Tax changes amidst necessity for fiscal discipline

Last week, President Anura Kumara Dissanayake announced a set of tax changes which will come into effect from 1 April next year. The announcement was followed by Fitch Ratings credit upgrade which elevated Sri Lanka’s foreign currency rating out of Restricted Default (RD) status to CCC+ in view of the successful conclusion of the sovereign bond restructuring arrangement. 

A key feature of proposed tax changes is the reform of personal income tax. The Advance Personal Income Tax (APIT) tax, which was imposed on the salaried employees by the Ranil Wickremesinghe administration, was a key talking point during the election period with main presidential candidates promising to provide relief to the middle class families as well as professionals by increasing the threshold apart from widening the tax slabs. Under the existing mechanism, the tax-free allowance is Rs. 100,000 per month for personal income tax, but it would be increased up to Rs. 150,000 from next April onwards. Employees in the banking sector in particular were extremely unhappy about the prevailing APIT regime and would have represented a fair chunk of those who voted for the NPP at the recent national elections.

However, it must be noted that the NPP’s manifesto for the Presidential Election guaranteed to raise the monthly threshold to Rs. 200,000 per month. Fortunately, the sanity has prevailed and the Government needs to be commended for deciding to go ahead with the relief that was negotiated by the previous Government with the IMF in respect of personal income tax. 

An interesting feature of the President’s parliamentary speech is the proposal to raise the existing Withholding tax (WHT) rate of 5% to 10% beginning from the next tax calendar. The hike in the tax ratio imposed on interest income comes at a time when the rate of interest paid on fixed deposits and saving accounts has declined considerably in correspondence with the monetary policy relaxation of the Central Bank. Therefore, the planned move would be perceived as a double whammy by senior citizens who do not receive a monthly pension and instead rely on the interest income of their retirement savings.

The NPP leaders pledged to grant an additional interest of 5% for the savings of the elderly during the election, and it would be interesting to see whether they would live up to their word. Nevertheless, the Government had declared that individuals with a monthly income less than Rs. 150,000 and those who are below the 10% tax bracket could request the Inland Revenue Department (IRD) not to deduct the WHT on their interest incomes. Yet, given the lethargy of the IRD, its implementation is doubtful. 

The imposition of VAT on digital services at 18% by making the providers of digital services liable to VAT based on consumers’ jurisdiction is a striking aspect of the tax reforms. Local digital platforms like Kapruka and PickMe were clamouring for this measure as the prevailing regime exempts digital service providers that operate out of Sri Lanka from having to pay VAT. This created an uneven playing field to the detriment of local digital platform providers. With the expected change, the popular ride-sharing platform Uber too will come under the VAT mechanism, and it would be interesting to observe how the island’s ride-hailing industry would evolve going forward under the new VAT system. 

Even though debt restructuring is almost over, Sri Lanka will face a tight fiscal situation over the next decade. People need to realise that although the country has now come out of bankruptcy, it cannot indulge in fiscal profligacy, and policymakers have no option but to walk on a narrow path based on fiscal consolidation. Despite its populist rhetoric during the election campaign, the top leadership of the ruling political alliance has understood the necessity to continue with the IMF-mandated structural economic reforms.