Expenses on Public Roads and Culverts: Tax Deductible?

Sushil Parajuli

Yes they are tax deductible, naturally so - if it meets the business expediency test. But what are the recognition criteria for expenses made on public roads and culverts from:

Accounting Perspective
Tax Perspective

Sushil Parajuli

Sushil Parajuli Accounting Perspective

From Accounting Perspective, under International Financial Reporting Standards (IFRS), expenses related to public roads, culverts, and similar public infrastructures that do not fall under the control of the entity are typically not recognized as assets or expenses on the entity's financial statements. Instead, these expenses are treated as costs incurred for using public services rather than acquiring or constructing assets. These expenses neither falls under the scope of IAS 16 on Property, Plants and Equipment nor are recognized as "assets" for the purpose of Conceptual Framework for Financial Reporting.

Paragraphs 4.3 to 4.25 of the Conceptual Framework for Financial Reporting provides three important tests for recognition of an asset. An asset is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits.

In case of expenses made for public infrastructures, unless it is recognizable as a Service Concession Arrangement, to recognize an item as an asset on the balance sheet, the entity must have control over the item and the ability to derive future economic benefits from it. Public infrastructures like access roads, culverts, local transmission setups are generally not owned and controlled by the entity but by governmental or public authorities. The reporting entity does not have the ability to control these assets or use them exclusively to generate future economic benefits - so they fail to be recognized as an "asset" in the books of account.

Sushil Parajuli

Sushil Parajuli Tax Perspective

Speaking from Tax Perspective, explanation (gha) of Section 21 of the Income Tax Act, 2058 provides the definition for Capital Nature Expenses:
(घ) "पुँजीगत प्रकृतिको खर्च भन्नाले देहाय बमोजिमका खर्च सम्झनु पर्छः-
(१) प्राकृतिक स्रोतको सम्भाव्यता अध्ययन, अन्वेषण र विकासका सम्बन्धमा लागेको खर्च,
(२) बाह्र महिनाभन्दा बढी लाभप्रद आयु भएको कुनै सम्पत्ति प्राप्त गर्दा लागेको खर्च, वा
(३) दायित्वको निःसर्ग गर्दा लागेको खर्च ।

Basically for tax purpose when the cost is incurred in relation to acquisition of an asset with a useful life exceeding 12 months, it can be termed as "expense of capital capital nature". For tax purposes under Section 2(kaRa) of the Income Tax Act 2058 "depreciable asset"- means an asset to the extent to which it is used in the production of income from a business or investment and that is likely to lose value because of wear and tear, obsolescence, or the passing of time; and excludes trading stock. Cost incurred in depreciable assets cannot be deducted in computing the taxable income except for under Section 19 as Depreciation Expenses.

Sushil Parajuli

Sushil Parajuli (२) बाह्र महिनाभन्दा बढी लाभप्रद आयु भएको कुनै सम्पत्ति प्राप्त गर्दा लागेको खर्च, वा

Income tax offers the definition of "asset" or "सम्पति" but it is a circular tautological definition. Tautological definitions can sometimes arise due to attempts to simplify language or provide an exhaustive description for the term being defined, but they can be criticized for not truly clarifying the meaning of a term and for potentially adding confusion.
Section 2(kaDha) of Income Tax Act, 2058:
(कध) सम्पत्ति: “सम्पत्ति” भन्नाले कुनै पनि किसिमको मूर्त वा अमूर्त सम्पत्ति सम्झनु पर्छ र सो शब्दले मुद्रा, ख्याति, प्रविधि ज्ञान, जायजेथा, कुनै व्यक्तिको विदेशी शाखामा रहेको स्वामित्व वा हित, आम्दानी गर्ने वा भविष्यमा आम्दानी प्राप्त गर्ने अधिकार र कुनै त्यस्तो सम्पत्तिको कुनै भाग समेतलाई जनाउँछ ।

So what is "सम्पति"? - It seems the tax law is not interested in defining the term "asset" itself and wants to leave it to the general accounting standards. Such is the intention of tautological definitions usually provided in laws.

