Local Taxation in Federal Nepal: Powers, Challenges, and Gaps

-CA Aastha Upadhyay

The author is member of ICAN, currently serving as Assistant Manager in a practicing firm in Nepal. She can be reached at: aastha.upadhyay100@gmail.com

 

Abstract

The promulgation of the Constitution of Nepal 2072 marks an important phase in Nepal for transitioning towards a federal system. Consequently, the Constitution has changed the fiscal powers and devolved to  all 753 local government (LG) authorities in Nepal, which includes more than ten categories of taxes such as property tax, house rent tax, house and land registration fees, vehicle tax, service fees and charges, tourism fee, advertisement tax, business tax, land revenue and entertainment tax under Schedule 8. Despite this constitutional backing, local governments still rely heavily on transfers from the center. This article looks closely at the legal provisions for LG tax, overreach of LG taxation, the gaps in revenue collection for LGs and the policy recommendation to address those issues. According to the provisions in the Constitution, the Local Governance Operation Act 2074, Intergovernmental Fiscal Management Act 2074, and empirical studies, this article argues that while the legal foundation is solid, weak institutional capacity, unclear policies, and poor coordination continue to hold back effective tax administration at the local level.

 

Keywords: Local Government, Fiscal Federalism, Taxation Powers, Own-Source Revenue, Intergovernmental Fiscal Transfer

 

1. Introduction

The adoption of the Constitution of Nepal, 2072 B.S., represented a landmark event in the evolution of Nepal's administrative and public financial management systems. Enforcing decades of centralization without making much attempt to devolve power, Nepal officially took the step towards the implementation of a three-tier federalism framework consisting of the Federal Government, the seven Provincial Governments, and seven hundred and fifty-three Local Governments. The latter include six Metropolitan Cities, eleven Sub-Metropolitan Cities, two hundred and seventy-six Municipalities, and four hundred and sixty Rural Municipalities. This was not just an administrative reshuffle but a genuine redistribution of executive, legislative, and fiscal authority.

 

Local government (LG) is taken as a public institution operating within a small geographic area such as a city, town, or rural district that constitutes the most proximate and accountable tier of governance for ordinary citizens (Acharya, 2018). The Local Governance Operation Act (LGOA) 2074, which replaced the Local Self-Governance Act 2055, grants local bodies comprehensive executive, legislative, and quasi-judicial powers, including the authority to enact local laws, manage basic services in health and education, oversee local infrastructure, adjudicate minor disputes, and most importantly, levy and collect taxes.

 

The rationale behind fiscal decentralization is grounded in strong and persuasive arguments. . Local governments operating within developing urban areas, emerging cities and rural municipalities are confronted with the dual challenge of ensuring greater access to infrastructure and basic services despite limited financial means in the presence of rapidly growing and urbanizing populations. The imbalance between local expenditure responsibilities and local revenue generation capacity remains one of the most persistent structural challenges in Nepal's fiscal federalism.

 

This article aims to analyze and interpret the local government taxation powers in Nepal, their constitutional basis, their exercise in practice, instances of overreach and inconsistency, and the systemic gaps that continue to undermine local fiscal capacity.

 

1. Review of Literature

 

1. Local Governance

 

Local governance is a multi-dimensional concept that encompasses not only the delivery of public services at the local level but also the creation of a productive environment for democratic participation of local stakeholders, support for market-led local development, and facilitation outcomes that enrich the quality of life of local people (Shah & Shah, 2006). This broader conception of local governance moves beyond mere administrative decentralization to encompass fiscal, political, and developmental dimensions that are essential for the realization of federalism's promise.

 

The historical trajectory of local governance in Nepal demonstrate both the potential and the constraints of decentralization. Right from the beginning, decentralization and local governance practices have been key issues in Nepalese policy, gaining momentum after the restoration of democracy in 2047 B.S. The Constitution of the Kingdom of Nepal 2047 recognized decentralization to ensure optimum involvement of local people in governance, pursuing principles such as devolution of power, building of institutional mechanisms, and promoting people's participation in local development activities (Sharma, 2016). However, these principles were only partially implemented, constrained by political instability and a predominantly centralized administrative culture.

