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

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CHALLENGES OF CHALLENGES OF GLOBALIZINGGLOBALIZING

TAX SYSTEMS : TAX SYSTEMS :SRI LANKA’S JOURNEYSRI LANKA’S JOURNEY

N. R. GAJENDRAN N. R. GAJENDRAN FCAFCA

Partner, Gajma & Co Partner, Gajma & Co

22

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

Corporation

Ease of Ease of Doing Doing

BusinessBusiness

World World RankRank 101101 120120 7676 107107 111111 6060 119119

SAARCSAARC

RankRank33 77 22 44 55 11 66

Starting a Starting a Business Business


SAARCSAARC

RankRank 11 77 44 66 55 22 33

Dealing Dealing with with

Licenses Licenses


SAARC SAARC RankRank 77 66 22 33 55 11 44

Employing Employing WorkersWorkers


SAARCSAARC

RankRank44 33 66 55 77 11 22

Registering Registering Property Property


SAARCSAARC

RankRank55 44 33 66 11 77 22

Sri Lanka

IndiaPakistan

Bangladesh

NepalMaldives

Bhutan

33

Getting Getting Credit Credit


SAARCSAARC

RankRank 44 11 33 22 44 55 66

Protecting Protecting investors investors


SAARCSAARC

RankRank44 33 22 11 44 44 55

Trading Trading across across bordersborders


SAARCSAARC

RankRank11 22 33 55 77 44 66

Enforcing Enforcing Contracts Contracts


SAARCSAARC

RankRank44 77 55 66 33 22 11

Closing a Closing a Business Business


SAARCSAARC

RankRank 11 66 22 44 33 55 77

DOING BUSINESS INDICATORS (Contd)

Sri Lanka

IndiaPakistan

Bangladesh

Nepal

Maldives

Bhutan

44

Paying Paying Taxes Taxes

WorldWorld

RankRank 158158 165165 146146 8181 9292 11 6868


PaymentPayment

(Number (Number per year)per year)

WorldWorld

RankRank 6262 6060 4747 1717 3333 11 1919


Time (Hours Time (Hours per year)per year)

WorldWorld

RankRank 256256 271271 560560 400400 408408 -- 274274


Total tax Total tax ratesrates

(% of profit)(% of profit)

WorldWorld

RankRank 63.763.7 70.670.6 40.740.7 39.539.5 32.532.5 9.19.1 39.839.8


PAYING TAXES

NOTE: SAARC ranking not done by World Bank or IFC

Sri Lanka

IndiaPakistan

Bangladesh

Nepal

Maldives

Bhutan

55

TAX SYSTEM IN SRI LANKATAX SYSTEM IN SRI LANKA

Taxes in Sri Lanka consist the following:Taxes in Sri Lanka consist the following:

Income TaxIncome Tax Economic Service ChargeEconomic Service Charge Partnership TaxPartnership Tax Social Responsibility LevySocial Responsibility LevyTaxes on goods and servicesTaxes on goods and services Value Added TaxValue Added Tax Excise DutyExcise Duty Custom DutyCustom Duty Turnover TaxTurnover Tax Ports and Airports Development LevyPorts and Airports Development Levy Tourism Development LevyTourism Development LevyBank Debit TaxBank Debit TaxStamp DutyStamp DutyShare Transaction LevyShare Transaction LevyBetting and Gaming LevyBetting and Gaming LevyThere is no tax on capital gains, no gift tax and estate duty There is no tax on capital gains, no gift tax and estate duty

66

Taxes administered by the Department of Inland Revenue includeTaxes administered by the Department of Inland Revenue include

Income Tax Income Tax Value Added Tax.Value Added Tax. Economic Service ChargeEconomic Service Charge Stamp DutyStamp Duty Bank Debit TaxBank Debit Tax Social Responsibility LevySocial Responsibility Levy Partnership Tax Partnership Tax Betting and Gaming LevyBetting and Gaming Levy

