Discover why Nepal’s 5-year tax break for startups i.e. 0% tax rate looks great on paper but fails in practice, and what the Government should do to pass on the real tax benefits to every startup business in Nepal!

Starting a startup business in Nepal can be thrilling and terrifying at the same time. You’ve got an idea, a few passionate people, and a laptop (or maybe a dusty desktop). What you don’t have is extra cash for taxes in your early days.

That’s why the Income Tax Act of Nepal, 2058 offers something exciting: a 100% tax exemption for the first five years of your business. Sounds like a dream, right?

But hang on: there’s a catch. Or a few dozen.

Despite this attractive clause, there may not be even a single startup that has actually benefited from it. It’s the classic case of “great on paper, painful in practice.”

Let’s break down what’s really going on, and why this seemingly generous provision has become more of a mirage than a milestone.

Understanding the 5-Year Tax Exemption Clause

So what exactly does the law say?

According to the Income Tax Act, startups using innovative technology, ideas, or methods and earning up to NPR 1 crore per year are eligible for 100% income tax exemption for five years from the start of operations, if they are designated as a startup by the government.

That sounds pretty straightforward. But there are two big problems:

1. Startups Aren’t Profitable in the Early Years

Let’s be honest: most startups don’t make profits for the first few years. Instead, they’re burning cash to build their product, test the market, hire talent, and try to survive. That means even if you qualify for the exemption, you won’t benefit unless you’re making taxable profits.

Worse, even if a startup business in Nepal finally turns profitable in year 4 or 5, they probably still have losses carried forward from earlier years. Those past losses must be adjusted before calculating taxable income, so the "exemption" has nothing left to exempt, making it practically useless.

Let’s break it down with numbers:

• Year 1 loss: NPR 3 lakhs
• Year 2 loss: NPR 2 lakhs
• Year 3 loss: NPR 3 lakhs
• Total accumulated losses = 3 + 2 + 3 = NPR 8 lakhs

Now in:

• Year 4, the business makes a NPR 3 lakh profit
  → Profit is offset: 3 lakh – 8 lakh = -5 lakh (still a loss, so no tax owed)
• Year 5, the business earns a NPR 5 lakh profit
  → Remaining loss to offset = 5 lakh – 5 lakh = 0
  → Technically, still no taxable income that year

End result?
Even by the fifth year, after all the struggle, the startup doesn't pay income tax; not because of the government exemption, but because their own losses already wiped it out.

So the startup gets zero actual benefit from the 5-year tax exemption, even though they complied with everything.

It’s like being given free dessert after you've already eaten and left the restaurant.

2. The “Designated Startup” Status Is a Black Box

To qualify, you must be a “designated startup” by the Department of Inland Revenue. Sounds official. But there’s no clear process on how to become one. No form. No criteria. No government website with guidance. Not even a hotline number. 

So far, no known startup in Nepal has officially received this designation, making this benefit practically inaccessible.

To make things more complicated, the term “startup” itself was only recently defined in Nepal under the Startup Enterprise Loan Operation Procedure, 2081 by the Ministry of Industry, Commerce and Supplies. While that law outlines what a startup is in terms of innovation, age, and revenue, the Income Tax Act hasn’t been updated to align with it.

The IRD has yet to publish any procedural guidelines on how startups can be recognized for tax exemption purposes.

Until the tax authority adopts a clear, accessible, and transparent designation process, this provision remains little more than a line in the law that looks nice, but does nothing in practice.

Tax Traps and Missed Support: What Startup Businesses in Nepal Really Need

To better understand why startups in Nepal struggle with taxes, we need to dive into two lesser-known but highly important parts of the system: TDS and VAT.

What is TDS (Tax Deducted at Source)?

TDS means that tax is automatically deducted from payments made to you, before you even get the money.

For example:

• If someone pays you interest income, they deduct 15% as TDS.
• If you earn rent, they take away 10%.
• If you provide services worth more than NPR 50,000, they deduct 1.5%

That might not sound like a lot, but here’s the catch:

Even if your business is not profitable, you still lose cash because of TDS.

Imagine this: you send an invoice for NPR 100,000 and expect full payment. But you receive only NPR 98,500. That 1.5% has been withheld, and you can’t use it. You still have to pay your employees, rent, internet bills, etc.

For startups, where cash flow is king, TDS can cause serious liquidity problems. And since tax refunds are rare and slow in Nepal, it’s like paying advance tax you might never get back.

