Critical tax issues for consideration in Budget 2019

Budget 2019 is much awaited by both the public and the business community. Some of the critical tax issues arising from the new tax regime have been conveyed to the Ministry of Finance. 

Economic Service Charge

Economic Service Charge (ESC) was introduced in 2004 to recover some tax in lieu of Income Tax from those entities that were exempt from Income Tax and those who were declaring loses in the accounts. In fact, this was done to recover loss of revenue due to tax exemptions, tax evasions and avoidance during that period. 

Though ESC is related to turnover, the intention was to collect a tax where Income Tax is not paid. Later ESC was made liable for even entities liable for Income Tax. However, ESC was allowed to be deductible from Income Tax liability. ESC could be carried forward and set off for four years against Income Tax. In addition, there was a maximum limit of Rs. 250,000,000 for ESC liability. 

The intention of the law in relation to Income Tax liable entities was to facilitate deductions of ESC to a large extent from Income Tax and thereby avoid double taxation. According to the current ESC regime there is no maximum limit on ESC liability. ESC carried forward is allowed only for three years. Further, the rate has been raised to 0.5% on the turnover of almost all business entities with the turnover of more than Rs. 12,500,000 per quarter. 

The component of ESC which cannot be deductible from Income Tax becomes a cost for business and in turn this may be passed on to customers. ESC, which started with the features of Income Tax (direct tax) is increasingly becoming an indirect tax such as VAT and NBT. ESC at 0.5% on exports may affect the competitiveness of our exports in the highly-competitive international market. Therefore, there is an urgent need to revisit the current ESC regime. 

ESC can be charged at 0.25% on export entities and entities showing a taxable income.

ESC can be charged at 0.5% on loss making and exempt entities.

With Holding Taxes

Currently, WHT tax is applicable on employment income, interest, rents, fees, partnership income, etc. 

WHT on rent is liable on any amount even, say Rs. 2,000 per month. Even if the income of the landlord is less than the statutory tax-free allowance of Rs. 500,000, still WHT has to be deducted. There are no provisions to get directions from the Department to stop such deductions. One segment of the society is charged with Income Tax though their income is less than statutory tax-free limit, making an inequitable element in the current system. Therefore, there is a need to stipulate a minimum limit such as Rs. 50,000 per month for rent for WHT purpose.

WHT on fees also needs to be revisited. Currently a fee of Rs. 50,000 or more paid by a business to an individual will be subject to a WHT of 5%. This person may not be an Income Tax liable person getting an income exceeding Rs. 500,000 per year. The Rs. 50,000 payment may even be a one-off payment. Even if a single person provide his services through a registered proprietorship he is subject to WHT while two or more people provide services through a partnership or a company such fees are not subject to WHT. This can be amended to say if fees in aggregate of Rs. 500,000 or more per annum are paid to an individual he should be liable for WHT in the following period WHT exemption can be broadened to cover proprietorships along with partnerships and companies.

Similarly, partnership income is also liable to WHT irrespective of the amount. Earlier there was a limit of Rs. 1,000,000 for a partnership to be liable for Income Tax. Presently no such tax-free limits exist for deduction of WHT and even an income of say Rs. 5,000 will be liable to WHT at 8% when allocating such profit to partners. 

If a partnership business earns an income of Rs. 1,100,000 in 2017/18, the partnership tax liability is Rs. 8,000. If this partnership has the same income for 2018/19, it will be liable to deduct a WHT of Rs. 88,000, in other words Income Tax attributable to partners. If the partners do not have any other income and the profit is shared equally there will be an over payment of Rs. 80,000. Startup entrepreneurs will be in difficulties if no minimum limit is set for WHT on partnership income. 

Thus, some of the provisions of the current Act may hinder informal sector of the economy and stifle the economic growth in the medium to long term. 

Therefore, Rs. 1,000,000 tax free allowance can be reintroduced for deduction of partnership WHT.

Income Tax

Under the earlier system exports income were subject to concessionary tax rates. Under the present system, a person who exports more than 80% of the turnover only is entitled for a concessionary rate. Any business entity starts exporting initially on a small way. Such exports become liable to Income Tax at the rate of 24%.

Any export income can be made liable to Income Tax at concessionary rate of 14%

Interest and penalties

Under the current Act, interest on tax in disputes can be as high as 20% per annum. The penalty imposed on non-compliance is prohibitively high in many instances. The system automatically calculates penalties. Huge penalty burdens along with tax liabilities may undermine many businesses in the medium to long term.

The Commissioner General must be given powers to determine interest and penalties fairly under just and equitable circumstances.  

Refunds and carry forward of over payments

According to the present payment schemes on many instances, tax payers find over payment of taxes especially income tax. The current system do not provide for any carry forward of such taxes to the subsequent year. Tax over payment occurs mostly due to incorrect calculation of payment rather than any erroneous tax computation. Therefore, provisions can be made to the effect that so long as returns are supported with audited statements of accounts and tax computations prepared by recognised professionals, over payment of income tax can be carried forward with subsequent scrutiny when the Department examines the return as a whole.    

Tax payments

Income Tax paid in various forms such as WHT, self-assessment payment and set off against ESC has complicated the tax payment process for ordinary taxpayer. Therefore, a need has arisen to simplify the payment methods.

Repair and improvement of fixed assets

For tax purpose, repair and improvement expenditure related to fixed assets has been limited to 20% of net tax written down value of such assets. The tax written down value will be less and less as the years go by. This would result in a situation where lesser and lesser amount only can be claimed for repair expenses as the time passes by. The reality is that when capital assets get older the repair expenses will be more. In the Sri Lankan context as a developing country, fixed assets such as heavy machineries are used for much longer period with proper repair and maintenance. An upper limit can be set as a percentage of turnover if at all such a limit is considered to be necessary. 

Further, business organisations will have to maintain separate record for each and every asset they possess to claim repair expenses. 

Thin capitalisation

This rule restricts the deductibility of interest expenses in calculating income of an entity for tax purposes. The restriction is based on capital (equity) to loan ratio with capital taken three or four times depending on manufacturing or non-manufacturing activity. Many companies run on losses for many years and may be highly indebted. Their balance sheets may show very low total of capital and reserves or even a negative figure due to accumulated losses. In such circumstances a company may not be able to deduct the interest expenses in the year they are incurred. Paradoxically, an entity may end up with an income for tax purposes despite actual losses due to the inability to deduct such expenses in the production of income.

Nation Building Tax    

Though there is a clear threshold limit of three million for a quarter small business entities and non-active business entities continue to receive NBT returns, remittance slips and notices. These NBT files can be deactivated or cancelled to avoid waste of time, resources and inefficiencies.

(The writer, FCA, ACMA, CPA, is a Chartered Accountant.)