The Sri Lankan tax system

 1. What are the taxes, duties and levies applicable in Sri Lanka?

The list includes Income Tax, Economic Service Charge (ESC), Value Added Tax (VAT), Nation Building Tax (NBT), Stamp Duty levied by Commissioner General of Inland Revenue (CGIR) and provincial councils, Tourism Development Levy, Betting and Gaming Levy, Share Transaction Levy, Telecommunication Levy, Luxury Tax on motor vehicle which substituted the Annual Luxury Tax on Motor Vehicles, Vehicle Entitlement Levy, Debt Repayment Levy, Crop Insurance Levy, Cellular Tower Levy, SMS advertising levy, Migration Tax, Casino Entrance Levy, Carbon Tax etc. Carbon Tax will be abolished from December as per the latest amendment to the Finance Act of 2018.

The Provincial Councils charge Mineral Tax, Prize Competition Tax, in addition to the Provincial Council Stamp Duty on Land, Motor Vehicles and Court Documents. 

Local authorities charge rates, Business Tax and Entertainment Tax.

At the point of importation the Director General of Customs collects Import Levies such as Customs Duty, Cess, Port and Airport Development Levy (PAL), Excise Duty, Special Commodity Levy in addition to the VAT, NBT and ESC. 

In addition to the above taxes, recently the Parliament enacted another levy on ‘commercial transactions’ into the Sri Lankan tax net under the aegis of ‘Foreign Commercial Transaction Levy’. So an analyst could count up to 30 taxes and levies in the tax system. The challenge posed to any Government is to rationalise these numerous taxes, levies and duties and create a simple tax structure in Sri Lanka.

2. How do these taxes contribute to the overall tax collection of the State?

As per the 2017 Ministry of Finance (MOF) Annual Reports (the last published report available publicly) reflects that 36% of the tax revenue is collected by the Commissioner General of Inland Revenue (CGIR) while 55% is collected by the Director General of Customs (DGC). The Department of Excise collects approx. 7% of the overall collection. 

Therefore, one can see the importance and the reliance on the border taxes for the collection of Tax Revenue. One may opine that this is not a healthy trend. Out of the import taxes also one could see the highest contributor is the Excise Duty on Motor Vehicles (23%) in the year 2017. 

Also it is significant to note that VAT gathers more revenue to the State than Income Tax. This element leads to Sri Lanka’s direct tax collection being lower than the indirect tax. 

In 2018, Excise Duty (ED) at 28% (ED collected from liquor, Tobacco/cigarette, petroleum products, Moto vehicles etc.) is the largest revenue contributor to the State Coffers closely followed by VAT which contributes 27%. One may also observe taxes such as NBT (4%), Telecom Levy (2%), Cess (4%) and PAL (6%) contribute negligible percentages to the overall tax collection of the country. 

Out of the Income Tax collection 12% is collection of taxes under the PAYE scheme (Rs. 32,920 million), 19% (Rs. 53,334 million) is from tax on interest and 16% is from collection of ESC (Rs. 44,720 million). The majority (52%) is from taxes from corporate and non-corporate (Rs. 143,588 million). 

One has to bear in mind that ‘Pay-as-you-earn (PAYE)’ is not a distinct tax but a mere mode of collection mechanism of Income Tax from employees similar to withholding tax which also refers to a collection mechanism of Income Tax. 

3. There has been a lot of debate on NBT. Should NBT be abolished? 

In 1998, Sri Lanka embraced the concept of taxing value addition, abandoning the hitherto applicable Turnover Tax, to become yet another country that as a Policy abandoned the cascading sales tax. In 2009, as a temporary measure as mentioned in the budget speech, NBT was introduced for only two years. 

However, the minds of the policymakers slipped the promise made in the budget speech 2009 (which was read in Parliament on 6 November 2008) and to date, NBT which is a tax on Turnover, essentially a cascading sales tax is being used in the country to gather revenue to State Coffers. 

Thus one may observe Sri Lanka is adopting a hybrid system for collection of indirect taxes – taxing the value addition as well as imposing a tax on Turnover thereby making a mockery of the policy to collect indirect taxes in an equitable manner as the same transaction is subject to tax on value addition and tax on the Turnover. 