 

The Constitution of Nepal 2072 transformed this paradigm by constitutionally entrenching the three-tier federal structure and assigning explicit and exclusive functions to each tier. Greater citizens' involvement in policy-making and public services must be maintained from self-organization, though local and national contexts continue to shape local governance practices (Marinetto, 2003). In this context, the Constitution establishes a robust fiscal framework encompassing independent revenue generation capacity, expenditure responsibilities and structured intergovernmental transfers.

 

1. Fiscal Federalism

 

Fiscal federalism is fundamentally a devolved function of fiscal authority; a process of granting independence and autonomy to sub-national governments by transferring expenditure responsibilities and revenue assignment powers to lower levels of government (Shah A. , 2020). The theoretical literature on fiscal federalism, originating with (Tiebout, 1956), (Musgrave, 1956), and (Wates, 1972) argues that decentralizing fiscal functions to lower-level governments can improve allocative efficiency by tailoring public goods provision to local preferences, increase accountability through electoral proximity, and promote inter-jurisdictional competition that drives down costs.

 

Many federalized countries have managed financial relations between national and sub-national units, enhanced economic growth and the efficiency of public expenditures, and maintained horizontal fiscal equality and macroeconomic stability under fiscal federalism frameworks (Martinez-Vazquez & McNab, 2005). Such achievements are the cooperative and coordination functions of different tiers of government, bringing substantial results in public finance management, resource allocation, and economic growth (Shrestha R. , 2019). This helps optimize public funds, distribution of resources and thereby leading to economic growth.

 

Nepal's Constitution has adopted the model of cooperative federalism, enshrining three tiers of government, federal, provincial, and local, based on the principles of coordination, coexistence, and cooperation. This confirms three elements of federalism: administrative, political, and fiscal. The constitution assigns tax-related responsibilities to sub-national levels through these elements, including revenue generation, fiscal transfers, and borrowing authority. However, Nepal is continuously struggling to achieve notable results of fiscal federalism (Dhungana & Acharya, 2021).

 

1. Constitutional and Legislative Framework for Local Government Taxation

 

1. The Constitution of Nepal 2072

 

The Constitution of Nepal 2072 is the foundational legal instrument governing the distribution of taxing powers among the three tiers of government. The Constitution's Schedule 8 enumerates the exclusive legislative powers of local governments, Schedule 6 lists provincial exclusive powers, and Schedule 9 enumerates concurrent powers shared between federal, provincial, and local governments. This tripartite division of power is the constitutional base of Nepal's for fiscal federalism.

 

The federal government retains the right to collect customs duty, value added tax (VAT), excise duty, corporate income tax, and personal income tax; the major and most productive sources of tax revenue. Entertainment tax, advertisement tax, vehicle tax, and house and land registration fees are concurrent rights of provincial and local governments. Local governments are exclusively mandated to collect property or land tax, business tax, house rental tax, and local natural resource taxes (Shrestha & Vanik, 2019).

 

1. Local Governance Operation Act 2074

 

The Local Governance Operation Act (LGOA) 2074 decentralizes the central authority in Nepal by granting comprehensive executive, legislative, and quasi-judicial powers to local units. The Act empowers local bodies to draft localized laws, manage basic services in health and education as provided in the Constitution, levy taxes within the constitutional framework, and oversee local courts for minor disputes. It replaced the Local Self-Governance Act 2055 and helped in operationalizing the constitutional provisions regarding local government functions in a more structured and comprehensive manner.

 

The LGOA provides 22 functions that are exclusively performed by the LGs as per Schedule 8, which includes various service delivery and regulatory functions. Some of the key functions include infrastructural development within the locality, management of natural resources and local forests, birth and death registration, running local markets, regulation of local industries, and very importantly, the administration of the tax measures listed in Schedule 8 of the Constitution. It is important for the LGs to develop annual budgets, utilize resources, impose taxes through legislations, and maintain accounts accurately.

 

1. Intergovernmental Fiscal Arrangement Act 2074

 

The objective of the Intergovernmental Fiscal Arrangement Act (IGFAA) of 2074 is to keep the financial relationship among the three tiers of government in the course of federalization through the formation of fiscal management structures, rules, and institutions (Government of Nepal, 2017a). Moreover, this Act provides the system of fiscal equalization grant, conditional grant, special grant, and matching grant from the central to provincial and local governments.

