Uproar over income tax on service exports

The 2025 Budget has imposed a 15% income tax on service exporters, and the new tax regulation would become effective from 1 April onwards. Prior to the new Budget, while exporters of goods were imposed a tax of 30%, exporters of services were exempted from income tax. As merchandise exporters were taxed at 30%, the IMF was questioning the validity of tax exemption granted to service exporters. In order to rectify the anomaly, the Government has now brought service exports too under the tax net. The previous administration was hoping to tax service exports at 30%, but the new administration has reduced it to 15%.

Unlike indirect taxes, direct taxes such as PAYE are politically unpopular. For a considerable period of time, the export sector was given a preferential tax rate with other sectors coming under the standard corporate income tax rate of 30%. With the implementation of the IMF-mandated economic reforms, the companies exporting goods too were taxed at the standard rate. The removal of the preferential status to the export sector, however, has not affected export earnings contrary to the pessimistic sentiments expressed by sceptics when the change was announced two to three years ago. Last year, the island achieved its highest-ever merchandise export earnings – $ 12.7 billion.

The removal of exemption of income tax on service exports has caused uproar among a section of the business community. In particular, it has disappointed members of the IT industry and some have even gone to the extent of claiming that it would result in loss of employment benefits of the IT sector employees. Opposition politicians have pointed out freelancers on Upwork/Fiverr, content creators and professionals working remotely for global companies would be impacted due to the removal of this tax exemption.

The move by the Government would undoubtedly have political ramifications. It is widely believed the youth overwhelmingly supported the NPP at the two previous elections and young individuals who earn foreign exchange via online freelance work would have felt been let down by the political alliance about whom they had high hopes. During the election campaign, the ruling party politicians created expectations among the populace that they could bring down taxes easily by removing waste and indulging in frugality. In such a backdrop, withdrawing the tax exemption carries political costs, especially when it affects a key group of the NPP’s support base.

Sri Lanka cannot be a country with low income taxes because social welfare has been an intrinsic legacy of the island since independence. The islanders’ demand for Singapore-styled income taxes while expecting Scandinavian-like social welfare is simply not practically feasible. The Government has proposed numerous social welfare programs from the Budget, and all those initiatives compel the Treasury to expand the tax base. In terms of the parameters set out by IMF, the Government needs to aim for a challenging budget deficit target of 5.2% of the GDP apart from raising the State revenue to 15.1% of the GDP in 2025.

Meanwhile, the IMF upon completing the Third Review of the EFF arrangement has stressed that sustained revenue mobilisation is crucial to restoring fiscal sustainability and ensuring that the Government can continue to provide essential services. The Fund has also emphasised the necessity to boost tax compliance and refraining from granting tax exemptions to maintain support for economic reforms. Maintaining unsustainable tax exemptions would undermine macroeconomic stability in addition to weakening the reform agenda. 

Economic reforms by nature are not politically popular and the NPP administration has no alternative but to proceed with revenue-based fiscal mobilisation although they vehemently opposed such policies when they were in the Opposition.