CHALLENGES OF GLOBALIZING TAX SYSTEMS : SRI LANKA

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CHALLENGES OF GLOBALIZING TAX SYSTEMS SRI
LANKAS JOURNEY

• N. R. GAJENDRAN FCA
• Partner, Gajma Co

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DOING BUSINESS INDICATORSA Copublication of the
World Bank and the International Finance
Corporation

Ease of Doing Business World Rank 101 120 76 107 111 60 119
Ease of Doing Business SAARC Rank 3 7 2 4 5 1 6
Starting a Business World Rank 29 111 59 92 60 34 52
Starting a Business SAARC Rank 1 7 4 6 5 2 3
Dealing with Licenses World Rank 160 134 93 116 125 8 119
Dealing with Licenses SAARC Rank 7 6 2 3 5 1 4
Employing Workers World Rank 111 85 132 129 155 7 14
Employing Workers SAARC Rank 4 3 6 5 7 1 2
Registering Property World Rank 134 112 88 171 25 178 33
Registering Property SAARC Rank 5 4 3 6 1 7 2
Sri Lanka
Maldives
Pakistan
Bangladesh
Bhutan
India
Nepal
3
DOING BUSINESS INDICATORS (Contd)

Getting Credit World Rank 97 36 68 48 97 135 158
Getting Credit SAARC Rank 4 1 3 2 4 5 6
Protecting investors World Rank 64 33 19 15 64 64 122
Protecting investors SAARC Rank 4 3 2 1 4 4 5
Trading across borders World Rank 60 79 94 112 151 110 149
Trading across borders SAARC Rank 1 2 3 5 7 4 6
Enforcing Contracts World Rank 133 177 154 175 123 94 38
Enforcing Contracts SAARC Rank 4 7 5 6 3 2 1
Closing a Business World Rank 39 137 51 102 95 120 178
Closing a Business SAARC Rank 1 6 2 4 3 5 7
Bangladesh
Sri Lanka
Pakistan
Maldives
Bhutan
India
Nepal
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PAYING TAXES

Paying Taxes World Rank 158 165 146 81 92 1 68
Paying Taxes SAARC Rank 6 7 5 3 4 1 2
Payment (Number per year) World Rank 62 60 47 17 33 1 19
Payment (Number per year) SAARC Rank 7 6 5 2 4 1 3
Time (Hours per year) World Rank 256 271 560 400 408 - 274
Time (Hours per year) SAARC Rank 2 3 7 5 6 1 4
Total tax rates ( of profit) World Rank 63.7 70.6 40.7 39.5 32.5 9.1 39.8
Total tax rates ( of profit) SAARC Rank 6 7 5 3 2 1 4
Pakistan
Bangladesh
Bhutan
Sri Lanka
Maldives
India
Nepal
NOTE SAARC ranking not done by World Bank
or IFC
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TAX SYSTEM IN SRI LANKA

• Taxes in Sri Lanka consist the following
• Income Tax
• Economic Service Charge
• Partnership Tax
• Social Responsibility Levy
• Taxes on goods and services
• Value Added Tax
• Excise Duty
• Custom Duty
• Turnover Tax
• Ports and Airports Development Levy
• Tourism Development Levy
• Bank Debit Tax
• Stamp Duty
• Share Transaction Levy
• Betting and Gaming Levy
• There is no tax on capital gains, no gift tax
  and estate duty

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TAXES ADMINISTERED BY THE DEPARTMENT OF INLAND
REVENUE

• Taxes administered by the Department of Inland
  Revenue include
• Income Tax
• Value Added Tax.
• Economic Service Charge
• Stamp Duty
• Bank Debit Tax
• Social Responsibility Levy
• Partnership Tax
• Betting and Gaming Levy
• Economic Service Charge (ESC) was introduced as a
  minimum alternative tax

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TAXES ADMINISTERED BY THE DEPARTMENT OF INLAND
REVENUE (Contd)

• ESC is payable on the turnover of a business if
  it exceeds Rs 7.5 million per quarter and rates
  varies from 0.05 to 1
• ESC is an advanced payment against income tax
  for those who are liable to income tax
• If a person is liable to ESC, 5 withholding tax
  on services is not applied
• Partnerships are liable to a partnership tax
  at the rate of 10 on its aggregated amounts of
  divisible profits and other income
• The partnership tax attributable to the share of
  profits of the partners is allowed against the
  income tax liability of the partners

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CHARGEABILITY TO INCOME TAX

• A resident is taxed on his worldwide income
• A non resident is taxed on profits and income
  arising in or derived from Sri Lanka
• Profits and income arising in or derived from
  Sri Lanka
• Property in Sri Lanka
• Services rendered in Sri Lanka
• Business transacted in Sri Lanka

