In today’s globalized economy, as foreign companies look to enter the Nepalese market, a key legal and tax concept comes into play: Permanent Establishment (PE). Understanding what constitutes a PE, when it triggers tax obligations, and how to comply with relevant laws in Nepal is essential for foreign businesses operating in or targeting the Nepali market.
This article offers a comprehensive breakdown of the concept of Permanent Establishment and Tax Residency for foreign entities in Nepal, covering legal definitions, business scenarios, exemptions, and implications under Nepalese tax laws and international treaties.
What is a Permanent Establishment (PE)?
A Permanent Establishment refers to a fixed place of business through which the business of a foreign enterprise is wholly or partly carried out in Nepal. According to Section 2(aab) of the Income Tax Act, 2058 (2002), a PE is formed when a non-resident foreign entity operates in Nepal for more than 90 days within a 12-month period, either continuously or intermittently.
Key Elements of a PE:
- Non-Resident Entity: A business registered outside Nepal.
- Business Activity: Economic, professional, or technical operations.
- Location: Any physical or operational presence within Nepal.
- Activities in Nepal: Specific conduct of business or services in Nepal.
These criteria combine to determine whether a foreign business has a sufficient presence in Nepal to warrant tax obligations.
Importance of PE for Tax Residency Determination
The presence or absence of a PE plays a decisive role in determining tax residency for foreign businesses under Nepalese law. Foreign companies interacting with Nepal generally do so via two broad models:
No Local Presence
The foreign entity operates from its home country and supplies goods or services to clients in Nepal without any physical presence. Such transactions generally do not establish a PE, and therefore, no tax obligations arise in Nepal.
With Local Presence
Here, the foreign company has a physical footprint in Nepal—such as employees, agents, or equipment. In these cases, the entity might qualify as having a PE, leading to tax liability under Nepalese laws.
This distinction is vital for avoiding double taxation, determining applicable tax rates, and ensuring compliance with Nepal’s regulatory environment.
Legal Framework for PE in Nepal
Several laws and directives govern the treatment of foreign entities and PEs in Nepal, including:
- Income Tax Act, 2058 (2002)
- Permanent Establishment Directive, 2077 (2019)
- Companies Act, 2063 (2006)
- Company Directive, 2072 (2015)
These instruments outline what qualifies as a PE, registration obligations, tax implications, and the treatment of cross-border transactions.
Scenarios That Constitute a PE in Nepal
Under Nepalese law, a foreign company is deemed to have a PE if any of the following business activities occur for more than 90 days in a rolling 12-month period:
- Use of a Dependent Agent
If a dependent agent conducts business on behalf of the foreign entity. - Installation or Use of Equipment
Deployment of machinery or equipment for business in Nepal. - Provision of Technical or Consulting Services
If employees or third parties render such services exceeding 90 days. - Construction or Supervision Projects
Involvement in infrastructure or related work for over 90 days.
Classification of Business Activities under PE
Nepalese regulations identify specific business activities that determine PE status:
- Independent Agents: Do not constitute PE.
- Fixed Place of Business: Automatically triggers PE, regardless of duration.
- Construction: Engagement beyond 90 days forms a PE.
- Service Providers: Presence for more than 90 days in a 365-day period creates a PE.
Even temporary or part-time presence can lead to PE classification if it meets the criteria above.
Exceptions Where PE Does Not Apply
Certain conditions exempt foreign entities from being classified as a PE in Nepal:
- Independent Agent Clause
Business done through a commercially independent agent is not a PE. - Short-Term Activity
If the activity in Nepal lasts less than 90 days in a 12-month period. - Imports Alone Don’t Constitute PE
Importing goods into Nepal without further commercial activity isn’t sufficient. - Individuals Excluded from PE
Only legal entities—not individuals—can be considered a PE. - Unregistered Entities
Only foreign entities properly registered in Nepal can qualify for PE status. - Lack of Activity in Nepal
No business conducted within Nepal means no PE is formed, even with customers there.
Business Operations Relevant to PE Determination
Foreign businesses must be aware that certain operations will likely trigger PE classification:
1. Purchase Activity
Buying goods in Nepal, without additional processing or selling, does not qualify as a PE activity.
2. Conversion or Manufacturing
If conversion (e.g., packaging, rebranding, or processing) takes place in Nepal, the business is considered active and a PE may be formed.
3. Sales Activity
- Sales made within or outside Nepal can be considered PE activity.
- However, sales to local importers do not count as business conducted in Nepal.
4. Storage or Warehousing
Setting up a godown (warehouse) for distribution in Nepal strongly indicates a PE presence.
PE in Special Business Scenarios
Even if a foreign company invests in Nepal, that alone doesn’t establish a PE. A PE requires active business operations. For example:
- Investment income, such as dividends or capital gains, does not trigger PE status.
- Similarly, employment income earned by individuals does not result in a PE.
Exemptions for Specific Activities
Under Sections 67 and 70 of the Income Tax Act, some income sources are explicitly excluded from PE considerations:
- International airline operations
- Telecom services including roaming
- Royalties, unless specified otherwise in treaties
Registration Requirements for PE in Nepal
Foreign businesses identified as having a PE in Nepal are legally required to register their PE with tax authorities. If structured as a branch office, registration under the Companies Act is also necessary. Without proper registration, the PE is considered non-compliant and may be penalized.
Taxation of Foreign Permanent Establishments (FPEs)
Once a foreign entity is recognized as a PE or Foreign Permanent Establishment (FPE), it is taxed similarly to local businesses. The following tax obligations apply:
- Corporate Income Tax: Levied on income generated through the PE.
- Filing Returns: The PE must file tax returns for all business conducted in Nepal.
- Overhead Allocation: Expenses, revenues, and liabilities must be appropriately allocated between the foreign head office and the PE.
- Remittances as Dividends: Any money sent from the PE to the parent entity is taxed as dividends.
- Capital Gains: If the PE is sold or terminated, any gain arising in Nepal is subject to tax.
Record-keeping is essential. The PE must maintain comprehensive books in a format prescribed by tax laws.
Interaction of PE Rules with Double Taxation Avoidance Agreements (DTAAs)
Nepal has signed Double Taxation Avoidance Agreements (DTAAs) with ten countries to help foreign investors avoid paying taxes in both jurisdictions. These countries include:
- China
- India
- Mauritius
- Sri Lanka
- Pakistan
- Republic of Korea
- Thailand
- Austria
- Norway
- Qatar
Treaty vs. Domestic Law
- Most of Nepal’s DTAAs were signed before the IT Act, 2058. Hence, Section 73(5) of the Act—which provides limitations on tax benefits—may not apply.
- For treaties signed after the IT Act, if no limitation of benefits clause is included, a treaty override could apply.
- According to the Nepal Treaty Act, 2047 (1990), if a domestic law conflicts with a treaty, the treaty provisions prevail.
This legal precedence ensures that foreign entities benefit from the most favorable terms unless otherwise stated.
Conclusion: What Foreign Entities Need to Know
Foreign companies planning to do business in Nepal must understand how Permanent Establishment rules affect their tax status. Whether offering consultancy services, engaging in construction, or setting up warehousing, it is critical to determine whether a PE exists and to take appropriate steps to register and comply with Nepalese tax regulations.
Failing to do so could lead to unintended tax liabilities, penalties, or loss of treaty benefits. For foreign investors and service providers, working with a law firm that understands PE nuances in Nepal is not just helpful it’s essential.