Economic Service Charge (ESC) was introduced as a minimum Economic Service Charge (ESC) was introduced as a minimum alternative taxalternative tax

TAXES ADMINISTERED BY THE DEPARTMENT OF INLAND REVENUE

77

ESC is payable on the turnover of a business if it exceeds Rs 7.5 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%million per quarter and rates varies from 0.05% to 1%

ESC is an advanced payment against income tax for those who ESC is an advanced payment against income tax for those who are liable to income taxare liable to income tax

If a person is liable to ESC, 5% withholding tax on services is not If a person is liable to ESC, 5% withholding tax on services is not appliedapplied

Partnerships are liable to a partnership tax at the rate of 10% on Partnerships are liable to a partnership tax at the rate of 10% on its aggregated amounts of divisible profits and other incomeits aggregated amounts of divisible profits and other income

The partnership tax attributable to the share of profits of the The partnership tax attributable to the share of profits of the partners is allowed against the income tax liability of the partnerspartners is allowed against the income tax liability of the partners

TAXES ADMINISTERED BY THE DEPARTMENT OF INLAND REVENUE (Contd)

88

CHARGEABILITY TO INCOME TAXCHARGEABILITY TO INCOME TAX

A resident is taxed on his worldwide incomeA resident is taxed on his worldwide income

A non resident is taxed on profits and income arising in or derived from A non resident is taxed on profits and income arising in or derived from Sri LankaSri Lanka

Profits and income arising in or derived from Sri LankaProfits and income arising in or derived from Sri Lanka Property in Sri LankaProperty in Sri Lanka Services rendered in Sri LankaServices rendered in Sri Lanka Business transacted in Sri LankaBusiness transacted in Sri Lanka

99

CHARGEABILITY TO INCOME TAX CHARGEABILITY TO INCOME TAX (Contd)(Contd)

Resident Person Resident Person

• A company is resident if

The registered or principal office is in Sri Lanka The registered or principal office is in Sri Lanka oror

the control and management of it’s businessthe control and management of it’s business are exercised in Sri Lankaare exercised in Sri Lanka

• An individual is resident if present in Sri Lanka for more than 183 days

1010

ASCERTAINMENT OF PROFITS AND OF PROFITS AND

INCOMEINCOME

All outgoings and expenses incurred in the production of profits and All outgoings and expenses incurred in the production of profits and income are deductibleincome are deductible

Entertainment expenses, 50% of advertising expenses and traveling Entertainment expenses, 50% of advertising expenses and traveling outside Sri Lanka (other than for exports) are disallowedoutside Sri Lanka (other than for exports) are disallowed

Management expenses are restricted to the lower of Rs. 1 millionManagement expenses are restricted to the lower of Rs. 1 million or 1% of the turnoveror 1% of the turnover

No tax depreciation for motor vehicles used for travelingNo tax depreciation for motor vehicles used for traveling

10% presumptive tax on dividend income10% presumptive tax on dividend income

10% presumptive tax on interest income, in the case of individuals 10% presumptive tax on interest income, in the case of individuals

1111

ASCERTAINMENT OF PROFITS AND INCOME ASCERTAINMENT OF PROFITS AND INCOME (Contd)(Contd)

THIN CAPITALIZATION RULETHIN CAPITALIZATION RULE

Interest payment between group companies are restrictedInterest payment between group companies are restricted

If the borrower is a manufacturer and if the loan exceeds 3 times If the borrower is a manufacturer and if the loan exceeds 3 times

of equity and reserves, interest on the excess is disallowedof equity and reserves, interest on the excess is disallowed

In the case of others, if the loan exceeds 4 times of equity and In the case of others, if the loan exceeds 4 times of equity and reserves , interest on the excess is disallowedreserves , interest on the excess is disallowed

1212


TRANSFER PRICING PRINCIPLETransactions between associated enterprises should be at arm’s Transactions between associated enterprises should be at arm’s length pricelength price

