For foreign entities doing business in Nepal, the concept of Permanent Establishment (PE) determines tax residency and the resulting obligations. This insight explains what creates a PE, the exceptions, how PEs are taxed, and how double-taxation treaties apply.
01What is a Permanent Establishment
Under Section 2(aab) of the Income Tax Act, 2058 (2002), a foreign entity’s place of business becomes a PE in Nepal where its operations are conducted, wholly or partly, through specific modes or locations in Nepal for more than 90 days (continuously or with intervals) within a 12-month period. The concept has four components: a non-resident entity (the owner), a business activity, a location in Nepal, and the activities carried out there.
02Why PE matters
PE is central to determining a foreign entity’s tax residency. Cross-border transactions occur either without local presence (generally not taxed in Nepal) or with local presence through agents or employees — where questions of double taxation, applicable rates and foreign tax credits arise. The PE concept resolves how such presence is taxed.
03Transactions that create a PE
Carried on for more than 90 days in 12 months, the following constitute a PE: business through a dependent agent; main equipment or machinery situated, used or installed in Nepal; technical, professional or consultancy services through employees or others; and construction, supervision or similar projects. A fixed place of business qualifies regardless of the number of days, while construction and service activities are tested against the 90-day threshold.
04Exceptions
No PE arises where business is conducted through an independent agent in the ordinary course of business, or where activity in Nepal does not exceed 90 days within 12 months. In addition: merely importing goods is insufficient; individuals/natural persons cannot be a PE (only entities can); the entity must be present and conducting business in Nepal; and an unregistered foreign entity cannot have a PE.
05Purchase, conversion and sales
Simply purchasing goods in Nepal (without conversion and sale) is not a business activity for PE purposes. Conversion activity in Nepal qualifies regardless of where purchase or sale occurs. Sales generally count — though sales to Nepali importers do not — and establishing a godown (warehouse) for sales is a business activity in Nepal.
06Investments and special cases
A business activity is essential — a non-resident merely holding investments in Nepal is not automatically a PE, and a PE cannot be created for employment or investment income of individuals. Certain activities are excluded by the Act or treaties: PE is not created for international flight operations, communication services (including roaming) or royalty income (Sections 67 & 70).
07Registration and taxation of PEs
A PE must be registered with the tax authorities, particularly where registered as a branch under the Company Act. PEs are treated as Foreign Permanent Establishments (FPEs) and taxed similarly to resident entities, with agreements between the FPE and its main entity allocating overheads, income and liabilities. FPEs file returns for their Nepali activities; amounts remitted abroad are treated as dividends and taxed; and gains on disposal of an FPE with a Nepali source are taxable. Comprehensive record-keeping in the prescribed format is required.
08PE and Double Taxation Avoidance Agreements (DTAAs)
Where a foreign entity creates a PE in Nepal, DTAAs can relieve double taxation of the FPE’s income. Many of Nepal’s DTAAs pre-date the IT Act, raising questions about the application of the limitation-of-benefit provision in Section 73(5) — to be read with the Nepal Treaty Act, 2047 (1990), under which domestic law inconsistent with a treaty is void to the extent of the inconsistency. Nepal has DTAAs with ten countries: China, India, Mauritius, Sri Lanka, Pakistan, the Republic of Korea, Thailand, Austria, Norway and Qatar. The decision on tax residency and PE registration should rest on a careful analysis of the transactions and the applicable treaties and law.