Impact of recent income tax changes on individuals with foreign employment income

Many employees working in Sri Lanka with foreign employment contracts may not be aware of this new requirement to pay income tax on a monthly basis

The Inland Revenue Department has recently issued updated Advance Personal Income Tax (APIT) tables, which are crucial for both employers and employees to understand. The APIT tables for the Year of Assessment (Y/A) 2025/26 have been published, taking into consideration the recent changes introduced via the Inland Revenue Amending Act No. 02 of 2025. These changes include an increase in personal relief to Rs. 1.8 million for the Year of Assessment, a revision of the first slab to Rs. 1 million from Rs. 500,000 (at the rate of 6%), and the removal of exemptions for foreign-source income and foreign service income.

As per the recent amendment, an individual’s gains and profits will be taxed at the maximum rate of 15% with effect from 1 April 2025 where:

The gains and profits earned or derived from any service rendered in or outside Sri Lanka to any person to be utilised outside Sri Lanka, where the payment for such services is received in foreign currency.

The gains and profits earned or derived from any foreign source where such gains and profits are earned or derived in foreign currency and remitted through a bank to Sri Lanka.

Accordingly, persons who were enjoying the exemption until 31 March 2025, are now required to pay income tax at the maximum rate of 15%, effective from 1 April 2025. 

This article focuses on the tax compliance obligations of individuals who are in receipt of foreign service income and/or foreign-sourced income, as stated above for the Year of Assessment 2025/26. The methodology for making income tax payments by a resident individual on foreign service income or foreign source income will vary based on the nature of the service contract, i.e., employment contracts as opposed to independent service providers or freelancers.

Resident employees with foreign employment contracts

There are eight APIT Tables introduced for the Year of Assessment 2025/26, which apply to various circumstances. Among these, the newly introduced Table 8 stands out due to its specific application to employment income received from foreign employers by resident employees in Sri Lanka.

APIT Table 8 for Foreign Employment

APIT Table 8 applies to resident employees who are physically present in Sri Lanka but work remotely for a foreign employer. It does not apply to independent service providers and freelancers, as their income is considered business income.

For Table 8 to apply, the following conditions must be met:

The employer must be a person completely outside Sri Lanka (i.e., the employer cannot have a Sri Lankan permanent establishment).

The employee’s services must be utilised outside Sri Lanka by the employer.

Payments to the employee must be received in foreign currency and remitted through a bank to Sri Lanka.

The following outlines the rates applicable for monthly cumulative employment income (converted into Sri Lankan Rupees at the exchange rate provided by the Central Bank of Sri Lanka) derived from foreign employers:

Up to Rs. 1,800,000: Relief from tax – No tax shall be deducted.

Exceeds Rs. 1,800,000 but not exceeding Rs. 2,800,000: 6% of cumulative employment income exceeding Rs. 1,800,000.

Exceeds Rs. 2,800,000: 15% of cumulative employment income less Rs. 360,000.

The total tax liability of the resident employee should be computed on the cumulative employment income by applying the above rates. Employment Income is taxed on a cash basis. These rates are effective from 1 April 2025. 

Legal obligations under the Inland Revenue Act

Advance Personal Income Tax (APIT) is also considered a withholding tax, as outlined in Section 83A (3) of the Inland Revenue Act. Accordingly, if a withholding agent fails to withhold tax from a payment as required:

The withholdee (employee) shall be jointly and severally liable with the withholding agent for the payment of the tax to the Commissioner-General.

The tax shall be payable by the withholdee within 15 days after the end of the calendar month in which the payment is received.

Therefore, when the employer fails to deduct APIT, the employee must pay the due APIT amounts within 15 days after the end of the calendar month in which the payment is received. Since the foreign employer is not registered under the Inland Revenue Act and has not established a permanent establishment in Sri Lanka, the obligation to pay the APIT monthly shifts to the employee.

The Revenue Authorities have imposed the obligation on the employee to comply with the requirement by making the due tax payment each month. For an example, an employee who receives a salary in the month of April 2025 should pay the due income tax on or before 15 May 2025. The payment must be made by reference to the employee’s Taxpayer Identification Number (TIN) as an Individual Income Tax (IIT) payment.

Implications for resident employees and foreign employers

The Inland Revenue Department should take further steps to create awareness of this new requirement for resident employees (if employed by a foreign employer) to calculate and pay taxes monthly. This administrative collection process has been highlighted as part of the APIT Tables, and mostly, Sri Lankan employers are well-versed in the application of the APIT table as it’s the employer who deducts the tax at source (APIT) from the employee. Many employees working in Sri Lanka with foreign employment contracts may not be aware of this new requirement to pay income tax on a monthly basis (especially since its notified via the APIT Tables) unless further steps are taken to create awareness.

If the resident employee has other sources of income other than employment income (i.e., investment, business, or other sources) such as rent or interest income, they should pay income tax on a quarterly self-assessment basis on such sources of income. While interest income received on foreign deposits in any foreign currency account will be exempt from income tax, any interest income from local savings and fixed deposits will be subject to income tax. Banks and financial institutions will withhold taxes at 10% at source, and the individual is responsible for settling the balance income tax (if any) on a quarterly instalment basis. A return of income should be duly filed for Y/A 2025/26 (period of 12 months starting 1 April 2025 to 31 March 2026) on or before 30 November 2026.

Further, foreign employers should be aware of this requirement to ensure that employees are paying taxes as required by domestic law where the foreign employer is not able to deduct the tax and remit it to the Inland Revenue Department.

The updated APIT Tables, particularly Table 8, reflect the evolving nature of employment. By understanding these changes, both employers and employees can better navigate their financial responsibilities and ensure compliance with the Inland Revenue Department’s guidelines.

Independent service providers and freelancers

Independent service providers and freelancers providing services to a person outside Sri Lanka, subject to the conditions set out in the law, will have to compute their tax liability on a self-assessment basis and pay income tax quarterly. Since their income is considered business income, any expenses incurred for the production of such income will be allowed as a deduction subject to the provisions of the income tax law.

The tax rates described above will apply: Up to Rs. 1.8 million per Y/A is not taxed, the next Rs. 1 million per Y/A is taxed at 6%, and the amount exceeding Rs. 2.8 million per Y/A will be taxed at 15% (if the conditions for the application of 15% described above are met). If the conditions are not met, progressive tax slab rates will apply.

Accordingly, on a self-assessment basis, one should estimate the tax liability on all sources of income and process payments in four quarterly instalments, commencing from 15 August 2025. The second quarter is due on 15 November 2025; the third quarter on 15 February 2026; and the fourth quarter on 15 May 2026. If there is any further tax due for the Y/A 2025/26, it should be paid to the Inland Revenue Department on or before 30 September 2026. The Return of Income should be filed on or before 30 November 2026. 

Non-compliance can lead to penalties and interest

Due to recent changes in income tax regulations, individuals who previously benefited from exemptions on foreign service income will now be required to pay income tax starting from 1 April 2025. These income earners must understand the compliance requirements and ensure the timely payment of income taxes, as non-compliance can result in penalties and interest.

(The writer is Principal – Tax and Regulatory at KPMG.)