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CHARGEABILITY TO INCOME TAX (Contd)

• Resident Person
• A company is resident if
• The registered or principal office is in
  Sri Lanka or
• the control and management of its business
  are exercised in Sri Lanka
• An individual is resident if present in Sri
  Lanka for more than 183 days

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ASCERTAINMENT OF PROFITS AND INCOME

• All outgoings and expenses incurred in the
  production of profits and income are deductible
• Entertainment expenses, 50 of advertising
  expenses and traveling outside Sri Lanka (other
  than for exports) are disallowed
• Management expenses are restricted to the
  lower of Rs. 1 million
• or 1 of the turnover
• No tax depreciation for motor vehicles
  used for traveling
• 10 presumptive tax on dividend income
• 10 presumptive tax on interest income, in the
  case of individuals

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ASCERTAINMENT OF PROFITS AND INCOME (Contd)

• THIN CAPITALIZATION RULE
• Interest payment between group companies
  are restricted
• If the borrower is a manufacturer and if the loan
  exceeds 3 times
• of equity and reserves, interest on the
  excess is disallowed
• In the case of others, if the loan exceeds 4
  times of equity and reserves , interest on
  the excess is disallowed

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ASCERTAINMENT OF PROFITS AND INCOME (Contd)

• TRANSFER PRICING PRINCIPLE
• Transactions between associated enterprises
  should be at arms length price
• An undertaking shall be an associated
  undertaking of another undertaking, if the
  first mentioned undertaking participates in
  the control of the second to an
  extent as may be prescribed
• Arms length price is the price applied in
  uncontrolled conditions in a transaction between
  persons other than associated undertakings
• Methods of arms length price should be
  prescribed

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TRANSFER PRICING PRINCIPLE (Contd)
ASCERTAINMENT OF PROFITS AND INCOME (Contd)

• Commonly used arms length pricing methods
• Comparable Uncontrolled Price method
• Resale Price method
• Cost Plus method
• Profit Split method
• Transactional Net Margin method

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ASCERTAINMENT OF PROFITS AND INCOME (Contd)
TRANSFER PRICING PRINCIPLE (Contd)

• NON RESIDENT COMPANY
• Head office expenditure of a non resident company
  is restricted to 10 of the profits
• Head office means executive and general
  administration expenditure incurred outside
  Sri Lanka
• This includes cost of remuneration and traveling
  of persons managing the Head office and
  cost of premises

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DOUBLE TAX AGREEMENTS

• MFN clause of the protocol may be used to ones
  advantage in the
• India Sri Lanka DTA
• eg (1) Establishment of construction site PE
  may be extended to 12 months
• ( as a result of Sri Lanka- Iran DTA)
• (2) Establishment of Service PE
  may be extended to 275 days
• (as a result of Sri Lanka Romania DTA)
• Absence of securing orders in the Agency PE
  clause may mitigate
• the establishment of PE under DTA between
  India - Sri Lanka and Pakistan - Sri Lanka
• Tax sparing clause is present in the DTA
  between India - Sri Lanka
• and Pakistan - Sri Lanka
• The absence of an article for Fees for Technical
  Services (FTS) may mitigate withholding
  payments on management / technical fees from
• Sri Lanka
• No capital gains tax in Sri Lanka

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ENCOURAGEMENT OF VOLUNTARY COMPLIANCE

• Self assessment system is in operation in
  Sri Lanka
• Other than a Quoted Public Company, audited
  accounts are not necessary , if the turnover
  is less than Rs 250 million or the profits
• is less than Rs 100 million
• In the case of an individual, 10 discount is
  granted if he pays his quarterly installment of
  income tax one month before the due date
• An individual who has paid more than Rs.
  250,000/- as income tax consecutively for five
  years is entitled to a reduction of 25 of all
  import levies in the import of a motor vehicle
• The income tax return of an individual will be
  accepted without any question if he pays 20 more
  income tax compared to that of the previous
  year

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ENCOURAGEMENT OF VOLUNTARY COMPLIANCE (Contd)

• TIME BAR FOR INCOME TAX ASSESSMENT
• 1 ½ years, if returns are filed on time
• In other cases 3 years
• No time bar for fraud or evasion
• Income tax outstanding cannot be recovered after
  5 years from
• the date on which the tax becomes
  final and conclusive

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VOLUNTARY COMPLIANCE (Contd)

