To gauge just how desperate the government is, consider this: the tax office wants a 500 percent increase in Tax Deductible at Source (TDS) on payments that internet service providers make to rent bandwidth and other Internet services. This would eat into the slim profit margins that ISPs have because more than 70 percent of their cost goes to renting the bandwidth and Internet ports. ISPs say the TDS would put them out of business overnight, because for all practical purposes they end up paying the TDS. In addition like any other business ISPs already pay 25 percent corporate income tax and there are invisible payments private firms have to make at various government departments to get their files moving.

So what we may be about to witness is another successful, all-Nepali, all-private initiative being taxed out of business because the government can't balance its books. "Bandwidth to us is what raw material is to a manufacturing industry," says Shyam Kumar Agrawal, Managing Director of Worldlink Communications. "Even makers of alcohol and tobacco are given concessions on raw material imports, but they are taxing us another 15 percent on bandwidth. This is absurd."
Sanjib Raj Bhandari of Mercantile Communications who introduced email and Internet to Nepalis agrees: "It doesn't make sense to remain in business when the government takes over 30 percent of your gross revenue, excluding income tax. We may as well close down." In January Mercantile had announced plans to take Internet services to 25 districts, but has put it on hold. And even its news portal, nepalnews.com would be hit.

Nepal's 13 ISPs employ over 500 people, most of them in white-collar jobs. Because staff turnover is high in the industry, they continuously train new entrants who often end up in some of the best IT companies in the world. Nepal has an estimated 25,000 email and Internet accounts, with more than 125,000 users.

ISPs were required to pay a three percent TDS on payments they made for bandwidth, Internet port and fax facility rentals three years ago. They lobbied hard to convince the government to waive even the three percent, arguing even that was too much because the market was very competitive and they ended up paying the tax (for the foreign provider) without being able to book it as a cost.
The tax office says because foreign companies ultimately pay the TDS the ISPs are only making a fuss. However, the foreign companies don't because most countries selling bandwidth don't have double taxation avoidance treaties with Nepal and so they cannot claim deduction. Secondly, even if there was a treaty, they would not pay the 15 percent because the industry is very competitive and works on very small margins of one or two percent. And instead of bothering to do business with Nepali companies, they would rather look for buyers elsewhere.
Apparently, the government saw logic in the ISP's argument for getting rid of the three percent because last year's rulebook did not specifically mention the tax on service providers. But the tax collectors did not think so and managed to force ISPs to pay three percent anyway. The rule remains unchanged, and this year the tax office has come up with a new interpretation: ISPs, like companies that pay commissions, royalty, management fees and technical service fees to external parties, would have to cough up 15 percent TDS. Compare that to insurance companies that pay 1.5 percent, and airlines that pay three percent.

The ISPs say they are not even mentioned in rules, so they are not liable to pay. But as compromise they say they are willing to pay the three percent they paid last year until the dispute is settled. ISPs met finance minister Ram Sharan Mahat to discuss these options last week. Sources say that even though the minister was sympathetic to their arguments, the tax department needs the tax to meet its revenue target and has stuck to its demand. Hence the deadlock.

An ISP pays a fee as bandwidth rental. Nepal's 13 ISPs use the facility from different companies and all, including the public sector Nepal Telecommunication Corporation which also runs its own ISP, pay for using the service. NTC pays $17,000 each month for about two megabits of bandwidth. Private companies pay anywhere between $15,000-$30,000 depending on the bandwidth they use. It is not clear if NTC pays TDS on all of its external payments, even though it says it does, something that the tax office does not confirm.

An ISP pays anywhere between Rs 700,000-3.5 million for registration and licensing, for a period of five years, depending on whether it uses its own V-SAT or not. Then there's another six percent of revenue they give-four percent as royalty and two percent to the rural telecom fund. And unlike, say, the 10 percent Telecom Service Charge NTC charges its customers, ISPs cannot add or pass on these to clients.

These charges on ISPs contrast with the government's ambitious goal of taking information technology nationwide under the new IT policy. Surendra Chaudhary, the Science and Technology minister likes to say that Nepal missed out on the industrial and the green revolution, and it cannot afford to miss the IT revolution. All that now sounds like empty rhetoric to IT entrepreneurs. After visiting India's IT hubs last summer even Prime Minister Girija Prasad Koirala found out that it takes a token IRs 1 to register an ISP in India and they pay a six percent sales tax which is passed on to the user. Now it looks increasingly like one hand of government destroys what the other hand tries to build.

ISPs are already paying almost as much as traders, cigarette or alcohol manufacturers in up-front taxes. Besides there are other mismatches: Internet technology changes almost every minute, but the government does not allow IT companies to depreciate capital goods by more than what it allows regular industries. The government's tax rules are also heavily skewed against information technology: a hard copy encyclopaedia has no tax, but an encyclopaedia on CD has 22 percent payable in levies and taxes.

Of the 13 ISPs, only seven are actually doing business, some of the others are said to be looking for someone to buy them out. Unless they have the economy of scale of the larger companies, there is just too much of a tax burden already. "If they were making as much money as the government thinks they are, why should the ISPs be closing shop?" asks Rajesh Lal Shrestha, Managing Director of Infocom. The company is one of the few new ones that have managed to get a foothold in the industry. "It is a killing proposition, thought-less and irrational," Shrestha says of the new TDS proposal. "To stay in business we would have to increase rates by up to 25 percent and usage would drop."

If that is so, one may as well ask why then have the companies not closed shop and invested elsewhere? Many are forced to continue because being a service industry, they affect customers directly-in terms of cancelled addresses and are forced to remain in business. "Our profits are in the range of 4-5 percent (without 15 percent TDS) and because we've already invested so much in the business, we cannot just close down," says Agrawal.

The tax office says it wants to make the royalty uniform to avoid confusion on TDS deductions, and until the law is changed they have to collect payments. Puskal Upadhayaya, Director at the Tax Department thinks the problem can be solved. He told us: "If it is a serious problem, the ISPs have to come to us and explain the nature of the business and we can agree on a separate TDS for the coming year. If royalty is high that can be settled because we don't want to kill any industry as we're made out to be."

Fine words. But it doesn't seem to instil too much confidence in the ISPs. "We just cannot pay 500 percent this year," says one.