As per paragraph 8.1 of Chapter 8 of the Income Tax Directive, 2066 Tax accounting encompasses the accounting framework tailored for income tax considerations. To ensure consistency and adherence to established norms, when the Income Tax Act explicitly outlines an accounting method, it must be adhered to. Conversely, if no such method is specified, conformity with widely acknowledged accounting principles becomes imperative. In this realm, compliance with Nepal Accounting Standard/Nepal Financial Reporting Standard, as endorsed by the Institute of Chartered Accountants of Nepal (ICAN) through the Nepal Accounting Board, is mandated. In situations where these standards are unavailable, recourse to International Accounting Standard/International Financial Reporting Standard (where applicable) is advocated. Should neither standard be accessible, accounting based on recognized norms (Best Practice) can be pursued as stipulated by the Act. This paragraph elucidates the multifaceted aspects of the Act's provisions concerning tax accounting, contextualized within the domain of accounting practices. So it is reasonable that we can resort to accounting standards issued by ICAN for the recognition of the "assets" where they are not clearly stipulated by the tax laws.

Sushil Parajuli

Let's take the case of श्रीराम सुगर मिल्स विरूद्ध आन्तरिक राजस्व विभाग Case Number: 072-RB-0473.

The Revenue Authorities, based on their interpretation, disallowed the deduction of expenses attributed to public roads, culverts, and bridges. This decision was grounded in the assertion that these expenses were ineligible for deduction according to Section 19 of the Income Tax Act, 2058, given that they pertained to assets not held by the taxpayer. Conversely, the taxpayer contended that these expenses bore a capital character due to their integral role in facilitating the regular course of factory operations. The taxpayer also invoked the Nepal Financial Reporting Standards to provide contextual guidance, but it was not deeply delved by the court.

Upon careful scrutiny, the court acknowledged that the taxpayer's investment in road infrastructure and culverts was intrinsically motivated by the desire to streamline the transportation of raw materials. A central tenet emphasized was that businesses inherently act in their self-interest, a principle demonstrated by the taxpayer in their elucidation of the indispensability of these expenses for optimizing operational efficiency. This sentiment was substantiated by a precedent (ठूला कारदाता कार्यालय बिरुद्ध श्रीराम सुगर मिल्स Case Number: 066-CR-0363), where the court had recognized the validity of categorizing road repair as a justifiable business expense, given its facilitative impact. In light of these considerations, the court reached the determination that the expenses in question indeed hold relevance within the business context and warrant allowance. Additionally, the court affirmed that the related depreciation expenses should be permissible for deduction, dismissing the notion of disallowance under Section 19 as regards capital expenditures. Furthermore, the court rendered a decision favoring the taxpayer's claim for deduction of expenses encompassing repair and enhancement activities, encompassing roads and bridges. This determination was rooted in the understanding that these expenditures were integral to the principles of business expediency and, consequently, eligible for deduction under the purview of the Income Tax Act, 2058.

Sushil Parajuli

Sushil Parajuli The taxpayer also invoked the Nepal Financial Reporting Standards to provide contextual guidance, but it was not deeply delved by the court.

The taxpayer, in an effort to offer context, also referenced the Nepal Financial Reporting Standards, although the court did not extensively explore this aspect. Notably, the court did not engage in a detailed discussion regarding the accuracy of the taxpayer's accounting treatment, as this was not the primary issue under consideration. It is worth noting that had the taxpayer chosen to adhere to the prevalent financial reporting standards in Nepal, it may have been entitled to deduct the complete amount as an expense. The application of Nepal Financial Reporting Standards would generally advocate for the full recognition of expenses related to public roads, culverts, and bridges (as discussed above).

However, the focal point of contention revolved around the taxpayer's inability to claim even the depreciation expenses. In this context, the court's decision to permit the deductibility of depreciation and maintenance expenses appears equitable, notwithstanding its non-alteration of the accounting treatment - an aspect that was not a point of divergence between the taxpayer and the revenue authority.