The saga does not end there as far as NBT and VAT is concerned. In Sri Lanka financial services attract VAT, though in most of the VAT jurisdictions financial services are exempt from VAT. In Sri Lanka too, up until the year 2002 financial services were exempt from invoice credit VAT methodology. 

In order to levy VAT on financial services, approximately 17 years back, policymakers introduced ‘profit VAT’ or ‘additive direct method’ of computing the tax on value addition in to the VAT Act. Consequently the financial services that are exempt from invoice credit VAT, are charged with profit VAT at the rate of 15%. 

In the year 2014 (by way of amending Act No. 10 of 2014), banking and finance which was exempt from NBT from the time of introduction of NBT (2009), was removed from the list of exemptions paving the way for the same to attract NBT. 

A legislative provision was introduced to the NBT Act to ensure that financial services would be liable for NBT on the same base taken for VAT on financial services. This results in the same Tax Base being subject to VAT and NBT at two distinct rates, payments, and tax returns for reporting, increasing the burden of compliance for both the tax payers and the tax administrators. 

In addition, recently a new tax under the Finance Act termed as ‘Debt Repayment Levy’ of 7% was also introduced on Banks and Financial Institutions on the same value addition base.

Hence an analyst would observe that both invoice credit VAT and VAT on financial services are overlapping with NBT on importers, service providers, manufacturers and retailers/whole sellers (subject to thresh hold difference) as well as NBT on financial services. Therefore NBT, which was introduced for a temporary period must be abolished. As mentioned above NBT contributes 4% to the overall tax collection.  

4. What are the five main challenges facing the tax system in Sri Lanka? 

There are many tax challenges to the Sri Lankan tax system including drafting clear and unambiguous tax provisions and Tax statues. This is due to the result of lack of sufficient tax academics’ and tax researchers in the country. In addition to this let me refer a few others.

a.Chaos created in the Income Tax regime due to the new Inland Revenue Act 

Faults in drafting leading to plethora of interpretational issues, practical issues with regard to initial implementation and transitional issues has created much uncertainty in the minds of the tax administrator, tax professionals and the taxpayers alike. 

Depending on the understanding and flexibility of the Commissioners’ some of these issues have the potential to lead to long term disputes with the Inland Revenue Department which may entail tax litigation

b.Lack of a ‘Tax Ombudsman’ for resolution of grievances of the tax payers without resorting to litigation and consequently tax payers losing confidence in the system 

c.The gap between the intention of the policymakers and the manner in which the tax office is interpreting the law to the advantage of the collection authority at the expense of the tax payers – this issue may be further highlighted when the Inland Revenue Officers start interpreting the new Inland Revenue Act

d.Sri Lanka’s low tax to GDP ratio of approx. 12% indicates that the system is failing to gather sufficient tax revenue to the State Coffers. There is a lot of room for addressing the ‘tax compliance gap’. However it continues to be a challenge. At this juncture where the reliance on foreign debt is very high, domestic tax collection, plays a great role in coming out of the debt trap. However this process must be carried out with appropriate skill and competency similar to the much quoted idiom of ‘plucking the feathers from the goose with the least amount of hissing’ 

e.Our tax system is unfair and inequitable as reflected in the direct to indirect ratio of tax collection (17:83 as per the Ministry of Finance Annual Report of 2017)

Whilst the policymakers have appreciated this inequity, over the years it has not reached the desired ratios or even reversed the ratio. This exercise also requires skill and the discipline of the policymakers and tax administrator. Broadening the Income Tax base plays a major role in this exercise whilst gradually cutting down the indirect taxes. It is interesting to see whether the introduction of Capital Gains Tax assisted this move by analysing the quantum of collection of the CGT. 

One could also opine that unavailability of the latest accurate data in relation to the tax collection also hinders this process. It is significant to note that the Ministry of Finance and the Inland Revenue Department has made their annual reports/performance reports available to the public only up to year 2017. 

