What is TDS (Tax Deducted at Source)?

TDS, or Tax Deducted at Source, is a pay-as-you-go method of collecting income tax in which the person making a payment (the withholding agent) deducts a prescribed percentage of tax at the moment the payment is made and deposits it directly with the Inland Revenue Department (IRD). Rather than waiting for the recipient to declare the income and pay tax at year-end, the government collects a slice of the tax up front, at the source of the income. The recipient receives the payment net of the deducted amount, and the deduction is recorded against their Permanent Account Number (PAN).

In Nepal the obligation to withhold falls on employers, companies, government bodies, and most registered businesses whenever they make a payment that has a source in Nepal — including salaries, interest, dividends, rent, royalties, commissions, service and consultancy fees, and contract or supply payments. The rate depends entirely on the nature of the payment and the status of the recipient: for example, a service fee paid against a VAT invoice is withheld at 1.5%, but the same kind of fee paid on a PAN-only bill (no VAT) is withheld at 15%. House or property rent paid to a natural person is withheld at 10%, dividends from a resident company at 5%, and interest on bank deposits paid to a natural person at 6%.

For many recipients the deducted amount is simply an advance: it is credited against their final annual tax liability, so they either pay the balance or claim a refund when they file their income-tax return. For certain payments, however, the deduction is treated as 'final withholding' — the tax is settled in full at source and the income does not need to be added to the recipient's other taxable income or reported again. This dual character (advance tax versus final tax) is central to understanding how TDS interacts with the rest of Nepal's income-tax system.

Example 1 — office rent. A company rents an office from an individual landlord for Rs 100,000 per month. Because rent on land or buildings paid to a natural person carries 10% TDS, the company withholds Rs 10,000, pays the landlord Rs 90,000, and deposits Rs 10,000 with the IRD. As rent to a natural person is a final withholding, the landlord's tax on that rent is fully settled — the Rs 90,000 is theirs to keep with no further income-tax filing required on that rent.

Example 2 — service fee, VAT vs PAN. Suppose a firm pays a consultant Rs 200,000. If the consultant is VAT-registered and issues a VAT invoice, TDS is 1.5% = Rs 3,000 withheld, and that amount is an advance credited against the consultant's annual tax. If instead the consultant issues only a PAN bill (no VAT), the rate is 15% = Rs 30,000 withheld. The much higher PAN-only rate is a deliberate incentive to bring suppliers into the VAT system.

Example 3 — bank-deposit interest and dividend. On Rs 50,000 of interest paid to an individual depositor, a bank withholds 6% = Rs 3,000 and the depositor's tax on that interest is final. Likewise, when a resident company distributes a Rs 100,000 dividend, it withholds 5% = Rs 5,000; the shareholder receives Rs 95,000 and owes no further tax on the dividend. In each case the withholding agent must deposit the deducted tax with the IRD within 25 days of the end of the Nepali month in which the deduction was made, and file the corresponding monthly eTDS return; the recipient can later download a TDS/tax-withholding certificate evidencing the credit.

TDS in Nepal is established by the Income Tax Act 2058 (2002 A.D.), which consolidated and modernised the country's income-tax law and replaced the earlier Income Tax Act 2031. Withholding is dealt with in Chapter 17 of the Act, principally Sections 87 to 92. Section 87 covers withholding by employers on remuneration (salary), Section 88 covers withholding on investment returns and service charges (interest, rent, royalty, dividend, natural-resource and service payments), Section 88A addresses windfall gains, and Section 89 covers withholding on contract and supply payments.

Section 88 sets a general withholding rate of 15% on payments such as interest, natural-resource fees, rent, royalty and service charges with a Nepal source, while prescribing reduced rates for specific items — for instance a lower rate on interest paid to a natural person on a non-business deposit, and a separate rate for dividends and investment-insurance profits. Section 90 requires the withheld tax to be paid to the IRD together with a statement within the prescribed time (25 days after month-end), Section 91 entitles the recipient to a tax-withholding certificate, and Section 92 lists the payments treated as final withholding — including dividends from a resident company, rent paid to a non-business natural person, interest paid by banks and financial institutions to natural persons, investment-insurance profits, and certain payments to non-residents.

Although the Act fixes the framework, the specific percentages are reviewed and adjusted by Parliament each year through the annual Finance Act (Aarthik Ain) that accompanies the national budget. This is why a rate may differ from the figure written in the original Act text — for example, dividends are commonly withheld at 5% under current rules — and why anyone applying TDS should check the rate in force for the relevant fiscal year. The IRD administers collection, operates the electronic TDS (eTDS) filing system, and enforces compliance.

TDS is frequently confused with VAT and with income tax generally, but the three are distinct. VAT (Value Added Tax) is an indirect consumption tax of 13% charged on the sale of goods and services; TDS is a method of collecting direct income tax from the recipient's income. The two can appear on the same transaction — a VAT-registered supplier charges 13% VAT on the invoice, while the buyer separately deducts 1.5% TDS from the payment — and they flow to the IRD through different returns.

A key distinction is advance versus final withholding. Where TDS is an advance, it is merely a prepayment that the recipient nets off against their assessed annual tax (paying any shortfall or claiming a refund). Where a payment is listed under Section 92 as final withholding — such as dividends, rent to a natural person, or bank-deposit interest to an individual — the deducted tax is the complete and final tax on that income, and the income is excluded from the recipient's further tax computation. Confusing the two leads people either to over-report final-withholding income or to forget to claim advance TDS as a credit.

Other related concepts include the PAN, which every withholding agent and most recipients must hold so deductions can be tracked; advance tax (अग्रिम कर), self-assessed instalment payments by businesses that complement TDS; final tax versus assessable income; and the income-tax slabs that determine an employee's salary withholding under Section 87. Late or non-deposit of TDS attracts interest and penalties under the Act, so timely deposit within the 25-day window and accurate eTDS filing are essential for compliance.