The IRD Circular Says It Was Always Taxable. Can Tax Be Collected for the Months Before It?

Date of the IRD circular in the case

2068.5.6

Start of the period assessed for excise

2067.10.14

Date of the Supreme Court decision

2074 Magh 29

Income Tax Directive clause on advance rulings

cl.1.3.9

A common view in finance teams goes like this. The law on a product or a transaction is unclear. Some tax offices collect, some do not. The company decides to wait: when the Inland Revenue Department issues a circular, it will start charging and paying. Until then, it reasons, nothing is due, because the Department itself had not made up its mind.

That view treats the circular as the start date of the tax. The Supreme Court did not. In the case discussed here, a manufacturer took exactly that position, won before the Revenue Tribunal, and lost in the Supreme Court. The months before the circular were assessed, and the assessment was upheld.

This article sets out what the Court decided and why, what it did not decide, what the Inland Revenue Department's own Income Tax Directive says circulars and advance rulings are worth, and what we would do instead of waiting.

The case in outline

The appellant was the Inland Revenue Office, Hetauda. The respondent was M.M. Polymers Pvt Ltd of Hetauda Industrial Area, Makwanpur. A joint bench of Justice Kedar Prasad Chalise and Justice Sarada Prasad Ghimire decided the appeal in case no. 138696 on 2074 Magh 29. The decision is reported at printed pages 179 to 181 of the Institute of Chartered Accountants of Nepal's collection of Supreme Court decisions on the VAT, Income Tax, Customs and Excise Acts. It is an excise case.

The facts, as the Court recorded them, are short. The company registered with the Inland Revenue Office, Hetauda on 2066.7.22 and sold various plastic goods from 2067.10.14. Among them were PET preforms: the small, thick tube of plastic that is blown into a bottle. The tax office assessed the excise the company should have paid on preforms for the period, as printed, from 2067.10.14 to 2068.6.27.

In the middle of that period, on the basis of a Department decision of 2068.05.05, the Inland Revenue Department sent circular no. 39 dated 2068.5.6 to all inland revenue offices and taxpayer service offices. The circular said that PET bottles and bottle preforms fall within the heading for plastic packing goods in the excise tariff in the Finance Act schedule. After the circular, the company collected and paid excise on preforms. Its position was that nothing was due for the months before.

The tax office decided against the company on 2069.2.25 and the Department upheld that on administrative review on 2069.6.7. The Revenue Tribunal, Kathmandu reversed both on 2070.5.20, accepting that excise for the period before the circular could not be recovered. The tax office appealed.

What each side argued

The tax office argued that PET preforms were excisable under the Excise Act, 2058 and the Finance Acts of 2067 and 2068 at 5 percent, which it said was not in dispute, and that other inland revenue offices were already collecting excise on the same item. The circular of 2068.5.6, it said, had not added a new charge. It only clarified that preforms fell within the plastic packing goods heading. So the argument that excise could not be collected before the circular was wrong.

The company argued that a preform is not a finished plastic packing good. It had paid excise after the Department's decision, and excise for the period before that decision could not be taken. Where there is doubt, the benefit goes to the taxpayer. Where the body that implements the law was itself in doubt, tax cannot be recovered for that period. And tax must be imposed under law.

Those are serious arguments, and versions of them are made in tax offices every month. The Court's answer to them is the useful part of the decision.

What the Court decided

The Court dealt first with the product. A PET preform, it said, is a compressed form of a PET bottle, and it becomes a bottle when blown, without any chemical process or further production stage. That excise applies to PET bottles was not disputed, so it could naturally be inferred that it applies to preforms too. The Court added that the company itself had collected and paid excise on preforms after 2068.5.6, so both sides in substance accepted that the preform was excisable (printed p.180).

Then the Court turned to the circular. It read the Finance Act 2068 schedule, section 3, excise tariff serial 3, heading 3923, as charging plastic packing goods at 5 percent ad valorem. The circular, the Court said, did not add a new classification that made PET bottles or preforms excisable. It clarified a provision already in the Excise Act and the Finance Act, and it was issued to remove a doubt that had arisen. In the Court's words, in paraphrase, a circular does no more than make clear what the law has already made clear, or settle a point where there was doubt (printed pp.180-181).

The Court also gave the practical reason for the circular. Other inland revenue offices were already collecting excise on the same transactions. A state of affairs in which one office collects and another does not, the Court said, must not be allowed to continue; the circular was issued to end that inequality and keep administration uniform (printed p.181).

So the Tribunal's view that excise before the circular could not be recovered was not lawful. The Court reversed the Tribunal's decision of 2070.5.20 and upheld the Department's review decision of 2069.6.7, which had upheld the tax office (printed p.181). The revenue won.

What the decision does not decide

An honest reading of a short judgment includes its gaps. This one leaves several questions open that a practitioner will want answered.

What the Income Tax Directive says circulars are worth

The M.M. Polymers decision is about excise. For income tax, the Inland Revenue Department has written down its own view of what its circulars are worth, in the opening chapter of the Income Tax Directive, 2066 (5th amendment, 2081). Three clauses on printed page 4 matter here.

Circulars interpret; they do not override. Clause 1.3.8 says the Department issues public circulars to make implementation of the Income Tax Act uniform, simplify administration and guide officers and taxpayers, and that they interpret the Act and the Rules as needed. A public circular that conflicts with the Act or the Rules is invalid to the extent of the conflict. Circulars issued before the Directive are deemed repealed to the extent they conflict with it (Income Tax Directive 2066, cl.1.3.8, p.4).