 

1. Tax Instruments Available to Local Governments Under Schedule 8

 

Schedule 8 of the Constitution of Nepal 2072 enumerates the following categories of taxes, fees, and charges within the exclusive or concurrent jurisdiction of local governments:

 

Table 1: Summary of Local Government Tax Powers Under Schedules of the Constitution of Nepal 2072

 

S.N.	Tax/Revenue Head	Constitutional Basis	Remarks
1	Property Tax (Sampatti Kar)	Schedule 8, Constitution 2072	Exclusive LG right
2	House Rent Tax (Ghar Bahal Kar)	Schedule 8, Constitution 2072	Exclusive LG right
3	House & Land Registration Fee	Schedule 8, Constitution 2072	Exclusive LG right
4	Vehicle Tax (Sawari Sadhan Kar)	Schedule 6/8, Constitution 2072	Concurrent: Provincial & LG
5	Entertainment Tax (Manoranjan Kar)	Schedules 6/8	Concurrent: Provincial & LG
6	Advertisement Tax (Bigyapan Kar)	Schedules 6/8	Concurrent: Provincial & LG
7	Business Tax (Byabasaya Kar)	Schedule 8, Constitution 2072	Exclusive LG right
8	Land Revenue (Malpot)	Schedule 8, Constitution 2072	Exclusive LG right
9	Service Charges & Fees	Schedules 9	Concurrent: Federal, Provincial & LG
10	Fines & Penalties (Danda Jaribana)	Schedule 9, Constitution 2072	Concurrent: Federal, Provincial & LG
11	Royalty from Natural Resources	Schedule 9, Constitution 2072	Concurrent: Federal, Provincial & LG
12	Tourist fee (Paryatan shulka)	Schedule 9, Constitution 2072	Concurrent: Federal, Provincial & LG

 

Property tax (Sampatti Kar) can be termed as one of the most significant instruments for raising own-source revenue for local governments across the globe and Nepal. Property tax is a direct tax levied against the value of the immovable assets owned by the taxpayer. This tax has the strength of being hard to evade and having a stable tax base. However, effective property tax collection depends on an accurate and updated property valuation list, enforcement capacity and effective dispute settlement, all of which are lacking in most Nepalese local governments, especially rural municipalities.

 

Business tax (Byabasaya Kar) is imposed on business organizations within the LG territory. It is an easily collectible source of income in the context of rapidly growing business activities in cities. However, the absence of the system of business registrations and poor enforcement leads to low returns on business taxes compared to their possible potential. However, some argue that collecting business tax by LG and income tax by Federal Government perceived as double taxation.

 

Collection of land revenue (Malpot) was performed by the federal government via the Department of Land Management and Archive. Constitutional devolution of Malpot to local governments is a substantial flow of revenues. However, due to the administrative capacity and physical infrastructure, land revenue and registration fees are collected by Federal Government on behalf of LG. Such transitional practice needs to be resolved as soon as possible.

 

Service fees and charges for tourism activities, vehicle parking, rental services, collection of herbs and scraps, and operation of carts, rickshaws, cable cars, and boats represent important non-tax revenues that can be mobilized with relatively low administrative cost. However, many LGs lack proper fee schedules, collection systems, and enforcement mechanisms for these charges.

 

1. Exercise of Taxation Powers: Practice, Overreach, and Inconsistencies

 

1. Progress in Tax Administration

 

As per Constitution and LGOA 2074, there have been improvements in terms of implementation of taxing power for the local governments. Local government have enacted tax laws in their respective local assemblies, formed revenue divisions under their administrative system and started the process of collecting taxes that fall under their jurisdiction. Metro cities like Kathmandu, Lalitpur, Pokhara, and Bharatpur along with other sub-metro cities have taken a more systematic approach towards tax administration with tax payment gateways online.

 

Despite having low capacity at the local level, devolving power related to tax administration at the LGs positively contributes to effectiveness of municipalities compared to devolving expenditure responsibilities through fiscal transfers alone (Khanal, 2016). This finding supports the constitutional mandate of distributing revenue administration among the three tiers of government as a step in the right direction. However, the best results cannot be obtained unless this is done for the best interest of taxpayers and the general population, with the tax system expected to positively contribute to overall human development (Dhungana & Acharya, 2021).

 

1. Instances of Overreach

 

Another important but overlooked issue in Nepal’s local fiscal federalism relates to local governments imposing excessive taxes either through overstepping their constitutional mandate regarding taxation authority, taxing an area twice in case it has been taxed previously by a provincial or federal government, or imposing a tax that does not have legislative approval.