5. Whilst there are many gaps in the current system, what do you see as the positive features of the tax system?

a.Though there is room for improvement we do have a stable tax appellate procedure both in relation to the Tax and Customs. First two stages are administrative in naturwe and on a question of law one could approach the Court of Appeal and the Supreme Court 

b.Measures being taken to automate the tax collection process. Despite the initial hiccups I believe that the successful implementation of RAMIS will open a new leaf in the tax administration in Sri Lanka

c.Ability to obtain rulings through the ruling committee, though it does not consist of independent members 

d.Measures being taken to broaden the tax base

e.Both policymakers and administrators have appreciated the importance of broadening the tax base. Of course it is not realistic to expect overnight results 

f.The Revenue Authorities are making endeavours to create awareness in relation to taxes among the tax payers such as by conducting seminars and trainings

g.Reasonably good website being maintained by IRD for the benefit of tax payers and other stakeholders – This website provides the Tax statutes and Regulations, latest notices and circulars, performance reports of the IRD etc. However a lacuna is that the unavailability of the Sri Lanka’s double tax avoidance treaties (DTAT) in the website although there is a list indicating the DTAT’s entered in to by Sri Lanka 

6. Whilst no tax system is perfect any tax system may have glaring features. Can you elaborate five such inequitable features of our tax system?

From time to time there have been inequitable features and policymakers do take steps to address these issues when pointed out. 

Let me list few of the inequitable features that exist in the prevailing system. 

a. WHT on interest

Interest which a final is ‘withholding payment’ being taxed at a flat rate as opposed to being taxed as a progressive system in my view is not correct. Whilst an individuals’ taxable income is taxed at a progressive manner, interest income is taxed at a fixed rate of 5% and it defies the concept of ‘broader shoulders bearing more taxes’. Preserving Equity in taxation is a fundamental feature in any policymaking. Therefore in my opinion interest should also be taxed using progressive rates. 

b. Capital Gains Tax 

The capital gains being taxed using a flat rate (10%) instead of using a progressive slab rate system is also inequitable from the context of equity in taxation although the 10% flat rate simplifies the process. Also there should be an exemption for assets that are held for a long period similar to the implementation of CGT in other countries. 

Contd. on page 25

At present the manner in which the CGT was introduced from 1.4.2018 has resulted in capital appreciation prior to 1/4/2018 being taxed in the case of capital assets held for business which should not be the case. No tax should have retrospective effect. 

c. Withholding tax on rent 

Injustice is caused to the lessor where an individual’s progressive tax rate is lower than the taxes withheld on the rent and there is no direction mechanism. Although currently the IRD has mentioned that refunds will be granted, it is a prolonged process and this could be avoided by issuing directions. 

d. Concessionary rate for companies only 

The entitlement of the concessionary rate of 14% is available only for companies and not individuals. For instance an education services rendered by a company would enjoy the 14% rate while an individual providing education services will be taxed at a progressive tax rates (maximum of 24%) though subject to a tax-free threshold. 

e. Use of the same tax methodology (imposition and computation) for large multi nationals and conglomerates, as well as small and medium enterprises in the same manner. Imposition and computation for small companies and individuals should be subject to a much simpler process 

f. Applying 15% VAT on leasing of residential accommodation compared to VAT-free status on sale of general residential accommodation and 6% VAT on sale of condominium residential properties. Since Leasing and Renting of residential accommodation entails a fulfilment of a basic necessity it should not be liable for VAT similar to countries such as Singapore and New Zealand which are considered the model VAT/GST mechanisms

7. What is the single most important initiative that should be taken to improve the tax system?

The subject of taxation and the tax laws are complicated in any country. Carrying out ad hoc surgeries is not the answer to improve reform and bring stability to the tax system. 

There has to be a long term plan for the tax system in Sri Lanka which must be complemented with short term action plans. The Sri Lankan tax system requires certainty, stability, equity and fairness, simplification and the rationalisation of the laws and the processes. I believe this could be achieved by establishing a National Tax Council independent from extraneous influences. 

Of course the National Tax Council should consist of adequate persons with skill and knowledge and experience and they should be entrusted with introducing tax reforms, making policies, drafting the supervision of the tax laws etc. The ‘National Tax Council’ should formulate and drive the long term and short term tax policies in Sri Lanka, and this would lead to the elimination of the uncertainties in the tax system in Sri Lanka.