Government Prepares to Implement Dual-Rate VAT; Experts Warn It’s a Step Backward

May 25, Kathmandu – After three decades of a single-rate value-added tax (VAT), the government has initiated comprehensive reforms to introduce a dual-rate VAT system. According to senior sources at the Ministry of Finance, plans are underway to transition the current single-rate VAT to a dual-rate structure.

Following the direction of Finance Minister Dr. Swarnim Waglé, the ministry and the Inland Revenue Department are working on these preparations. VAT was first introduced in Nepal on December 16, 1997 (Mangsir 1, 2054 BS), replacing taxes such as sales tax, hotel tax, entertainment tax, and contract tax.

Initially set at 10 percent, the rate was increased by 3 percent to 13 percent in January 2005 (Magh 2061 BS) due to revenue shortfalls during the Maoist conflict.

Throughout its implementation, VAT was applied at a single rate until now. The Ministry has confirmed that the VAT system will be modified to a dual-rate format. A task force established under Minister Waglé is currently studying the potential impacts and challenges of applying dual rates.

The task force has recommended retaining the upper rate at 13 percent and adding a lower rate of 4 or 5 percent.

Preparations are also underway to bring many items currently exempt from VAT into the lower 4 or 5 percent bracket. When consulted, the Inland Revenue Department indicated it is capable of implementing the dual-rate VAT, prompting the minister to instruct initiation of implementation preparations.

A Ministry source noted, “For three decades, Nepal’s VAT system maintained a single rate, which was favorable. Initially, exemptions were limited to essentials like food grains and vegetables, but over time the exemption list expanded, causing distortions in the VAT system. Now, we aim to reduce the exemption list and impose a lower rate (4–5%) on those items.”

Additionally, preparations are underway to tax goods and sectors that should be VAT-liable but have remained outside the system so far.

With the dual-rate system, the government also plans to organize the refund process for taxpayers. “After filing returns and paying VAT, taxpayers will receive refunds promptly credited to their accounts,” as instructed by the finance minister, the source said.

Previously, unadjusted balances in purchase and sales tax offsets were carried forward to future tax adjustments, which caused issues that this new approach aims to address.

Experts estimate that applying 4 or 5 percent VAT to previously exempt goods will not significantly increase prices. A tax administrator commented, “Costs have been rising due to inability to claim VAT on exempt goods, but with inclusion in the VAT net, input tax credits will be claimable, keeping costs stable.”

Although discussions on the dual-rate VAT are ongoing within the Ministry of Finance, no final decision has been made. Finance Minister Waglé is keen to consult with Rastriya Swatantra Party Nepal chairperson Ravi Lamichhane and Prime Minister Balen Shah before making a decision.

However, tax experts and former tax administrators warn that a dual or multi-rate VAT system will increase costs for both the government and taxpayers and may lead to greater tax evasion. Economist Dr. Rup Khadka points out that most countries in the world apply VAT at a single rate, and Nepal should not reverse course by moving back to a dual-rate system.

Dr. Khadka stated, “India also tried multi-rate GST but has been shifting towards a single rate. Model countries like New Zealand maintain a single VAT rate. We should continue with a single rate system.”

Former Inland Revenue Department Director General Dirgharaj Mainali noted that dual rates would increase administrative burden and scrutiny costs. “The current VAT exemption list is very long and reducing it is good, but having two rates may increase compliance costs and leakage,” he said.

Another former director general warned that dual rates might increase distortions and that lobbying could lead to expanding VAT exemptions, urging the reforms to be advanced carefully.

The private sector has long advocated for a multi-rate VAT, suggesting lower rates on some goods below the current 13 percent.

However, former directors caution that competition among rates might prompt reduction of the higher rate, fostering distortions.

They also argue that dual rates should not be implemented through the budget without adequate preparations, including system, classification, credit mechanisms, and accounting processes.

VAT to be applied on private education, health services, and costly vegetables

The government is planning to levy VAT on private sector education and health services, expensive vegetables, fruits, and processed food products. Discussions about applying a lower VAT rate in these sectors are ongoing.

“If dual rates are introduced, these goods and services may attract the lower VAT rate, but if a single rate remains, they might be subject to the full 13 percent VAT,” a source said.

According to the Ministry of Finance, there is a strong intention to reduce the VAT exemption list, which means most currently exempt goods and services will come under VAT.

However, exemptions will continue for staples such as food grains, lentils, rice, vegetables, fish, fresh meat, financial and insurance services, milk, fertilizer, salt, public transport, and government services.

Threshold for VAT registration to be increased to those with transactions over 5 million

Currently, businesses with transactions exceeding 5 million NPR must register for VAT. Those in service or goods-services sectors with monthly transactions over 3 million NPR must also register. The government plans to raise this VAT registration threshold.

“The new threshold has not been finalized but is expected to increase,” sources said.

The threshold might be raised to between 7.5 million and 10 million NPR.

Currently VAT-exempt goods and services