CHALLENGES OF GLOBALIZING TAX SYSTEMS : SRI LANKA’S JOURNEY

1. CHALLENGES OF GLOBALIZING TAX SYSTEMS :SRI LANKA’S JOURNEY N. R. GAJENDRAN FCA Partner, Gajma & Co

2. DOING BUSINESS INDICATORSA Copublication of the World Bank and the International Finance Corporation Sri Lanka Maldives Bangladesh Pakistan Bhutan India Nepal

3. DOING BUSINESS INDICATORS (Contd) Bangladesh Sri Lanka Pakistan Maldives Bhutan India Nepal

4. PAYING TAXES Pakistan Bhutan Bangladesh Sri Lanka Maldives India Nepal NOTE: SAARC ranking not done by World Bank or IFC

5. 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

6. 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

7. 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

8. 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

9. 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 it’s businessare exercised in Sri Lanka • An individual is resident if present in Sri Lanka for more than 183 days

10. 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

11. 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

12. ASCERTAINMENT OF PROFITS AND INCOME (Contd) TRANSFER PRICING PRINCIPLE • Transactions between associated enterprises should be at arm’s 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 • “Arm’s length price” is the price applied in uncontrolled conditions in a transaction between persons other than associated undertakings • Methods of arm’s length price should be prescribed

13. ASCERTAINMENT OF PROFITS AND INCOME (Contd) TRANSFER PRICING PRINCIPLE(Contd) • Commonly used arm’s length pricing methods • Comparable Uncontrolled Price method • Resale Price method • Cost Plus method • Profit Split method • Transactional Net Margin method

14. 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

15. DOUBLE TAX AGREEMENTS • MFN clause of the protocol may be used to one’s 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

16. 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

17. ENCOURAGEMENT OF VOLUNTARYCOMPLIANCE (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

18. 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

19. 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

20. 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 • New undertakings located outside Colombo and Gampaha Districts

21. 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

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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

28. 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

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

30. THANK YOU