Bank interest, dividends, and treasury bills: Tax implications in the hands of individual

In our latest series on ‘taxation explained’, KPMG Principal – Tax and Regulatory Suresh Perera, LLB, Attorney-at-Law, FCMA (UK) responds to questions on taxation aspects on bank deposits, shares and treasury bills in which most invest their money.

Q: Can you explain the tax implication in relation to interest from fixed deposits/savings?

Investment in fixed deposits and savings is the most common and simple technique used by most people. The liability to income tax and the manner in which such tax liability to be discharged could vary according to the circumstances and instructions provided by the taxpayer.

In analysing the income tax liability of interest from fixed deposits and savings, the first step is to ascertain the “source” to which it belongs in the hands of a particular taxpayer. Interest could be either “business income” or “investment income”. In case of most of the individual taxpayers, interest income is investment income as opposed to business income. So, this issue is not a very complicated issue for individuals. But there may be exceptions in a very rare case.

But since the applicable tax rules including the ability to deduct expenses against interest income, irrespective of whether it stems from “business income” or “investment income” source, is identical , this issue of classification is not material nowadays under the new Inland Revenue Act , unlike under the previous Inland Revenue Act (IRA 2006) (under the previous Inland Revenue Act before 2018, if the “source” was “interest” as opposed to “business income”, no expenses was permitted as a deduction). Therefore, under the new IRA (IRA 2017), when calculating Assessable Income from investment income or business income, if there are expenses incurred to earn such interest income, such expenses could be deducted.

As a general rule, interest from fixed deposits and savings is liable for tax in the hands of a resident individual, as a part of taxable income, on application of progressive slab & tax rates. That is 6%, 12% or 18%. As most of the readers would recall this used to be a final tax of 5% before the introduction of recent tax revisions effective from January 2020.

However, for a non-resident, the applicable tax rate is 5%. A non-resident who is a non-citizen the tax of 5% would be considered a final tax. There are distinct rules governing non-resident who is a citizen of Sri Lanka in relation to interest on fixed deposits and savings.

But not all fixed deposit/savings interest is liable for income tax. Interest on Foreign currency denominated deposits will enjoy an exemption. You may recall a few years back there were exemptions for interest received by senior citizens and savings accounts held by a minor. These exemptions are not available under the new Inland Revenue Act No. 24 of 2017. 

A significant point to note in relation to interest income is that, almost everyone has interest income from savings/deposit. Therefore, even in case of employees who have opted for APIT scheme, if their total income is more than the personal relief of Rs. 3 million, therefore are compelled to make self-assessment payments in a quarterly basis in addition to fulfilling the obligation of filing the Return of Income (on or before 30 November). However, a person whose income is below Rs. 3 million from all sources including investment income, need not make self-assessment payments.

Q: How would you compare the income tax on investment in listed company shares and treasury bills?

Expenditure incurred in purchase of both treasury bills and listed shares are eligible for a tax deduction within the Rs. 1.2 million ‘expenditure relief’.

Whilst return on treasury bills is subject to income tax in the hands of an individual holder, as per the progressive tax blocks, the taxation of dividends flowing from listed company shares is not comparatively straight forward.

Tax on dividends

The tax liability of dividends would depend on the nature of dividends. There are certain dividends that are exempt from income tax such as dividends paid by a resident company engaged in entrepot trade involving import, minor processing and re-export; offshore business, providing front-end services to clients abroad; headquarters operations of leading buyers for management of financial supply chain and billing operations, logistics services including bonded warehouse or multicounty consolidation in Sri Lanka.

Another category of dividends that would be tax free in the hands of the recipient is dividends paid by a company incorporated outside Sri Lanka (foreign dividends). In case of Pass-through dividends also due to a recent amendment to the Law, there could be a tax liable component as well as an exempt component.

The dividends that do not qualify for an exemption, would attract income tax as a part of taxable income of the person on application of the progressive tax rates and slabs. i.e as mentioned above 6%, 12% and 18%. Dividends received from listed shares do not enjoy a specific exemption.

Listed shares Vs Treasury Bills

In case of listed company shares, capital gains or trading profits on disposal of shares would be tax free always, whereas capital gains from Treasury Bills will attract tax. Hence from this aspect listed company shares rank above treasury bills.

So, upon a comparison purely from a tax perspective, clearly investment in listed company shares rank above treasury bills and a clear winner, due to sales proceeds being completely exempt from income tax whereas disposal of treasury bills by an individual is subject to income tax. But however, investment decisions and selections should not be driven only from the perspective of tax efficiency.

Future REITs

Significant point to note is that whilst the listed company shares is an attractive option from the tax perspective when compared with the treasury bills, once the units of Real Estate Investment Trusts (REITs) are listed in the Colombo Stock Exchange (CSE) as per the prevailing tax law, REIT unit would certainly be a better investment option for an investor from a tax perspective. As per the current income tax law, both the return on the listed REIT (dividend) as well as sales proceeds of the REIT units will be totally tax-free.