Read with M.M. Polymers, the picture is consistent. A circular is the Department's reading of the law. Where the reading is right, the tax was always due and the circular adds nothing to the date. Where the reading is wrong, the circular does not make it right: it is invalid to the extent it conflicts with the Act.

Advance rulings bind; circulars do not. Clause 1.3.9 describes the advance ruling, which the Directive calls a new arrangement made by the Income Tax Act, 2058. A particular taxpayer may apply to the Department to remove a doubt about whether, and how far, a provision applies to them. The Department gives its view in an advance ruling, and while that ruling is in force the Department is bound to act on it for that person. Where a public circular and an advance ruling conflict, the advance ruling applies to the person to whom it was issued. And rulings issued before the Directive that conflict with it stay in force for that person until the Department issues a fresh ruling to them, rather than being deemed repealed (Income Tax Directive 2066, cl.1.3.9, p.4).

That is the clearest statement in the corpus of where protection actually lies. The page we read does not print the section number of the Act that creates advance rulings, and we have not read the Act, so we do not cite one.

Supreme Court principles are law; Tribunal principles are not binding. Clause 1.3.6 says principles laid down by the Supreme Court are equal to law and must be followed by officers, while principles laid down by the Revenue Tribunal are not legally binding on the Department, though following them may be appropriate where the Tribunal states a reasoned view after weighing the law (Income Tax Directive 2066, cl.1.3.6, p.4). The practical consequence for M.M. Polymers is obvious: the company had a Tribunal win, and it did not survive.

These clauses are in the Income Tax Directive. We have not indexed the VAT Directive, 2069 and do not say whether it contains equivalent rules for VAT. Do not carry the advance ruling point across to VAT or excise without checking.

Two other decisions that sit beside it

A later circular cannot be applied to a return already filed. In the Siddhartha Bank leasehold improvements case (printed pp.99-104), which we have written about separately, the tax office relied on a circular dated 2064.11.13 to reclassify the bank's leasehold improvements. The bank's return had been filed on 2063.09.30. The Court held that the later circular could not be applied to a return filed before it, and applied clause 1.3.8 of the Directive to treat a circular that conflicted with the Directive as invalid to that extent.

That looks like the opposite of M.M. Polymers, but it is not. In Siddhartha Bank, the circular departed from the Department's own Directive, which supported the bank's treatment. In M.M. Polymers, the circular agreed with the Finance Act, which already charged the tax. The question in both cases is the same: what does the law itself say? The circular's date matters only when the circular is trying to change the answer.

A repealed circular is argued, but not decided. In LTO v. Shivashakti Ghee Udyog Pvt Ltd (decided 2073 Kartik 23, printed pp.34-36), the tax office argued that the circular issued after the Nandan Ghee decision had been repealed from 2063.4.1, so the Tribunal should not have relied on it. The Court did not deal with that argument directly. It applied the principle from the Nandan Ghee decision itself. So the corpus contains no ruling on what a repealed circular is worth. What Shivashakti does show is that where a Supreme Court principle sits behind a circular, withdrawing the circular does not withdraw the principle.

Illustrative example

The figures below are invented to show the arithmetic and the decision points. They are not from the case.

A packaging manufacturer begins selling a new moulded product on 1 Shrawan. Its tax manager thinks the product probably falls within a taxable heading, but two other companies in the same line are not charging, and the local office has said nothing. The board decides to wait for a circular.

Sales of the product run at NPR 25,00,000 a month. Eight months later the Department issues a circular saying the product has always fallen within the taxable heading. Assume, for illustration only, a rate of 5 percent.

Now take the alternative. In month one, the company charges the tax on its invoices and pays it, while recording in a letter to the tax office that it considers the classification arguable. If the circular later confirms the charge, nothing is lost. If the Department later decides the product is not taxable, the question becomes one of recovering what was paid, which is a better place to argue from than defending an assessment with no tax collected from customers.

A third route, where the tax is income tax, is to apply for an advance ruling on the point. If the Department rules in the company's favour, clause 1.3.9 of the Directive says the ruling binds the Department for that company while it remains in force, even if a later public circular says otherwise.

What changes the answer

The result in M.M. Polymers rests on a finding that the circular only clarified the law. These facts would move the analysis:

What we would keep on file

Our view

In our view the M.M. Polymers decision is right on its facts, and it is a useful corrective to a habit we see often. The habit is to treat the absence of a circular as permission. It is not. If the Finance Act charges the tax, the tax is due from the date the Act says, and a circular that later says so is telling you what was already true.

What is usually got wrong is the direction of the risk. Companies wait because they think the downside of waiting is small: if the circular never comes, they saved the tax; if it comes, they start charging. The downside is larger than that. When the assessment arrives, the tax for the earlier months cannot be passed to customers whose invoices were settled long ago. It comes out of margin, possibly with interest and penalty, and the company has spent the intervening months building a file that shows it knew the point was arguable.

What we would do first depends on the tax. For income tax, where the amount justifies it, we would apply for an advance ruling: on the Department's own Directive, that is the only instrument that binds it for a particular taxpayer. For VAT and excise, where we have not confirmed an equivalent route, we would usually charge and pay while recording the disagreement in writing, so that the dispute is about recovering tax paid rather than defending tax never collected. Where neither is commercially possible, we would at least provide for the tax in the accounts and keep the analysis on file.

Where the law is genuinely unsettled, we would not pretend otherwise. A circular that goes beyond the Act should not bind anyone, and we would argue that firmly. But the argument has to be that the Act does not cover the item, not that the Department had not yet said it did. M.M. Polymers shows which of those two arguments wins.

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