If issues are identified, the taxpayer may be contacted for clarification or additional documentation. Desk audits are the most common type of audit and are often used to select cases for more comprehensive field audits. They are relatively quick and non-intrusive for taxpayers.

Field Audit

A field audit involves an in-depth examination of a taxpayer’s financial records and books of accounts at the taxpayer’s place of business. Tax officers visit the business premises to inspect original documents, interview staff, and observe business operations. Field audits are more comprehensive than desk audits and may cover multiple tax years. They are typically conducted for complex cases, large businesses, or when significant discrepancies are suspected. Field audits require extensive preparation by taxpayers to compile and present all relevant financial records and supporting documentation for review.

Investigative Audit

An investigative audit is conducted when tax fraud or serious non-compliance is suspected. It involves a detailed examination of a taxpayer’s affairs, often in coordination with other government agencies. Investigative audits may include surveillance, interviews with third parties, and forensic analysis of financial records. The focus is on gathering evidence of deliberate tax evasion or fraud. These audits are more adversarial in nature and may lead to criminal prosecution in severe cases. Taxpayers have limited rights during investigative audits and are advised to seek legal counsel.

Issue-Oriented Audit

An issue-oriented audit focuses on specific aspects of a taxpayer’s return or particular tax issues rather than a comprehensive review. For example, it may examine only claimed deductions, reported foreign income, or VAT compliance. These targeted audits are used to address common areas of non-compliance or verify taxpayer claims in high-risk areas. Issue-oriented audits are often shorter in duration than full field audits. Taxpayers are required to provide documentation related to the specific issues being examined. These audits may be conducted as desk audits or through field visits depending on the complexity of the issues involved.

Criteria & Requirements for Tax Audits in Nepal

The Inland Revenue Department uses various criteria to select taxpayers for audit:

• Random selection: A certain percentage of returns are randomly selected each year.
• Discrepancies in returns: Inconsistencies between different tax returns or with third-party information.
• High-risk industries: Sectors prone to tax evasion receive greater scrutiny.
• Large/complex businesses: Companies above certain turnover thresholds face more frequent audits.
• History of non-compliance: Taxpayers with past violations are at higher risk of audit.
• Unusual items or large variations: Significant changes in income/deductions from previous years.

Requirements for taxpayers selected for audit include:

• Maintaining books of accounts and financial records for at least 5 years
• Providing access to physical and electronic records when requested
• Designating representatives to assist auditors and answer queries
• Submitting additional documentation or clarifications as required
• Allowing tax officers to inspect business premises if needed

Procedure for Tax Audit in Nepal

• Step 1: Audit Selection and Notification
• Step 2: Preliminary Document Review
• Step 3: Field Visit and Detailed Examination
• Step 4: Discussion of Findings
• Step 5: Audit Report and Assessment

Step 1: Audit Selection and Notification

Description: The IRD selects taxpayers for audit based on risk assessment criteria. Selected taxpayers are notified in writing about the audit, specifying the tax periods covered and type of audit to be conducted. The notification includes a list of initial documents to be submitted and the timeline for the audit.

Step 2: Preliminary Document Review

Description: Tax officers conduct an initial review of the taxpayer’s returns, financial statements, and other relevant documents. This helps identify areas requiring further examination and additional records that may be needed. Officers may request clarifications or additional information from the taxpayer at this stage.

Step 3: Field Visit and Detailed Examination

Description: For field audits, tax officers visit the taxpayer’s premises to conduct a thorough examination of original books of accounts, invoices, contracts, and other financial records. They may interview key personnel and observe business operations. For desk audits, this step involves a detailed review of submitted documents at the tax office.

Step 4: Discussion of Findings

Description: The audit team prepares a list of issues identified during the examination. These findings are discussed with the taxpayer, who is given an opportunity to provide explanations or additional evidence. Areas of agreement and disagreement are documented.

Step 5: Audit Report and Assessment

Description: Based on the examination and discussions, the audit team prepares a final audit report detailing their findings and tax adjustment proposals. An assessment order is issued specifying additional taxes payable or refunds due. The taxpayer has the right to appeal the assessment if they disagree with the findings.

Read More: Taxation in Nepal Nepalese Tax Structure Income Tax Rules, 2059

Documents Required for a Tax Audit in Nepal

Taxpayers should be prepared to provide the following documents during a tax audit:

• Tax returns for the years under audit
• Audited financial statements
• Books of accounts (general ledger, sales/purchase registers, etc.)
• Bank statements and reconciliations
• Invoices, bills, and receipts
• Fixed asset registers
• Inventory records
• Contracts and agreements
• Import/export documentation
• Payroll records
• VAT/excise registers
• Board meeting minutes
• Any other documents supporting income and expense claims

Areas of Focus on Tax Audits in Nepal

Tax audits in Nepal commonly focus on the following areas:

• Verification of reported income from all sources
• Examination of claimed deductions and their eligibility
• Review of related party transactions and transfer pricing
• Compliance with VAT and excise regulations
• Proper deduction and deposit of withholding taxes
• Calculation and payment of advance income tax
• Compliance with foreign exchange regulations for international transactions
• Capital gains calculations and reporting
• Classification and depreciation of fixed assets
• Valuation and accounting of inventory
• Treatment of provisions and contingent liabilities
• Compliance with tax incentives and exemption conditions

Tax Audit Preparation in Nepal

To prepare for a tax audit, taxpayers should:

• Review past tax returns for potential errors or inconsistencies
• Ensure all required tax forms and schedules are complete and accurate
• Organize financial records and supporting documents systematically
• Reconcile tax return figures with financial statements and accounting records
• Prepare explanations for any unusual items or significant changes from prior years
• Review compliance with tax deadlines and deposit requirements
• Conduct internal reviews of high-risk areas (e.g. related party transactions)
• Designate key personnel to assist with the audit and brief them on procedures
• Consider engaging tax professionals for guidance and representation

Post-Audit Procedure & Compliance in Nepal

After the completion of a tax audit:

• Taxpayers should review the audit report and assessment order carefully
• If there are disagreements, taxpayers can file an appeal within 30 days
• Any additional taxes assessed must be paid within the specified timeline
• Taxpayers should address compliance issues identified during the audit
• Implement improved record-keeping and internal control procedures
• Consider advance rulings for complex tax issues to prevent future disputes
• Maintain open communication with tax authorities for ongoing compliance

Penalties for failure of Tax Audit in Nepal

• Late filing fees of NPR 100 per day of delay
• Interest on unpaid taxes at 15% per annum
• Penalties of up to 100% of the tax amount for concealment of income
• Fines up to NPR 40,000 for failure to maintain proper records
• Suspension of business licenses or import/export rights
• Potential criminal prosecution for tax fraud in severe cases

Read More:

1. Tax Audit Process in Nepal
2. An Overview of Tax Law in Nepal
3. Tax Law for Foreign Companies in Nepal
4. Corporate Tax Law in Nepal
5. VAT Registration Process in Nepal

Frequently Asked Questions

Contact Tax Lawyer in Nepal

Disclaimer: This material is presented solely for informational purposes, without constituting legal advice, counsel, or solicitation, and no liability shall arise from any actions, omissions, or reliance on its contents, directly or indirectly, in any manner whatsoever, irrespective of the jurisdiction or specific circumstances.