What is VAT (Value Added Tax)?

VAT is a tax charged on the goods and services you sell. In Nepal, it’s currently 13%.

Now, if your annual revenue crosses:

• NPR 50 lakhs (goods) or
• NPR 30 lakhs (services or goods & services )

you are required to register for VAT.

Once registered:

• You must add 13% to your prices, which can make your services expensive.
• You must submit regular filings, monthly or quarterly, whether or not you make sales.
• And you must keep extensive paperwork, which eats into time and resources.

For example: If your startup charges NPR 1,00,000 for a digital marketing campaign, you’ll need to charge NPR 1,13,000 with VAT. Now your clients may hesitate to pay extra, and you’re stuck in the middle.

Many startups end up absorbing the VAT cost themselves, eating into already thin margins.

Tax Rate in Nepal: Where Do Startups Stand?

Let’s look at the bigger picture of the tax rate in Nepal to understand where startups fall:

• General corporate tax rate: 25%
• Special industries (like hydropower, agriculture): 20%
• Banks & financial institutions: 30%
• Income tax for individuals: Progressive, from 1% to 36% based on slabs

So even after the 5-year exemption (if it were to actually work), a typical startup could end up paying 25% of their profits as corporate tax.

Now compare that with other countries:

• India offers a 3-year tax holiday to eligible startups and reduced corporate tax rates.
• Singapore exempts startups from tax on the first SGD 100,000 of income for 3 years.
• Estonia taxes only distributed profits, not retained earnings.

Nepal’s system? Still stuck in the “good-on-paper” phase.

Real-World Impact: Why These Issues Matter

Let’s paint a real picture. Imagine a small but promising startup business in Nepal, called EcoBazaar. They sell eco-friendly household products like bamboo toothbrushes, reusable shopping bags, and compost bins, through an online store.

They’re young, driven, and bootstrapped. Like many startup businesses in Nepal, they dream of making a difference and making a living.

Year 1: The Hustle Begins

EcoBazaar launches with just NPR 2 lakhs in savings and a few interns. They manage to make NPR 10 lakhs in revenue that year, but after paying for supplies, rent, packaging, marketing, and salaries, they end the year with a net loss.

Now here’s the twist: they take on a few B2B clients; hotels and cafes who pay them for bulk eco-products. Each of those clients deducts 1.5% TDS from their payments.

So although EcoBazaar didn’t make a profit, they still lost NPR 20,000 to TDS, money that went straight to the tax office.

No refunds. No exemptions. Just cold, hard cash, gone.

Year 2: Growth Comes With a Price

Things start looking up. Sales hit NPR 35 lakhs. They get featured on a local sustainability podcast. Word spreads. Orders increase.

But now they’ve crossed the NPR 30 lakhs service threshold, so they are legally required to register for VAT.

Suddenly, they’re not just shipping bamboo toothbrushes, they’re also dealing with:

• VAT invoices
• Monthly tax filings
• Record-keeping of every little transaction

They hire a part-time accountant just to handle this complexity. That’s another NPR 17,300+/ month burned.

To top it off, clients now start asking, “Do I really need to pay 13% extra VAT?”

Sales slow down. EcoBazaar tries to absorb the VAT cost themselves, squeezing their already razor-thin margins.

Year 3: Profit, Finally! But No Relief

After two years of grinding, they finally turned a small profit. Let’s say NPR 2 lakhs.

Here’s where that 5-year tax exemption for startups should finally kick in, right?

Wrong.

They have carried forward losses from Year 1 and Year 2, so legally, their taxable income is still zero. The exemption means nothing because there’s nothing to exempt.

They’ve paid TDS, navigated VAT, hired an accountant, and stayed compliant, all while receiving zero actual benefit from the government’s tax holiday.

Sound familiar?

If you’re an entrepreneur in Nepal, this probably isn’t a hypothetical story. It’s your reality.

EcoBazaar’s journey is the same as hundreds of startups who:

• Do the right thing
• Register legally
• Pay their taxes
• But get no practical tax relief

The system, as it stands, ends up punishing early effort and delaying support until it’s too late to matter.

A Tax Break for Grants, But Not for Investments?

Here’s another surprising flaw in Nepal’s tax laws: Section 12(c) of the Income Tax Act allows individuals to deduct seed funding to startups from their taxable income, but only if it's given as a grant, not an investment.

