Rigid salary caps hinder small and cottage businesses from hiring skilled talent, undermining their growth, productivity, and competitiveness

Dechen Dolkar

Cottage and small businesses in the country are finding it increasingly difficult to attract skilled talent, including expatriates, due to rigid salary caps imposed under the Income Tax Rules and Regulations 2001.

This cap on salary, which sets monthly salary limits based on company size, has become a major bottleneck for businesses reliant on high-performing professionals.

Under the current tax regulations, salaries above the prescribed limits—Nu 70,000 for large industries, Nu 60,000 for medium industries, Nu 40,000 for small industries, and Nu 30,000 for cottage industries—are not deductible as business expenses.

Companies that exceed these caps face penalties during tax assessments, making it difficult for companies to compete in the job market.

A proprietor of a small business revealed that the salary cap blindsided his hiring strategy. “I was unaware of the strict salary cap based on company size. My aim was to offer salaries that ensured financial stability and job satisfaction, which are crucial for productivity and retention,” he said.

He said that during tax filing, he was informed that the salaries exceeded the allowable ceiling, resulting in additional taxes and fines. “This situation highlights a broader issue for small businesses in high-cost areas like Thimphu, where standard salary caps do not reflect the reality of living expenses,” he added.

Another employer said that tax regulations constrained him from offering higher compensation, whether through increased salaries or bonuses, despite his willingness to do so.

“With the competition for talent not only within Bhutan but also from countries like Australia, these regulations make it harder to attract skilled employees,” he said.

According to the Income Tax Rules and Regulations 2001, the total bonus payable is limited to 10 percent of the assessed net profit or three months’ basic pay per employee, whichever is lower.

A finance ministry official said that the salary caps for unincorporated businesses, such as sole proprietorships and partnerships, are intended to promote tax fairness and minimise tax avoidance.

“For unincorporated businesses, business income is directly treated as the owner’s income. Since the owners and managers are often the same individuals, it becomes easier to inflate salaries to reduce taxable income,” the official said.

Without a salary cap, owners could classify a large portion of profits as salaries, thereby lowering their taxable income and overall tax liability, he added.

However, incorporated companies are not subject to salary caps for employees. These companies operate under the Companies Act of Bhutan 2016, which mandates financial transparency through audits and mandatory disclosures. “The corporate structure and oversight reduce the risk of inflated salaries and ensure proper tax compliance.”

Unincorporated businesses, however, lack similar governance structures, giving sole owners or partners full discretion over salary decisions without external oversight, he said. “This freedom makes it easier to inflate salaries by reclassifying a significant portion of business profits as salaries, effectively reducing taxable income and increasing the risk of tax avoidance.”

The finance ministry has observed that businesses offering higher salaries tend to have turnovers exceeding Nu 10 million. For such entities, incorporation is recommended as a pathway to greater transparency and compliance with tax laws.

However, business owners argue that pushing for incorporation is not a catch-all solution for smaller enterprises, many of which lack the resources to transition.

An entrepreneur said that the finance ministry is only looking at one side of the story, which is the perceived risk of smaller firms avoiding or manipulating their tax returns. “That’s a really narrow view. Why can’t the government look at this as an opportunity to help facilitate smaller businesses grow and expand?” he said.

A proprietor of a cottage business said that tax evasion is a criminal offence, and any responsible business would comply with the law.

“The real issue here is that this salary cap is stifling small businesses from hiring skilled talent to boost productivity and grow,” he said. “If tax manipulation is happening, it is the Department of Revenue’s job to detect and penalise such practices.”

According to the third-quarter report of the National Statistics Bureau, there are 440 large industries, 804 medium industries, 18,199 small industries, and 10,754 cottage industries in the country this year. Of these small and cottage industries, 3,981 are in the production and manufacturing sector, 24,250 in the service sector, and 1,970 in the construction sector.