Can Multi-Rate VAT Discourage Nepal’s Informal Border Trade?

In the budget for FY 2025/26, the government pledged to study the feasibility of introducing multiple VAT rates in Nepal. Earlier, in 2007, the Ministry of Finance formed a high-level panel to examine the possibility of introducing a dual VAT system. The panel, led by noted economist Prof. Dr. Madan Kumar Dahal, included Tul Raj Basyal, senior economic adviser at the Ministry of Finance, senior government officials, experts, and representatives from the private sector.

The task force recommended three different VAT rates instead of the existing single rate of 13 percent. It proposed rates of 1 percent, 4 percent, and 13 percent for different products and services, considering Nepal’s porous border and increasing trade concentration with its southern neighbor. The task force also suggested broadening the tax base and reducing the list of VAT-exempt items.

According to the report, items under the 1 percent VAT category would include primary agricultural and herbal products, agricultural machinery, pesticides, pharmaceutical products and raw materials, jewelry, electrical goods, and power-generation machinery. It also recommended a 1 percent VAT on non-profit education, training and research, air and road transportation, courier services, and professional services.

Under the 4 percent VAT category, the task force proposed including processed agricultural and forestry products, vanaspati ghee, butter, ice cream, cheese, processed meat, fish and fruits, sweets, textiles and yarns (except wool), IT-related products, mobile phones, and other electrical goods. Likewise, it recommended a 4 percent VAT on private healthcare services, the printing and publication of educational materials, packaging materials, and mineral products.

The report suggested levying a 13 percent VAT on all other goods and services except basic agricultural products, essential daily consumables, live plants and animals, government and non-profit healthcare, non-profit education, art and cultural goods, sculpture work, and public passenger transportation. It also noted that many occupations still remain outside the VAT net. Problems such as under-invoicing, underreporting, non-issuance of invoices, tax evasion, and inaccurate accounting continue to challenge VAT administration. The report argued that these issues could be addressed through the introduction of multiple VAT rates.

In 2015, however, a high-level Tax System Review Commission rejected private sector demands for multiple VAT structures and advised the government to continue with the existing VAT rate for at least five more years. The government currently imposes a 13 percent VAT on imported and locally produced goods. Yet, even after the commission’s recommendations, no changes have been made to the VAT rate structure in Nepal.

Nepal introduced VAT in November 1997, replacing four taxes: Sales Tax, Contract Tax, Hotel Tax, and Entertainment Tax. At present, VAT is levied at 13 percent, although certain goods and services are either zero-rated or exempted. In the upcoming federal budget, business communities have again demanded the introduction of multiple VAT rates, arguing that neighboring India also applies multiple GST rates, which function similarly to VAT.

India currently operates multiple GST slabs, including 5 percent, 18 percent, and 40 percent. Previously, it had slabs of 5, 12, 18, and 28 percent. By reducing tax rates on several goods and services, India made many products cheaper, which boosted consumption, sales, production, and overall GDP growth. As a result, many residents of Nepal’s border areas increasingly cross into Indian markets to purchase cheaper daily necessities.

Nepal and India are among the few countries in the world whose citizens do not require visas or passports to enter each other’s territories. Due to the unrestricted movement of people, Nepal experiences a high volume of informal border trade with India, estimated to be equivalent to formal trade, resulting in the loss of billions in customs revenue.

There are two major forms of informal trade from India to Nepal. The first occurs directly through customs points, where countless individuals bring in daily necessities without paying import duties. The second occurs through unofficial border routes, where carriers use small transport vehicles, motorcycles, bicycles, or even individuals traveling alone or in groups. In addition, under-invoicing, quantity fraud, and manipulation of HS codes during formal imports also contribute to informal trade. The influx of cheap smuggled goods has severely harmed emerging domestic industries while causing significant revenue losses for the government.

Border markets in India are flourishing, while markets in Nepal are shrinking. Land prices in Indian border towns such as Raxaul, Sunauli, Rupaidiha, and Jogbani are now comparable to those in Delhi and Mumbai. The primary causes of this informal trade include high import duties, high VAT rates, and high production costs for similar goods in Nepal. Although the government periodically adjusts import duties and income taxes through annual budgets, it has not revised the 13 percent VAT rate on daily necessities for decades. This rigidity in VAT policy appears to be a major factor encouraging informal border trade with India.

Moreover, Nepal’s shadow or underground economy continues to grow. According to a 2018 study by Medina and Schneider, Nepal’s shadow economy accounted for an average of 37.5 percent of the total economy, compared to the global average of 27.78 percent in 2015 across 158 countries.

The current single VAT rate of 13 percent places all commodities — whether basic goods or luxury items — within the same tax bracket. The World Bank emphasizes that combating the informal economy is not only about enforcing laws and punishing offenders, but also about making the formal sector more attractive and encouraging positive tax-paying behavior. Building trust in government is essential to convincing citizens that paying taxes is worthwhile.

Nepal already operates a limited dual VAT structure through zero-rated and 13 percent VAT categories, meaning businesses are already familiar with maintaining separate VAT accounts. However, Nepal appears to remain overly focused on revenue collection through a single VAT rate while paying insufficient attention to its broader economic impacts. The introduction of multiple VAT rates could help reduce informal imports from the southern border. Nepal should therefore reform its VAT system by considering the positive economic effects of India’s multi-rate GST system. Given India’s rapid economic growth, Nepal should seriously consider introducing a multi-rate VAT system in the years ahead.