An undertaking shall be an associated undertaking of another An undertaking shall be an associated undertaking of another undertaking, if the first mentioned undertaking participates in the undertaking, if the first mentioned undertaking participates in the control of the second to an extent as may be prescribedcontrol of the second to an extent as may be prescribed

““Arm’s length price” is the price applied in uncontrolled conditions in Arm’s length price” is the price applied in uncontrolled conditions in a transaction between persons other than associated undertakingsa transaction between persons other than associated undertakings

Methods of arm’s length price should be prescribedMethods of arm’s length price should be prescribed

1313

TRANSFER PRICING PRINCIPLETRANSFER PRICING PRINCIPLE (Contd)(Contd)

Commonly used arm’s length pricing methodsCommonly used arm’s length pricing methods

Comparable Uncontrolled Price methodComparable Uncontrolled Price method

Resale Price methodResale Price method

Cost Plus methodCost Plus method

Profit Split methodProfit Split method

Transactional Net Margin methodTransactional Net Margin method


1414

ASCERTAINMENT OF PROFITS AND INCOME ASCERTAINMENT OF PROFITS AND INCOME (Contd)

NON RESIDENT COMPANYNON RESIDENT COMPANY

Head office expenditure of a non resident company is Head office expenditure of a non resident company is restricted to 10% of the profitsrestricted to 10% of the profits

Head office means executive and general administration Head office means executive and general administration expenditure incurred outside Sri Lankaexpenditure incurred outside Sri Lanka

This includes cost of remuneration and traveling of persons This includes cost of remuneration and traveling of persons managing the Head office and cost of premisesmanaging the Head office and cost of premises

TRANSFER PRICING PRINCIPLETRANSFER PRICING PRINCIPLE (Contd)(Contd)

1515

DOUBLE TAX AGREEMENTS

MFN clause of the protocol may be used to one’s advantage in theMFN clause of the protocol may be used to one’s advantage in the India – Sri Lanka DTAIndia – Sri Lanka DTA

eg: eg: (1) Establishment of construction site PE may be extended to 12 months (1) Establishment of construction site PE may be extended to 12 months ( as a result of Sri Lanka- Iran DTA) ( as a result of Sri Lanka- Iran DTA)

(2) Establishment of Service PE may be extended to 275 days (2) Establishment of Service PE may be extended to 275 days (as a result of Sri Lanka – Romania DTA) (as a result of Sri Lanka – Romania DTA)

Absence of “securing orders” in the Agency PE clause may mitigateAbsence of “securing orders” in the Agency PE clause may mitigate the establishment of PE under DTA between India - Sri Lanka and the establishment of PE under DTA between India - Sri Lanka and Pakistan - Sri LankaPakistan - Sri Lanka

Tax sparing clause is present in the DTA between India - Sri LankaTax sparing clause is present in the DTA between India - Sri Lanka and Pakistan - Sri Lankaand Pakistan - Sri Lanka

The absence of an article for Fees for Technical Services (FTS) may The absence of an article for Fees for Technical Services (FTS) may mitigate withholding payments on management / technical fees from mitigate withholding payments on management / technical fees from Sri LankaSri Lanka

No capital gains tax in Sri LankaNo capital gains tax in Sri Lanka

1616

ENCOURAGEMENT OF VOLUNTARY COMPLIANCE

Self assessment system is in operation in Sri Lanka Self assessment system is in operation in Sri Lanka

Other than a Quoted Public Company, audited accounts are not Other than a Quoted Public Company, audited accounts are not necessary , if the turnover is less than Rs 250 million or the profitsnecessary , if the turnover is less than Rs 250 million or the profits

is less than Rs 100 millionis less than Rs 100 million

In the case of an individual, 10% discount is granted if he pays his In the case of an individual, 10% discount is granted if he pays his quarterly installment of income tax one month before the due datequarterly installment of income tax one month before the due date

An individual who has paid more than Rs. 250,000/- as income tax 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 consecutively for five years is entitled to a reduction of 25% of all import levies in the import of a motor vehicle import levies in the import of a motor vehicle

