CHALLENGES OF GLOBALIZING TAX SYSTEMS : SRI LANKAS JOURNEY

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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
Sri Lanka
Maldives
Pakistan
Bangladesh
Bhutan
India
Nepal
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DOING BUSINESS INDICATORS (Contd)
Bangladesh
Sri Lanka
Pakistan
Maldives
Bhutan
India
Nepal
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PAYING TAXES
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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