• TAXPAYER PRIVILEGE CARDS
• An individual who pays more than Rs. 1 million as
  income tax
• is entitled to a Gold Card. (for non
  citizens it is Rs. 2million)
• An individual who pays more than Rs. 500,000/- as
  income tax
• is entitled to a Silver Card (for non
  citizens it is Rs. 1 million)
• Privileges of the card holder
• Overdraft facility
• Credit Card facility
• Priority treatment at Government agencies
• Use of business class lounge at the airport

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TAX INCENTIVES

• Income tax exemption is available for the
  following
• Agriculture
• Agro processing
• Industrial and machine tool manufacturing
• Machinery manufacturing
• Electronics
• Export of non -traditional products

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TAX INCENTIVES (Contd)

• Income tax exemption (Contd)
• Information Technology
• Large scale projects exceeding Rs. 1 billion
• Infrastructure development for generation of
  power
• Tourism
• Recreation
• Warehousing and cold storage
• Garbage collection or disposal
• Construction of houses
• Construction of hospitals

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TAX INCENTIVES (Contd)

• Income tax exemption (Contd)
• Relocation of undertakings outside Colombo and
  Gampaha Districts
• Research and development
• Venture capital
• Manor houses or thematic bungalows
• New or upgraded cinemas
• Reopening of abandoned factories
• New undertakings in the Eastern Province
• New undertakings in lagging regions

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FOREIGN DIRECT INVESTMENTS

• FDI is protected under Article 157 of the
  Constitution of the Democratic Socialistic
  Republic of Sri Lanka
• Sri Lanka has entered into investment protection
  agreement with India and Pakistan
• Sri Lanka is one of the founder members of
  Multi-lateral Investment Guarantee Agency (MIGA)
  of the World Bank.
• The Board of Investment (BOI) is a one-stop
  investment facilitation agency
• BOI can enter into agreements to grant special
  concessions and privileges overriding income tax,
  Custom and Exchange Control laws
• Entire Sri Lanka is considered to be an
  Investment Promotion Zone (IPZ)
• 100 foreign investment is possible for other
  than areas specifically reserved for Sri Lanka,
  regulated areas and areas subject to conditional
  approvals

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AREAS FOR FOREIGN INVESTMENT

• Areas Totally Reserved for Sri Lanka
• Money lending
• Pawn- broking
• Retail trade investment with a capital less than
  US 1 million
• Coastal fishing

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AREAS FOR FOREIGN INVESTMENT (Contd)

• Areas Subject to Automatic or Conditional
  Approval
• Foreign investments in the areas listed
  below will be
• approved limited to 40 . Foreign ownership
  in excess
• of 40 will be approved on a case by case basis
  by the BOI
• Export of goods subject to quota restriction
• Tea, rubber, coconut, coca, rice, sugar and
  spices
• Non renewable natural resources
• Timber based industries using local timber

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AREAS FOR FOREIGN INVESTMENT (Contd)

• Areas Subject to Automatic or Conditional
• Approval (Contd)
• Fishing (deep sea fishing)
• Mass communications
• Education
• Freight forwarding
• Travel agencies
• Shipping agencies

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AREAS FOR FOREIGN INVESTMENT (Contd)

• REGULATED AREAS
• The following areas has to be specifically
  approved
• Air transportation
• Coastal shipping
• Manufacture of arms, ammunitions, explosives,
  military vehicles and equipment air-craft and
  other military hardware
• Manufacture of poisons, narcotics, alcohols,
  dangerous drugs and toxic, hazardous or
  carcinogenic materials
• Producing currency, coins or security documents
• Large scale mechanized mining of gems
• Lotteries

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VALUE ADDED TAX

• Value Added Tax (VAT) is imposed on a person who
  carries on a taxable activity, if the
  turnover exceeds Rs1.8 million per annum
• VAT may be computed using the addictive method
  (supply of financial services) or deductive
  method (other supplies)
• VAT Rates - 0, 5, 15 and 20
• VAT exemptions are available for certain
  goods and services
• Input tax can be deducted from the out put tax
  subject to maximum of 85 of the output tax
• No input tax deduction is available if the
  out put tax rate is 5
• The input tax rate cannot exceed 15
• No input tax deduction against exempt
  supplies
• Whole and retail activity is excluded from
  VAT

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VALUE ADDED TAX (Contd)

• VAT ON FINANCIAL SERVICES
• Accounting profit before income tax has
  to be adjusted for
• remuneration and for economic depreciation to
  compute the value addition
• VAT rate is 20
• Credit is available for normal VAT paid

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CHALLENGES

• Inflation
• Interest rates
• Rupee depreciation
• Heavy dependence on women
• External shocks

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