The income tax return of an individual will be accepted without any 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 question if he pays 20% more income tax compared to that of the previous yearprevious year

1717

ENCOURAGEMENT OF VOLUNTARY COMPLIANCE (Contd)

TIME BAR FOR INCOME TAX ASSESSMENTTIME BAR FOR INCOME TAX ASSESSMENT

1 ½ years, if returns are filed on time1 ½ years, if returns are filed on time

In other cases 3 yearsIn other cases 3 years

No time bar for fraud or evasionNo time bar for fraud or evasion

Income tax outstanding cannot be recovered after 5 years from Income tax outstanding cannot be recovered after 5 years from the date on which the tax becomes final and conclusivethe date on which the tax becomes final and conclusive

1818

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

1919

TAX INCENTIVESTAX INCENTIVES

Income tax exemption is available for the following :

Agriculture Agriculture

Agro processing Agro processing

Industrial and machine tool manufacturingIndustrial and machine tool manufacturing

Machinery manufacturingMachinery manufacturing

ElectronicsElectronics

Export of non -traditional productsExport of non -traditional products

2020

TAX INCENTIVES (Contd)TAX INCENTIVES (Contd)

Income tax exemption (Contd)Income tax exemption (Contd)

Information TechnologyInformation Technology

Large scale projects exceeding Rs. 1 billionLarge scale projects exceeding Rs. 1 billion

Infrastructure development for generation of powerInfrastructure development for generation of power

TourismTourism

RecreationRecreation

Warehousing and cold storageWarehousing and cold storage

Garbage collection or disposalGarbage collection or disposal

Construction of housesConstruction of houses

Construction of hospitalsConstruction of hospitals

New undertakings located outside Colombo and Gampaha DistrictsNew undertakings located outside Colombo and Gampaha Districts

2121

Income tax exemption (Contd)Income tax exemption (Contd)

Relocation of undertakings outside Colombo and Gampaha DistrictsRelocation of undertakings outside Colombo and Gampaha Districts

Research and developmentResearch and development

Venture capitalVenture 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

TAX INCENTIVES (Contd)TAX INCENTIVES (Contd)

2222

FOREIGN DIRECT INVESTMENTSFOREIGN DIRECT INVESTMENTS

FDI is protected under Article 157 of the Constitution of the FDI is protected under Article 157 of the Constitution of the Democratic Socialistic Republic of Sri LankaDemocratic Socialistic Republic of Sri Lanka

Sri Lanka has entered into investment protection agreement with Sri Lanka has entered into investment protection agreement with India and PakistanIndia and Pakistan

Sri Lanka is one of the founder members of Multi-lateral Investment Sri Lanka is one of the founder members of Multi-lateral Investment Guarantee Agency (MIGA) of the World Bank.Guarantee Agency (MIGA) of the World Bank.

The Board of Investment (BOI) is a one-stop investment facilitation The Board of Investment (BOI) is a one-stop investment facilitation agencyagency

BOI can enter into agreements to grant special concessions and BOI can enter into agreements to grant special concessions and privileges overriding income tax, Custom and Exchange Control privileges overriding income tax, Custom and Exchange Control lawslaws

Entire Sri Lanka is considered to be an Investment Promotion Zone Entire Sri Lanka is considered to be an Investment Promotion Zone (IPZ)(IPZ)

100% foreign investment is possible for other than areas 100% foreign investment is possible for other than areas specifically reserved for Sri Lanka, regulated areas and areas specifically reserved for Sri Lanka, regulated areas and areas subject to conditional approvalssubject to conditional approvals

2323

AREAS FOR FOREIGN INVESTMENTAREAS FOR FOREIGN INVESTMENT

Areas Totally Reserved for Sri Lanka

Money lendingMoney lending

Pawn- brokingPawn- broking

Retail trade investment with a capital less than US $ 1 millionRetail trade investment with a capital less than US $ 1 million

