An overview of Sri Lanka's taxation framework

In Sri Lanka taxes are levied by various regulatory authorities by virtue of the powers vested in them. Here, we have set out an outline of the key taxes of the country. The list is not exhaustive and aims to be of general guidance only.

Income Tax

Income tax is charged on every person (residents and non-residents) on profits and income. Residents are charged on their global income while non-residents are charged on income arising in or derived from Sri Lanka.

Income tax is charged for a year of assessment which is a period of 12 months commencing on April 1 in any year to March 31 of the following year. The law provides for changes in year of assessment upon a written request and the concurrence of the Commissioner General of Inland Revenue (CGIR), who is the tax chief of Sri Lanka.

Sri Lanka has a self-assessment regime for income tax payments. Accordingly, any person liable to income tax is required to compute his/her tax liability and remit such tax in four quarterly instalments. The due dates of quarterly instalments are: first quarter – on or before August 15 of that year; second quarter – on or before November 15 of that year; third quarter – on or before February 15 of the next year; fourth quarter – on or before May 15 of the next year.

Individual taxpayers are entitled to a 10% discount on self-assessment payments made at least one month prior to the relevant quarterly due date. A person who has not paid the quarterly tax payment by due date will be liable to a penalty of 10% of the tax in default if paid within one month of the due date and a further 2% for every additional month for which the instalment remains in default. In order to avoid this penalty, the minimum payment to be made for each quarter for the relevant year of assessment is an amount not less than a quarter of the tax of the preceding year of assessment. Where the taxpayer has opted to make the quarterly payments on a preceding year basis, the final tax payment for the relevant year of assessment has to be made on or before September 30 of the next year.

Returns & Residency

The due date for filing an income tax return is on or before November 30 following the end of the year of assessment. Consequences of non-compliance with regards to filing include a penalty payment of LKR50,000 ($360) and loss of time bar to raise assessments.

Any individual who is physically present in Sri Lanka for more than 183 days or more in any year of assessment will be considered to be a resident of the country for income tax purposes for that particular year of assessment.

The Inland Revenue Act stipulates that a resident person in Sri Lanka is required to pay income tax on his global income. However, there is an exemption from income tax on any profits and income derived from outside Sri Lanka of any individual who is not a citizen of Sri Lanka and who is employed in Sri Lanka in any undertaking. Therefore, any income that is derived from outside Sri Lanka by a non-citizen who is employed in Sri Lanka will not be liable to income tax in Sri Lanka.

Tax Rates

An individual is charged on such person’s taxable income on progressive rates based on the level of income. The rates currently applicable are: on the first LKR500,000 ($3600), 4% of the taxable income; on the next LKR500,000 ($3600), 8% of the taxable income; on the next LKR500,000 ($3600), 12% of the taxable income; on the next LKR500,000 ($3600), 16% of the taxable income; on the next LKR1m ($7200), 20% of the taxable income; and a rate of 24% on the balance of taxable income above this level.

A resident of Sri Lanka for income tax purposes will be entitled to claim a tax-free allowance of LKR500,000 ($3600) for each year of assessment. An individual who has profits from employment and is a resident or citizen of Sri Lanka is entitled to a further deduction of LKR250,000 ($1800) as a qualifying payment.

Resident Companies

Income tax is charged in respect of the profits and income wherever it may arise from every person resident in Sri Lanka at the rates specified in the tax act.

A company having its registered or principal office in Sri Lanka, or where the control and management of its business are exercised in Sri Lanka shall be deemed to be a resident of Sri Lanka. A company incorporated in Sri Lanka will have a registered office in Sri Lanka. Therefore, even though the shares of the company are owned entirely by non-residents of Sri Lanka, a company incorporated in Sri Lanka will be considered to be a resident of Sri Lanka for income tax purposes.

The statutory rate of income tax is applied on the taxable profits, which is arrived at after adjusting the accounting profits as recorded in the audited financial statements of the company.