First, many LGs have imposed ad hoc fees on goods transportation, particularly on agricultural produce moving through their jurisdiction. These 'check post fees' or 'transit charges' are not constitutionally authorized and effectively amount to internal tariffs that affects markets, raise consumer prices, and violates the common economic space established by cooperative federalism. This practice has been declared unconstitutional in several cases, as decided by the Supreme Court of Nepal.

 

Secondly, there has been an overlap in levying fees and charges for the use of roads or the registration of vehicles by both the province and local government, owing to some ambiguity in the concurrent powers provided under Schedules 6/8/9 of the Constitution. Some local governments levy vehicle taxes irrespective of whether a province has levied such taxes on those vehicles.

 

Third, some LGs have been charging excessive taxes for their hoarding boards and advertisements without clear guidelines and a transparent system that makes it easy for them to enforce these fees arbitrarily.

 

Fourthly, as per the law determined by the provincial government, the local government collects revenue on the collection of stone, gravel, and sand by contracting out. According to the provincial law, the revenue should be shared between the province and the local government, but since the amendment to the Local Government Operation Act states that the collection of such revenue in the local consolidated fund. Such contradictory provision has created dispute between local governments and province.

Finally, there have been cases reported where LGs charge for services that they fail to deliver, especially in the areas of environmental clearances, building permits, and business registrations. Such instances of charging without service delivery are examples of excesses on one hand and poor governance on the other.

 

1. Inter-Jurisdictional Co-ordination

 

In accordance with the Intergovernmental Fiscal Arrangement Act, The Government of Nepal has adopted a single revenue administration system for jurisdictional coordination. As per the act, the value added tax and internal excise duty are collected by the federal government and distributed among the federal, provincial and local levels at the rate of 70, 15, 15 percent respectively, the royalty of natural resources will be collected by the federal government and distributed among the federal, provincial and local levels at the rate of 50, 25, 25 percent respectively. Similarly, the vehicle tax is collected by the provinces and retain 60 percent to the provinces and distribute 40 percent to the relevant local levels. Likewise, entertainment tax, advertisement tax are collected by the local levels and retain 60 percent to the local levels and 40 percent is deposited to the province. There is a provision that the amount received by the provinces and local levels are deposited in a divisible fund and distributed on the recommendation of the National Natural Resources and Fiscal Commission. This seems ideal provision to facilitate intergovernmental coordination. The IGFAA 2074 also provides a framework for resolving such disputes, but the Inter-Provincial Council and fiscal coordination mechanisms have been slow to address any conflicts in practice. Provincial governments have in some cases enacted provincial tax laws that encroach on local tax space, while local governments have resisted provincial oversight on the grounds of constitutional autonomy.

 

The absence of a national tax policy framework specifically governing the concurrent tax bases has left a dangerous vacuum. The real need for the hour is to have an authoritative declaration as to which tier has the primary taxing authority, at what rate, and how double taxation can be avoided.

 

1. Critical Gaps in Local Government Own-Source Revenue Generation

 

1. Institutional Capacity Gaps

 

The main gap that hinders effective LG tax administration is the lack of institutional capacity. Most of the local governments, especially the four hundred and sixty rural LGs, do not have enough trained personnel, information technology, and organizational capability to determine the tax base, determine the tax liability, issue bills, collect payments, and enforce compliance on all the taxes within their jurisdiction. Revenue section staff typically have limited training in tax administration, valuation, or enforcement law.

 

Property tax, potentially the most productive own-source revenue instrument, requires an accurate, current, and comprehensive property valuation database. Most LGs lack such a database. In most cases, the records regarding properties are outdated and fail to consider the real value of these properties.

 

1. Legal and Regulatory Gaps

 

Despite the comprehensive constitutional framework, there are still some gaps within the existing constitution in terms of legality. First, the provision related to concurrent taxing bases in the Schedules 6/8/9 of the Constitution are not clearly stated, causing much confusion about which level is responsible. Second, even though the IGFAA 2074 provides the general structure of intergovernmental fiscal relationship, the law is silent on how to regulate the rate and base, as well as resolving disputes.

 

Further, the lack of a uniform local tax legislation that would be equivalent to the Income Tax Act on a national level means that there is a large disparity between the two systems. This causes problems regarding the efficient processing of taxes, particularly when a business has multiple locations within several LGs. This limits the potential for automated tax administration and data sharing.

