Tax Policies

 Sri  Lankan Tax Policies

Sri Lanka’s steep income tax hikes are seen as a gamble with the corporate sector and individuals are expected to be hit hard by the move as investable capital turning into government current spending.

The move could discourage and strangle investments, analysts say, though they see increasing tax revenue as well as cutting state spending as the key tools to reduce deficits and debt in the medium term.

The tax hikes come after Sri Lanka declared sovereign debt default in April this year. Sri Lanka ran out of reserves after authorities cut taxes and printed money for stimulus for two years ignoring repeated warnings on debt and external viability.

The new tax hikes will take the country beyond a pre-2019 tax regime with higher corporate income tax rates and higher marginal personal income tax rates though value added tax at back at 15 percent.

Spectacular bracket creep

The tax free threshold is 100,000 rupees a month, as in pre-2019, but the rupee is now worth about half its previous value, with the dollar collapsing from 182 to 360 to the US dollar in a spectacular case of bracket creep.

The highest marginal rate is 36 percent from 24 percent in 2019.

The corporate taxes which were at a 28 percent have been increased to 30 percent under the new amendments. The concessional 14 percent for exports will no longer be available.

Former President Gotabaya Rajapaksa soon after his election in 2019 slashed Value Added Tax (VAT) to 8 percent from a 15 percent along with several other tax cuts like Pay As You Earn (PAYE) tax, withholding tax on interest, debit tax on banks and financial institutes and Nation Building Tax (NBT) on household goods.

However analysts say some tax hikes are necessary.

“If you bring in any reforms, there must be a consensus with the people. If you forcefully go to do this . Then going to backfire abundantly,” Umesh Moramudali , an economic analyst, told Economy Next.

“In an overall view, everyone in general is benefiting. Without the tax increases there will be no IMF finalization and we won’t move on to recovery.”

Moramudali further stated that, without tax hike Sri Lanka will further print money or borrow more, which has more adverse impacts compared to higher tax rates in an economy.

“For the smooth functioning of the economy, it’s a huge task,” he said.

“But in the absence (of tax), the situation is likely to be much worse,” he said, adding that the policy errors are the main reason for the current situation of the country.

While the public took news of value added tax hikes with little protest, there has been heavy push back on income tax. People pay value added tax as they spend, little by little, but income taxes are charged on unspent money and they have to be paid in lump sums.