The current general corporate tax rate is 28%. However, there are certain concessionary rates that can be claimed for certain businesses/ industries. A snapshot of concessionary rates available for the year of assessment 2015/16 are: general rate to all including non-governmental organisations, offshore foreign currency banking unit of a bank, and specialised housing banks, 28%; liquor or tobacco industry, 40%; partnership, 8%; club or association,10%; venture capital, 12%; petroleum exploration, 12%; stand-alone small and medium-sized enterprises (other than professionals) with turnover below LKR750m, $5.4m), 12%; export or deemed export with domestic value addition at least 65% and with Sri Lanka brand name registered in Sri Lanka, 10%; qualified export profits, 12%; maintenance of storage, software development or labour supply, 10%; educational services, agricultural undertaking and poultry farming, 10%; provision of health care services, 12%; local hand-loom products manufacture, 12%; sale of goods in local market by an export-oriented company, 12%; sale of products manufactured in Sri Lanka for the payment of FC, 12%; supply of goods or services to foreign ships, 12%; alternative power generating project including mini hydro power, 12%; supply of certain services to exporters, 12%; trans-shipment agency fees, 12%; research activities, 20% ( maximum 16% for an individual); unit trust management company, 10%; and stand-alone companies with taxable income below LKR5m ($36,000) other than manufacturers or service providers, 12%.

Dividend Tax

A resident company is required to pay 10% as dividend tax on any dividend distributed by the company. The resultant profits from dividends will not form part of the total statutory income of the recipient. The dividends to any non-resident shareholders can be repatriated outside Sri Lanka through the securities investment account. Where the recipient is a resident of a country with which Sri Lanka has a double-tax treaty, the rate specified in such treaty will apply.

In each year of assessment a resident company is required to distribute a minimum of 10% of its distributable profits for that year as dividends before September 30 after the end of that year of assessment. Companies which fail to comply with this requirement are liable to pay deemed dividend tax. This is a penal provision to compel the company to undertake a mandatory distribution of dividends each year.

Deemed Dividend Tax

Deemed dividend tax is imposed at the rate of 15% on one-third of the distributable profits for that year. Distributable profits are computed by considering the accounting profits after removing the impact of capital and tax expenditure. This tax, however, will not be imposed in situations where any other laws prevent the company from distributing any dividends.

Tax Losses

Tax losses incurred can be utilised or set off against income from taxable sources (such as interest) subject to restrictions. Tax losses can be carried forward indefinitely and utilised against taxable profits of future periods (subject to exceptions).

Non-Resident Companies

A company registered as an overseas company will be considered to be a non-resident for income tax purposes.

A non-resident will be liable to income tax on the profits and income arising in or derived from Sri Lanka. This will include profits from rendering services in Sri Lanka, property in Sri Lanka or business transacted in Sri Lanka. The prevailing income tax rate applied to profits of such company will also be at the rate of 28%. Where the company registered in Sri Lanka is a resident in a country with which Sri Lanka has a double-tax treaty, the articles in such treaty will apply in determining the tax liability of such company in Sri Lanka.

Where the non-resident is not in a position to prepare financial statements for the relevant year of assessment, the law allows such person to pay income tax on a presumptive rate on receiving approval for such arrangement from the CGIR. The minimum presumptive rate is 6%.

Remittance Tax

This tax will only apply to an overseas company registered in Sri Lanka as it is only imposed on a company that is not resident in Sri Lanka. A profit remittance tax of 10% will be charged on the aggregate amount of remittances made by such firm. The tax paid may be claimed as a tax credit in the country where the recipient resides if the recipient is a resident of a country with which Sri Lanka has a double-tax treaty.

Withholding Tax

A stringent withholding tax (WHT) system is in place in Sri Lanka which requires that tax be withheld from certain local and international payments including interest, dividend, management fee, fees for technical services and royalty. For instance, banks and financial institutions deduct WHT on interest at the rate of 2.5% for any partnership, charitable institution and any individual, and 8% for any body of persons on or after April 1, 2015.

Tax Clearance Obligations

In the case of cross-border remittances, a tax clearance certificate is required to be obtained prior to remitting the payment. According to the circular issued by the Inland Revenue Department (IRD), all commercial banks must insist on a tax clearance certificate to be obtained from the IRD prior to affecting any remittance of funds overseas. A tax clearance certificate is required for the remittance of the following payments:

• Communication services, which includes telecommunication and internet services;
• Computer software and information services;
• Royalties, licence and franchise fees;
• Remittance in respect of foreign loans, capital repayment and interest payments, if such loan has been obtained prior to April 1, 2012;
• Remittances to foreign contractors engaged in public and private sector services in Sri Lanka, which include design, construction and installation of projects, contract payments, surplus funds arising from the contracts and projects;
• Remittances in respect of services rendered by persons outside Sri Lanka in relation to management services; and
• Remittances on service contracts, which include human resources management and information technology management.