Coastal fishingCoastal fishing

2424

AREAS FOR FOREIGN INVESTMENT AREAS FOR FOREIGN INVESTMENT (Contd)

Areas Subject to Automatic or Conditional Approval

Foreign investments in the areas listed below will be Foreign investments in the areas listed below will be approved limited to 40% . Foreign ownership in excessapproved limited to 40% . Foreign ownership in excessof 40% will be approved on a case by case basis by the BOIof 40% will be approved on a case by case basis by the BOI

Export of goods subject to quota restrictionExport of goods subject to quota restriction

Tea, rubber, coconut, coca, rice, sugar and spicesTea, rubber, coconut, coca, rice, sugar and spices

Non renewable natural resourcesNon renewable natural resources

Timber based industries using local timberTimber based industries using local timber

2525

AREAS FOR FOREIGN INVESTMENT (Contd)

Areas Subject to Automatic or ConditionalAreas Subject to Automatic or Conditional

Approval (Contd)Approval (Contd)

Fishing (deep sea fishing)Fishing (deep sea fishing)

Mass communicationsMass communications

Education

Freight forwardingFreight forwarding

Travel agenciesTravel agencies

Shipping agenciesShipping agencies

2626

AREAS FOR FOREIGN INVESTMENT AREAS FOR FOREIGN INVESTMENT (Contd)(Contd)

REGULATED AREAS

The following areas has to be specifically approvedThe following areas has to be specifically approved

Air transportationAir transportation

Coastal shippingCoastal shipping

Manufacture of arms, ammunitions, explosives, military vehicles and Manufacture of arms, ammunitions, explosives, military vehicles and equipment air-craft and other military hardware equipment air-craft and other military hardware

Manufacture of poisons, narcotics, alcohols, dangerous drugs and Manufacture of poisons, narcotics, alcohols, dangerous drugs and toxic, hazardous or carcinogenic materialstoxic, hazardous or carcinogenic materials

Producing currency, coins or security documentsProducing currency, coins or security documents

Large scale mechanized mining of gemsLarge scale mechanized mining of gems

LotteriesLotteries

2727

VALUE ADDED TAXVALUE ADDED TAX

Value Added Tax (VAT) is imposed on a person who carries on a Value Added Tax (VAT) is imposed on a person who carries on a taxable activity, if the turnover exceeds Rs1.8 million per annum taxable activity, if the turnover exceeds Rs1.8 million per annum

VAT may be computed using the addictive method (supply of VAT may be computed using the addictive method (supply of financial services) or deductive method (other supplies) financial services) or deductive method (other supplies)

VAT Rates - 0%, 5%, 15% and 20%VAT Rates - 0%, 5%, 15% and 20%

VAT exemptions are available for certain goods and servicesVAT exemptions are available for certain goods and services

Input tax can be deducted from the out put tax subject to maximum Input tax can be deducted from the out put tax subject to maximum of 85% of the output taxof 85% of the output tax

No input tax deduction is available if the out put tax rate is No input tax deduction is available if the out put tax rate is 5%5%

The input tax rate cannot exceed 15%The input tax rate cannot exceed 15%

No input tax deduction against exempt suppliesNo input tax deduction against exempt supplies

Whole and retail activity is excluded from VATWhole and retail activity is excluded from VAT

2828

VALUE ADDED TAX (Contd)VALUE ADDED TAX (Contd)

VAT ON FINANCIAL SERVICES

Accounting profit before income tax has to be adjusted forAccounting profit before income tax has to be adjusted for

remuneration and for economic depreciation to compute the value remuneration and for economic depreciation to compute the value additionaddition

VAT rate is 20%VAT rate is 20%

Credit is available for normal VAT paidCredit is available for normal VAT paid

2929

CHALLENGESCHALLENGES

InflationInflation

Interest ratesInterest rates

Rupee depreciationRupee depreciation

Heavy dependence on womenHeavy dependence on women

External shocksExternal shocks

3030

THANK YOUTHANK YOU

Documents

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