Taxes: Proposals and the way forward

When formulating fiscal proposals, attention must be paid to their socioeconomic implications rather than mere arithmetical figures and pre-determined targets. For example, the full benefit of reduction of petrol prices did not reach the masses

By S.A. Azeez 

It was proposed to raise the individual tax free allowance to Rs. 2.4 million from Rs. 500,000, almost a 500% increase. If implemented, this would have left very few individuals paying income tax in this country. This proposal was withdrawn.

Share Transaction Levy

Share Transaction Levy is a proper way of taxing share transactions in the Colombo Stock Exchange. Whether there is a profit or not, the levy is charged on each share transaction. This levy was removed and reintroduced later.

Corporate Tax Rate 

The Corporate Tax Rate was 28% for large companies and 12% for small and medium companies (SME companies). A new single tax rate of 17.5% has been introduced for large and small companies other than trading companies. Most of the corporate incomes tax comes from a few companies which are regarded as large tax payers. The reduction from 28% to 17.5% would have had a substantial impact on the Government revenue from direct taxes. No company had any grudge in paying 28% tax. 

The Corporate Tax Rate is 34% in India while it is 24% in Malaysia. What is the idea behind reducing the rate to 17.5% which would cause the Government to lose its revenue substantially? In the meantime SMEs have been affected due to the increase in rate from 12% to 17.5%. Small-scale exporters who try to hold a foothold in the international market have to pay income tax at an increased rate of 17.5%. Will not this be a disincentive to small-scale entrepreneurs? 

VAT hike

Recently, it has been proposed to charge Value Added Tax (VAT) at 15%, removing most of the exemptions. It is true too many exemptions are not good for any tax system. However, removing exemption on healthcare services is a matter of concern. Growth and improvement of private healthcare services over the years have substantially reduced the Government’s burden on healthcare expenditure. 

Not everybody who makes use of a private hospital is rich or super rich. Some patients who get admitted to private hospitals for coronary bypass surgery or similar treatments sell their properties or borrow to settle their hospital bills. Now on the top of hospital bills, people have to pay 15% VAT and 2% Nation Building Tax (NBT) to the Government. This may be alright for well developed countries such as Australia, Canada and the United Kingdom where the Government takes care of social welfare with advanced healthcare and educational services free of charge. 

Annual company registration fee

It has been proposed to charge an annual registration fee of Rs. 60,000 from private companies. This is a charge to be levied in addition to annual return fee of Rs. 5,500. After the proposal was presented, a large number of companies have been wound up. The proposed fee would discourage individuals from forming new companies with the consequence of more and more informal businesses cropping up in the country. Most of the countries encourage registration of more and more companies. Thousands of companies are formed every day in China. No country is charging such a high fee for keeping a company.

Socioeconomic implications 

When formulating fiscal proposals, attention must be paid to their socioeconomic implications rather than mere arithmetical figures and pre-determined targets.

The full benefit of reduction of petrol prices did not reach the masses. Transport charges did not come down sufficiently. Transport businesses and super rich people who own two or three vehicles were the ones who really benefited. Increased use of oil causes air pollution in the major cities. We spent $ 2.7 billion in 2015 on oil which is the highest import in Sri Lanka over the years. Under such circumstances the Government can consider imposing VAT on petrol (not on diesel and kerosene) and exempt the healthcare sector from VAT as earlier. 

Economic Service Charge

Economic Service Charge (ESC) is effectively a direct tax. Income tax liability is set off against ESC paid. Therefore, the ESC threshold can be reduced to a lower limit, such as Rs.15 million per quarter. A business organisation having an annual turnover of Rs. 60 million, even if we take the net income at 2% of turnover, it should have a net profit of Rs.1.2 million. Thus, the reduction of ESC threshold would help in widening direct tax base.

In many advanced countries, most of the direct taxes are deducted and paid at source. If properly implemented this would reduce tax evasion significantly in this country. 

Capital Gains Tax

Now there is a proposal to reintroduce Capital Gains Tax. This is a tax (falling within income tax) on gains on sale of capital assets. When a capital asset is sold, normally the proceeds are used to buy capital assets or to make capital investments. When there is a tax on capital proceeds, this may affect the capital investments in the country since the tax collected can be used for current expenditure purposes by the Government. Further, it may affect capital mobility, hindering economic growth. 

