Nothing is certain except death and taxes

The recent Tax Act has many taking to social media and scrambling to understand the impact on their disposable income. While of course it is burdensome to pay higher taxes in a high inflation environment without real wage adjustments, it is important to note that the Tax revenue in Sri Lanka was among the lowest in the world in January 2020, falling from 11.6% of GDP in 2019 to 8.1% of GDP. 

Following this decline in revenue, Sri Lanka’s financial situation became unsustainable, which resulted in a credit rating drop and its exclusion from international financial markets. Currently, Sri Lanka needs to put measures in place to raise revenue if its public finances are to return to a sustainable course.

In January 2020, there were two different types of tax reforms announced. One of them increased the tax thresholds and rates and the second modified the PAYE and WHT tax collection methods. 

Pay-As-You-Earn (PAYE) is a tax collecting strategy that mandates that most firms withhold the required tax from employees’ salaries and remit it to the Government on a monthly basis. Without this option, it is up to the employee to choose whether to voluntarily start a monthly deduction or to self-disclose, file annual income tax forms and personally remit the tax payment. 

Banks and other financial institutions that pay interest on deposits or businesses that charge fees are required by the WHT tax collection method to withhold a portion of the payment as WHT and send it to the Government. The WHT can be used by tax payers to offset their tax obligation when they file tax returns.

The mandatory PAYE tax system was eliminated by the Government in 2020 and an optional Advanced Personal Income Tax (APIT) system was instituted in its place a few months later. This meant that each employee was responsible for setting up a personal tax file, disclosing their income to the Government and paying their own dues; rather than the employer being required to withhold income taxes from employees and return them to the Government on a monthly basis. 

The majority of employees in Sri Lanka did not need to file yearly income tax returns due to the simplicity of the PAYE mechanism which handled all of their tax deductions. As a result, this modification mandated that the majority of individual taxpayers who had not previously filed income tax returns self-initiate opening a tax file and filling returns.

Employees with an annual income larger than 1,200,000 who were not eligible for tax payments, now are – comparatively since 2020 those with income greater than 3,000,000 were eligible for tax. Combining the effects of eliminating the PAYE tax system with raising the income eligibility level and lowering the tax rate resulted in a rise in the cost of tax administration and a fall in tax payment compliance. 

The amount of income tax collected by the Government in 2019 through PAYE was 49,445 million, compared to 15,353 million in 2021 through APIT. The combination of these three policy changes has led to a 69% decrease in income tax collection.

To put it plainly, the current crisis is a direct result of tax revenue collections weakening since 2019 that lead to unsustainable levels of debt dependency and cash flow management issues. If the 2019 prevailing system of 11% revenue collection continued, the effects of the current situation would be far less severe. 

It is estimated by the think-tank Verité Research that a WHT collection being resumed at a 5% or 10% collection rate, that Sri Lanka may increase tax revenue related to interest income, fees, and other income by 34.4 billion or 68.8 billion from June to December 2022 alone. Therefore, as Benjamin Franklin once said: “In this world, nothing is certain except death and taxes.” It is time Sri Lanka foots the overdue bill.