Taxable Income & Exemptions: Section 10, Deductions & Real Cases

Core Concepts: What is Taxable Income?

Taxable income is the gross income minus allowable deductions and exemptions as per the Income Tax Act, 2058 (2002). It is the base on which tax is calculated.

Key Definitions

1. Income Year: The 12-month period (Baisakh 1 to Chaitra 30) for which income is computed.
   • Example: For the income year 2080/81, income earned from Baisakh 1, 2080, to Chaitra 30, 2081, is considered.
2. Assessment Year: The year following the income year when tax is assessed and paid.
   • Example: Tax for income year 2080/81 is assessed and paid in 2081/82 (Assessment Year).

flowchart TD
    A["Income Year
(Baisakh 1 - Chaitra 30)"] -->|Income Earned| B["Assessment Year
(Follows Income Year)"]
    B -->|"Tax Assessment"| C["Income Tax Department
(Assessment Year: 2081/82)"]
    A -->|"Example:"| D["Income from
Baisakh 1, 2080
to Chaitra 30, 2081"]
    C -->|"Tax Paid"| E["Assessment Year
2081/82"]

Exemptions Under Section 10

Section 10 of the Income Tax Act lists incomes that are fully or partially exempt from tax. These include:

Worked Example: Donation Deduction (Past Exam Question)

A businessman has an adjusted taxable income of Rs. 1,000,000 and donates Rs. 200,000 to a public school. Compute the allowable donation deduction.

Solution:

1. Maximum allowable donation = 10% of taxable income = 10% × 1,000,000 = Rs. 100,000.
2. Actual donation = Rs. 200,000 (but only Rs. 100,000 is deductible).
3. Taxable income after deduction = 1,000,000 – 100,000 = Rs. 900,000.

Deductible vs. Non-Deductible Expenses

Not all expenses can be deducted while computing taxable income. The Income Tax Act specifies which expenses are allowed and which are disallowed.

Allowed Deductions (Section 19)

Non-Deductible Expenses (Disallowed)

Real-World Applications

1. Daraz (Nepal’s E-Commerce Giant)

• Which Idea? Depreciation (Block D) & Business Expenses
• How?
  • Daraz deducts depreciation on servers, delivery vans, and warehouse equipment under Block D (10%–20% per year).
  • Salary of delivery agents, rent for warehouses, and marketing expenses are fully deductible as business expenses.

2. Ncell (Telecom Company)

• Which Idea? Capital Gains & Depreciation
• How?
  • When Ncell sells old telecom towers, the capital gain is taxed only if the sale price exceeds the depreciated value.
  • Depreciation on new towers is claimed over 5–10 years (as per Block D rules).

3. Kathmandu Retail Shop (Small Business)

• Which Idea? Profit & Loss Carry Forward (PCC) & Donations

• Worked Example: A Kathmandu-based retail shop has the following P&L for 3 years:

  Year	Profit/Loss (Rs.)
  2080	(50,000)
  2081	100,000
  2082	(30,000)

  Question: If the shop donates Rs. 20,000 to a school in 2082, how is the taxable income computed?

  Solution:

  1. Losses can be carried forward to set off against future profits.
  2. Total losses (2080 + 2082) = Rs. 80,000.
  3. Profit in 2081 = Rs. 100,000 → Net taxable income = 100,000 – 80,000 = Rs. 20,000.
  4. Donation deduction (2082) = Rs. 20,000 (but only 10% of taxable income is allowed).
     • Taxable income before donation = Rs. 20,000.
     • 10% of 20,000 = Rs. 2,000 (only Rs. 2,000 is deductible).
  5. Final taxable income = Rs. 20,000 – 2,000 = Rs. 18,000.

Step-by-Step: Computing Taxable Income

Let’s take a real Nepali business example (a Kathmandu-based restaurant).

Given Data (Income Year 2080/81)

Step 1: Compute Gross Income

• Gross Income = Revenue – COGS = 5,000,000 – 2,500,000 = Rs. 2,500,000

Step 2: Add Back Non-Deductible Expenses

• Owner’s Personal Car Expenses (Rs. 50,000) → Not deductible.
• Fine for Late Tax Payment (Rs. 20,000) → Not deductible.
• Adjusted Gross Income = 2,500,000 + 50,000 + 20,000 = Rs. 2,570,000

Step 3: Deduct Allowable Expenses

Total Deductions = 300,000 + 1,200,000 + 200,000 + 150,000 + 257,000 = Rs. 2,107,000

Step 4: Compute Taxable Income

• Taxable Income = Adjusted Gross Income – Total Deductions = 2,570,000 – 2,107,000 = Rs. 463,000

Dr. Gross Income (2,500,000)
    Cr. COGS (2,500,000)
    Cr. Rent (300,000)
    Cr. Salaries (1,200,000)
    Cr. Utilities (200,000)
    Cr. Depreciation (150,000)
    Cr. Donation (257,000)
    **Balance (Dr.) = Taxable Income (463,000)**

Exam Tip: How to Score Full Marks

1. Always define key terms (Income Year vs. Assessment Year, Taxable Income vs. Gross Income).
2. Show calculations step-by-step (like the Kathmandu restaurant example).
3. Highlight disallowed expenses (personal, capital, penalties).
4. Use Section references (e.g., "As per Section 10(1)(b), donations are deductible up to 10% of taxable income.").
5. For PCC (Profit & Loss Carry Forward), always:
   • Set off losses against profits in sequence.
   • Compute 10% of taxable income for donations.
6. Draw t-accounts or tables for deductions and exemptions (examiners love visuals!).

Final Note:

• Memorize Section 10 exemptions (agriculture, dividends, donations).
• Practice PCC problems (they appear every year in exams).
• Real-world tie-ins (Daraz, Ncell, Kathmandu shops) help remember formulas.

Good luck! 🚀