If Sri Lanka’s budget deficit is low and the economy is on a strong footing, Capital Gains Tax may be advantageous for the economy. Even if Capital Gains Tax is introduced for some reasons, it should be formulated in such a way that it would have a minimal impact on investment and business. Presently stamp duty is charged at the point of transfer of capital assets. Similarly, a levy can be introduced to be payable at the time of each capital transaction is executed. The levy can be calculated as a percentage of the transaction amount in order to reduce any complications. 

Widening the direct tax base

To increase tax revenue substantially and equitably in the medium to long term, the main focus has to be inevitably on widening the direct tax base. In this country, there is a large informal economy and a huge tax base to pay direct taxes but only a small fraction pays direct taxes. Ways and means have to be found to bring the large proportion of people who are capable of paying income tax but currently not paying any tax, in to tax net. 

Today even a mason earns more than Rs. 2,500 per day and his annual earnings would easily exceed tax free threshold of Rs. 500,000. The tax culture in Sri Lanka needs to change. There is a fear psychosis among the people about income tax. If some organisations or even the Government ask for some donations, people from all walks of life flock to donate. But when it comes to tax, they are very reluctant. It is necessary to study and find out the various causes for this mentality. 

Institutes such as CA Sri Lanka (Institute of Chartered Accountants) and universities can undertake research in this direction. The existing taxpayers should be made use of to carry the message to the rest of the community to promote and create a tax-paying society. For this to happen, existing taxpayers must be content and happy with the tax system. The masses must feel that the tax money is put into constructive and useful purposes.

In tax investigations, materiality and reasonableness should be the main criteria whether to call a tax payer and investigate a matter. Calling for further queries and information from an existing taxpayer must be kept to a minimum. The people who pay tax on time and file returns on time should get written appreciation from the Inland Revenue Department irrespective of large or small tax payers. Non-compliance on clear cut matters such as failure to furnish return, non-payment of declared or agreed taxes, etc. can be strictly dealt with. 

Basic principles 

Basic principles by which a Government is meant to be guided in designing and implementing an equitable taxation regime include: 

•  Efficient – A tax system should raise enough revenue such that Government projects can be adequately supported, without burdening the economy too much (not particularly the tax payer), as not to become a disincentive for performance (internal and external investment, work returns and savings). Also tax collection efforts should not cost an inordinately high percentage of tax revenues
•  Equitable – Taxation should be governed by people’s ability to pay, that is, wealthier individuals or firms with greater incomes should pay more in tax while those with lower incomes should pay comparatively less. Taxes should equally burden all individuals or entities in similar economic circumstances. Taxes should be allocated among individuals fairly and reasonably. In taxation systems, the principle of equality is considered as the most important. As Adam Smith put it forward: “The subjects of every state ought to contribute towards the support of the government as nearly as possible in proportion to their respective abilities.” This implies that every person should pay the tax according to his ability and not the same amount. It further means that every taxpayer should not pay at the same rate; rather every taxpayer should pay the tax proportion to his income of the taxpayer blanket
•  The principle of certainty – There should be certainty in taxation because uncertainty creates a favourable climate for tax evasion, hence compromising the taxation objectives. By this principle, it means that the tax which each individual taxpayer is bound to pay should be certain. The time, the manner of payment and the amount to be paid must be clear to the taxpayer. Thus, this requires that there should be no element of arbitrariness in a tax. 
•  Broad-basing: taxes should be spread over as wide as possible section of the population, or sectors of economy, to minimise the individual tax burden. 
•  The principle of simplicity – This is ability of the taxpayer to understand. The principle of simplicity is one of principles of taxation and it advocates that tax system should be plain and simple to understand by the common taxpayers. It should not be complicated to understand how to calculate and ultimately ascertain how much to be paid. The system should not be incomprehensible to the layperson, nor should it appear unjust or unnecessarily complex. This is to minimise discontent and costs.

Policymakers have to do a balancing act in accommodating all of the above principles. In addition, the relevant authorities should consider realistic avenues to ensure a progressive tax system from different perspectives such as taxes on consumer goods and services, especially. The consequence of taxes on goods and services (even VAT for that matter) may ultimately turn into a regressive tax system in relation to low and middle income people. 

(The writer is a Chartered Accountant and can be reached via email [email protected].)