That’s right: if you give money to a startup and ask for nothing in return, you get a tax break. But if you invest in exchange for equity, like any rational investor, you get no deduction at all.

This well-intended but poorly worded policy discourages actual investment and limits much-needed funding for startups.

We covered this in detail here:

Weird Tax Concept and Its Impact on Startup Business in Nepal

What Needs to Change: 5 Actionable Fixes for a Startup-Friendly Tax System

If the government of Nepal truly wants to support its rising startup ecosystem, not just in words but in action, then it’s time to move beyond vague promises and introduce concrete, meaningful reforms.

Here are five practical and impactful recommendations, each designed to solve a specific pain point for startup businesses in Nepal.

1. Create a Clear, Accessible Startup Designation System

What problem it solves:
Right now, the “designated startup” status (which is required to access the 5-year tax exemption) is a mystery. There’s no form, no clear criteria, no process.

How to fix it:

• Build an online portal where startups can apply for “designated” status.
• Set clear eligibility criteria, such as company age (under 5 years), turnover (under NPR 1 crore), and focus on innovation or technology.
• Ensure approval within 30 days, and maintain a public registry of approved startups.

Why it matters:
This would unlock access to the tax exemption, remove confusion, and build trust in government policy.

2. Exempt Startups from TDS for Their First 3 Years

What problem it solves:
Startups are currently losing precious cash to TDS deductions, even when they’re not profitable. This strains their cash flow and adds unnecessary compliance burdens.

How to fix it:

• Waive TDS obligations for recognized startups.
• Alternatively, refund TDS quickly through a streamlined portal if full exemption isn’t possible.

Why it matters:
This will improve liquidity, reduce friction in business transactions, and help startups reinvest in growth rather than wait on refunds. If we are to offer full tax exemption for startup businesses in Nepal, why not exempt Tax Deducted at Source as well?

3. Raise the VAT Threshold for Startups

What problem it solves:
Startups are forced to register for VAT too early, at just NPR 30 lakhs (services) or 50 lakhs (goods), leading to extra costs, complex filings, and customer resistance to higher pricing.

How to fix it:

• Raise the VAT registration threshold to NPR 1 crore for startups.
• Allow an “opt-in” model for early-stage businesses that prefer to register.
• Simplify compliance: permit quarterly or bi-annual filings instead of monthly.

Why it matters:
This change would ease the compliance burden, make early-stage services more competitive (without VAT markup), and give startups more breathing room to grow before facing tax bureaucracy.

4. Offer Tax Incentives to Startup Employees

What problem it solves:
Startups struggle to compete with big companies when it comes to salaries. They often attract talent using stock options or performance bonuses, but the current tax system penalizes employees for this.

How to fix it:

• Offer personal tax rebates to employees who work full-time in startups during the company’s early growth phase.
• Exempt income tax on stock options or bonus shares earned from recognized startups.

Why it matters:
These steps would help startups attract and retain high-quality talent, making startup jobs more rewarding and financially viable, especially for young professionals.

5. Give Tax Breaks to Startup Investors

What problem it solves:
Access to capital is one of the biggest barriers for startup businesses in Nepal. But investors are hesitant because there’s little incentive (or protection) in early-stage investing.

How to fix it:

• Offer tax credits or deductions to angel investors, venture capitalists, or institutions that invest in designated startups.
• Provide capital gains tax exemption if they hold the investment for at least 3 years.

Why it matters:
This would stimulate funding, bring more private capital into the ecosystem, and help promising startups raise the money they need to scale.

Conclusion: Turning Talk into Tangible Action

The promise of a 5-year tax holiday for startup businesses in Nepal could have been a much needed push for startups. But in its current form, it’s more of a symbolic gesture than real support.

From the unclear designation process to the invisible benefits of an exemption during loss years, the provision does little to ease the burdens startups face. Add to that the TDS trap, VAT headaches, and a rigid tax system, and the dream of building a company quickly turns into a maze of bureaucracy.

But this doesn’t have to be the case.

With a few strategic policy shifts, Nepal can move from lip service to leadership in startup development. It’s time to turn promises into practice and build a startup ecosystem that truly thrives.

Additional Resources

• Weird Tax Concept and Its Impact on Startup Business in Nepal
• Seed Capital for Startups in Nepal: Grant or Investment? Let’s Fix It Now!
• ‘Grant’ or ‘Investment’ in Startups to Lower Tax Rate in Nepal!