1. Political Economy Constraints

 

Beyond institutional and legal gaps, political economy factors significantly constrain LG tax mobilization. Local elected representatives often face direct electoral accountability to the same taxpayers they are expected to tax, creating incentives to keep tax rates low or to avoid enforcement against politically influential constituents. In addition, the culture of dependency on central transfers, inherited from decades of centralized governance has reduced the urgency that local leaders attach to own-source revenue mobilization.

 

1. Data and Information Gaps

 

Systematic data on local government own-source revenue collection disaggregated by tax type, LG category, and region is not comprehensively published. The Ministry of Federal Affairs and General Administration (MoFAGA) and the Ministry of Finance collect aggregate fiscal data from local governments, but the quality, timeliness, and precision in data are insufficient for rigorous analysis and policy design. Without reliable baseline data on tax bases and collection performance, it is impossible to set credible revenue targets, identify non-compliant taxpayers, or evaluate the impact of administrative reforms.

 

1. Fiscal Transfer Dependency and the Revenue-Expenditure Imbalance

 

A defining feature of Nepal's local fiscal landscape is the structural dependence of local governments on intergovernmental fiscal transfers. In FY 2083/84, the total amount of grants that are to be transferred to the local government is equal to Rs. 31,46,239 lakhs, which accounted for roughly 14.8 percent of the total national budget of Rs. 2,12,43,444 lakhs (Ministry of Finance, 2083/84). Such an inter-governmental transfer system exists due to the basic contradiction between expenditure obligations and revenues of the local government.

Figure 1: Fiscal Transfer Dependency Chart

 

The theoretical literature on fiscal federalism recognizes that a degree of vertical fiscal imbalance where central governments collect more revenue than they spend, and sub-national governments spend more than they collect which is normal and even desirable in well-functioning federations. Central governments will always incur fewer compliance costs in the case of general taxes such as VAT and personal incomes whereas the local governments have relative advantages in the provision of local public goods.

 

Despite having low capacity at the local level, devolving power related to tax administration to LGs positively contributes to the effectiveness of municipalities compared to devolving expenditure responsibilities alone through fiscal transfers (Khanal, 2016). This finding underscores the importance of genuine revenue decentralization, and not merely expenditure decentralization, as a strategy for making local government effective and accountable.

 

1. Conclusion and Recommendations

 

Nepal's constitutional framework for local government taxation is, in principle, among the most comprehensive in South Asia. Schedule 8 of the Constitution assigns a substantial portfolio of tax and non-tax revenue instruments to local governments, the LGOA 2074 operationalizes their administrative and legislative powers, and the IGFAA 2074 establishes the broader intergovernmental fiscal framework. The assignment of revenue administration powers to local governments represents a step in the right direction toward effective fiscal federalism.

 

However, there still exists a substantial discrepancy between what is promised constitutionally and what is achieved fiscally. The following policy recommendations are offered to address these challenges and strengthen local government fiscal capacity:

 

First, the federal government should prioritize investment in property tax administration systems including comprehensive property valuation databases, Geographic Information System (GIS) based mapping of taxable properties, standardized assessment methodologies, and training of local revenue staff.

 

Secondly, the IGFAA 2074 needs to be amended to include a provision that will address issues arising out of concurrent taxes, including primary jurisdiction, rate range, and anti-double taxation. The country will need a national tax policy coordination committee comprised of representatives from all three levels of government.

 

Thirdly, the federal and provincial governments should support LGs in establishing integrated revenue management systems including business registration databases, billing and collection platforms, and taxpayer grievance mechanisms that reduce the administrative cost of compliance and enforcement. Also, fiscal transfers must contain incentive structures regarding own source revenue performance.

 

Fourthly, civil society and professional organizations, including the Institute of Chartered Accountants of Nepal (ICAN), should engage with local governments to build fiscal literacy among both administrators and citizens fostering understanding of the link between local taxation and local service delivery that is essential for democratic accountability in fiscal federalism.

 

In conclusion, the effective exercise of constitutional taxation powers by Nepal's local governments is not merely a fiscal matter, it is a prerequisite for the realization of the broader democratic and developmental promise of Nepal's federal transformation. Strengthening local tax administration, closing legal gaps, preventing overreach, and reducing grant dependency are interconnected necessities that require coordinated action by all three tiers of government, civil society, and the professional community.

 

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