Notes of Chapter 2(a, b): Global vs Scheduler (Tax Calculation Systems), Source vs Worldwide Taxation.
Chapter 2(a): Global vs Scheduler (Tax Calculation Systems)
1. Global Income Tax System
Definition:
This system aggregates all income sources of a taxpayer and applies a single progressive tax rate. Income is taxed collectively, rather than by individual sources.
Desirability:
Generally preferred due to:
- Reduces Tax Planning: Uniform taxation discourages manipulating investments based on tax advantages.
- Ensures Fairness: Income tax is based on a person’s total earning capacity, promoting tax equity.
- Simplifies Administration: Combining all income streams into a single tax calculation reduces complexity.
2. Scheduler Income Tax System
Definition:
Under this system, income is categorized and taxed based on its source. Different types of income are assessed and taxed independently, potentially using different rules and rates.
Desirability:
This approach is less desirable, due to several concerns:
- Encourages Tax Planning: Taxpayers may shift income or expenses to take advantage of lower rates in specific categories.
- Lacks Equity: Different tax treatments for different sources lead to inconsistent tax burdens, undermining fairness.
- Complex Administration: Varying deductions and classifications across income types increase administrative burdens.
Global vs Scheduler Income Tax System
| Criteria | Global Income Tax System | Scheduler Income Tax System |
|---|---|---|
| Definition | All income sources are combined and taxed jointly | Income from each source is taxed separately |
| Tax Calculation Basis | Single progressive rate on total income | Different tax rates/structures for different sources |
| Equity | More equitable—reflects total ability to pay | Less equitable—varies by income type |
| Administrative Complexity | Simpler—consolidated tax structure | More complex—requires classification and multiple calculations |
| Tax Planning Opportunity | Limited scope for tax planning | Greater chance for tax avoidance/manipulation |
| Encouragement for Resource Shift | Discourages shifting income between sectors | Encourages shifting to lower-taxed income sources |
| Historical Origin | Introduced by Britain in 1799 | Introduced by Britain in 1803 |
| Nepal's Practice | Closer to global system—aims to treat all income equally | Elements of scheduler system exist due to exemptions and rates |
Chapter 2(b): Source vs Worldwide Taxation
1. Source-Based Taxation (Territorial Taxation)
Definition:
Under source-based taxation, a country taxes income that is generated within its national borders. Both residents and non-residents are subject to tax on income earned within the country. However, income earned by residents from outside the country is not taxed.
Global Practice:
This system is predominantly adopted by developing countries. These nations often rely on foreign investments for economic growth and revenue generation. Since residents typically have limited foreign investments, taxing only domestic income does not result in significant revenue loss.
Desirability:
Generally not preferred, especially by developed nations, for the following reasons:
- Reduces Tax Base: Income earned abroad by residents remains untaxed, shrinking the overall taxable amount.
- Promotes Offshore Investment: Encourages residents to invest in foreign or tax haven jurisdictions.
- Administrative Challenges: Differentiating between domestic and foreign income sources is complex and burdensome.
- Facilitates Tax Evasion: Creates loopholes for hiding domestic income under the guise of foreign earnings.
- Inequitable: Results in unequal tax treatment of domestic and foreign income for residents.
2. Worldwide Taxation (Resident-Based or Universality Principle)
Definition:
Worldwide taxation requires residents to pay tax on income earned both domestically and internationally, regardless of where the income originates.
Desirability:
This system is generally favored by developed countries due to the following advantages:
- Broadens Tax Base: Tax is levied on all income, increasing potential revenue.
- Discourages Capital Flight: Equal treatment of domestic and foreign income removes incentive to invest in low-tax jurisdictions.
- Simplifies Administration: No need to determine the location of income sources.
- Ensures Equity: Provides consistent tax treatment across all income sources for residents.
Source vs Worldwide Taxation:
| Criteria | Source-Based Taxation | Worldwide Taxation |
|---|---|---|
| Definition | Tax imposed only on income earned within the country | Tax imposed on global income of residents, regardless of source |
| Taxpayers Affected | Residents and non-residents taxed only on domestic income | Residents taxed on both domestic and foreign income |
| Treatment of Foreign Income | Foreign income of residents is not taxed | foreign income of residents is taxed |
| Preferred by | Mostly developing countries | Mostly developed countries |
| Impact on Tax Base | Narrower tax base | Wider tax base |
| Investment Incentive | May encourage foreign investment | May discourage capital flight |
| Equity | Less equitable—treats foreign and domestic income differently | More equitable—uniform tax treatment |
| Administrative Complexity | Difficult to distinguish foreign vs domestic income | Simpler for tax administration |
| Nepal's Practice | Applies to non-residents and residents' Nepal-source income | Also applies to residents’ foreign income (mixed system) |
