In his presentation the Budget Speech for 2016, the Minister of Finance proposed to introduce a New Income Tax Law on the following lines: “Existing tax laws in the country are cumbersome, complex and based on traditional British concepts. The complexity of the tax laws has been identified as an impediment for the effective implementation of tax policy in Sri Lanka. It has led to various complications thereby hampering the effective implementation of the tax policy. Therefore, we need to redraft the tax laws to bring about necessary improvements to the legal framework to ensure clarity, consistency and simplicity towards reflecting the features of modern tax systems which will help taxpayers to understand the system easily and eliminate loopholes that have been created by the ambiguities in laws while strengthening tax administration. For this purpose, we will receive technical assistance from IMF and I propose to complete the project/process by end 2016.”
In keeping in line with the pronouncement, the proposed Inland Revenue Act (“new Bill”) has been published by gazette dated 16 June and was issued on 19 June. According to the new Bill the effective date of the proposed Inland Revenue Act is expected to be for any year of assessment commencing 1 April and will thereby have the effect of repealing the Inland Revenue Act No. 10 of 2006 (as amended). However, as per the Section 203 (2) of the new Bill, the current law (i.e. the Inland Revenue Act No. 10 of 2006 (as amended)) will continue to apply in respect of events occurring prior to the date of commencement of this new Inland Revenue Act.
Upon analysis of the past two decades of Sri Lanka with regard to Income Tax laws, the proposed Act will be the third Inland Revenue Act since the year 2000. However, the new Bill is structurally different to the laws we have been conversant with historically. For instance, the terminology is different and the new law deviates from the previous taxability provisions. The concept of statutory income has been removed.
What does the new
At a high level, it is clear that the income tax exemptions are limited and the tax rates are streamlined. The key changes as enlisted below.
Individuals and non-corporates
- The present 10 sources of income have been regrouped under four sources, namely, employment income, business income, investment income and other income.
- Capital gains tax has been introduced at 10% (with certain exemptions)
- The progressive tax slabs for individuals has been revised as depicted in figure 1.
- The tax free allowance of Rs. 500,000will remain the same for all citizens and residents of Sri Lanka.
- The present maximum of 16% tax rate on employment income has removed and employed individuals will fall in line with the standard progressive tax slabs as per figure 1. However, qualifying payment relief on employment income of an individual who is tax resident in Sri Lanka has been increased from Rs. 250,000to Rs. 700,000. However, the exhaustive list of exemptions that were afforded on profits from employment have been removed. As such, employed individuals can draw a salary of Rs. 100,000 per month tax free.
- The Bill is silent on the 10% discount for early settlement of self-assessment payments, therefore it is presumed that this is removed.
- The withholding tax rate on interest of 2.5% on bank deposits for resident individuals has been increased to 5%.
- The qualifying payment was previously extended to non-citizen non- resident employees as well but the concession does not apply to this class of individuals as per the new Bill.
- The exemption of interest income of senior citizens has now been classed as a qualifying payment subject to a ceiling of Rs. 1.5 million.
- The 10% rate for non- corporate entities such as charitable institutions,employee trust funds, provident or pension funds and termination funds has been increased to 14%.
- The present 8% partnership tax has been removed.
- Scope of the withholding tax has been expanded. Accordingly, rent, interest on loan and partner’s share of any partnership income would be liable to withholding tax.
- The basis of computation of tax has been changed with the reclassification of the sources of income and taxation of capital gains.
- Capital allowance rates and mechanism of computation has been revised.
- The current law provides for an indefinite carry forward of tax losses, the new Bill restricts the carry forward period of unutilised tax losses to six years. Furthermore, losses are deductible only against business profits from the same activity/rate.
- n The withholding tax on dividends and interest has been increased from 10% to 14%.
- n The concept of notional tax credit on Interest on government securities in the secondary market is removed.
- n Exemption granted to specific institutions have been removed.
- n Withholding tax on service payments have been introduced at the rate of 5% and 14% subject to certain conditions.
- n Tax rates have been revised under three tiers structure as, lower rate of 14%, standard rate of 28% and higher rate of 40%. The sector wise corporate tax rates are depicted in figure 2.
- n Resident companies are not entitled to claim withholding tax on interest as tax credit and interest net of withholding tax to be subject to tax.
- n No tax exemptions have been proposed via the New Bill but the concessions for various developments can be obtained via enhance depreciation allowances.
- n The concept of Deemed dividend tax has been removed whereas the scope of dividend has been widened to capture capitalisation of profits.
- n The present threshold to Small and Medium Enterprise (SME) of Rs. 750 million has been reduced to Rs. 500 million.
- n In order to ascertain the business income of a non-resident, the “Permanent establishment” concept has been introduced in the Bill.
- n Transfer Pricing rules have been modified drastically with the introduction of a Dispute Resolution panel, revised rules and an extensive penalty regime for various degrees of non-compliance.
- The present time bar period for raising assessments of 18 months has been extended to four years (other than in the case of default assessments). This causes greater degree of uncertainty of application of tax rules by a taxpayer since the return filed for a particular year of assessment remains open for assessment for a far longer timeframe.
- The appellate procedure has been revised.
- The advanced ruling mechanism has been modified and the concept of “public rulings” and “private rulings” have been introduced. A fee mechanism to be introduced for application of private rulings. The turnaround timeframe is set at 90 days within the date of request.
A key observation is the term “solely” in the context of invoking the 14% concessionary rate, the wording of the law is that it is granted for instance “in the case of a company solely conducting a business of exporting goods and services” and so on. This is a very restrictive concession as the term “solely” appears in all instances where the 14% rate has been afforded (except for SMEs). This will be very challenging to the tax payers when there is any other business income along with the specified business activity. Since sectors such as export, agriculture, educational, promotion of tourism and information technology are key drivers to the economic growth, the policymakers should accommodate some flexibility in order to encourage and develop them.
While the new Bill keeps in line with the policy pronouncement and these changes are done to simplify the tax framework, broadbase the tax network and ease collection in a bid to generate more tax revenue for the growth and betterment of the country. It is worrying that the effective date of this Act is proposed to be 1 April 2017. The Inland Revenue Department in April, issued a notice to taxpayers to continue with the present law until further notice. We are already a quarter into the year of assessment 2017/2018 most of the taxpayers comply with their monthly statutory tax payments such as PAYE and WHT under the Inland Revenue Act No. 10 of 2006. As such, introducing the proposed Act with retrospective effect should not leave room to penalise them such taxpayers subsequently and it must be clarified by the Department of Inland Revenue. In the alternative, the effective date should be a future date allowing taxpayers to work with certainty of tax policies. Also, it would be meritorious if that the Minister of Finance reintroduces the office of Tax Ombudsman as proposed in the budget for the year 2017 as this will enhance the taxpayer’s confidence in exercise of their rights.
(The writer is Director – Tax Services, BDO Partners.)