Advance Tax Rulings

The tax office has a committee for interpretation of tax laws, which issues advanced tax rulings. The law provides a time period of six months for obtaining rulings or interpretations from the committee.

Treaty Network

Sri Lanka is a party the South Asian Association for Regional Cooperation multilateral treaty as well as to 42 bilateral double-tax treaties. The latter include: Australia, Bangladesh, Belgium, Canada, China, Denmark, France, Finland, Germany, Hong Kong, India, Indonesia, Iran, Italy, Japan, Korea, Kuwait, Malaysia, Mauritius, Nepal, the Netherlands, Norway, Oman, Pakistan, the Philippines, Poland, Qatar, Romania, Russia, Saudi Arabia, Singapore, Sweden, Switzerland, Thailand, the UAE, the UK, the US, Vietnam, Seychelles, Belarus, Palestine and Luxembourg.

Transfer Pricing

Transfer prices are used when an entity transfers its products to an entity within the same group. These transfer prices may have the effect of shifting profits between those entities thereby gaining tax advantages which were not contemplated by the taxing statutes.

In order to curb this practice the Inland Revenue Act provides that any profits and income arising, derived or accruing from, or any loss incurred in any transaction entered into between two associated undertakings should be ascertained having regard to the arm’s length price.

The arm’s length price of a transaction is to be determined according to any of the methods set out in the regulations. The methods prescribed are comparable uncontrolled price method, resale price method, cost plus method, profit split method and transactional net margin method.

The Sri Lankan transfer-pricing rules govern international as well as domestic transactions between associated undertakings and the transfer pricing documentation is prescribed. The regulations permit both unilateral and bilateral ( including multilateral) advance pricing agreements in the case of international transactions.

The regulations warrant certain key disclosures in the directors report for the purposes of transfer pricing, including a record of transactions entered into with associated undertakings, the transfer-pricing policy statement, management perception of the risk factors involved, amounts outstanding, items pertaining to related-party balances, and provisions and other material information pertaining to related-party transactions that are necessary for understanding of the financial statements or are required to be disclosed under any other law or as part of any other applicable accounting standard.

Pay-As-You-Earn

Sri Lanka has a pay-as-youearn (PAYE) scheme where the tax law imposes a liability on every employer to deduct the income tax from the remuneration of his employees at the time of making such payments to the employees.

According to the Inland Revenue Act, any entity which engages an individual to perform any services as an employee will be liable to deduct income tax through PAYE.

The income tax on employment income will be deducted in accordance with the PAYE tax tables as stipulated by the IRD. Accordingly, the employer must calculate the tax on the wages, salaries, allowances and other benefits it pays to its employees as per the department’s tax tables and remit such sums to the benefit of the CGIR on or before the 15th of the subsequent month in which such payment is made.

The employee is not required to furnish a return of income where such employee has no other source of income other than employment income on which PAYE has been deducted by the employer.

Value-Added Tax

Value-added tax (VAT) is mainly a sales tax which is imposed at the point of import or supply of any goods or services.

The VAT Act has two rates that are applicable at 11% and 0% depending on the goods and services that are being supplied.

The VAT Act also lists certain items which are exempt. The nature of the supply made and the business carried out by the company must be considered in ascertaining the rate of VAT applicable or if such supply is exempt. A person making taxable supplies of more than LKR3.75m ($27,000) per taxable period or LKR15m ($108,000) per annum is required to register for VAT purposes.

If the company exceeds the registration threshold and is registered for VAT, it has to charge VAT at the rate of 11% on the supplies it makes to its customers. This is referred to as the output VAT.

The company will be required to pay the net of output tax minus the input tax to the CGIR. Input VAT refers to the VAT paid on purchases of goods and services from another registered person or the VAT paid to the Customs at the import point.

As a general rule a person who makes taxable supplies can set off the input VAT paid on purchases of goods and services against the output VAT liability of such person.

Input VAT can be claimed up to 100% of the output VAT, subject to certain restrictions.

VAT is also charged on the supply of (provision of) financial services on the value attributable from financial services.

Nation Building Tax

The nation building tax (NBT) is imposed on every person who imports articles, manufactures any article, carries on the business of providing a service of any description and carries on the business of wholesale or retail sale of any article other than such sale by the manufacturer of that article being a manufacturer and engaged in the business of real estate.

A company which has a liable turnover of more than LKR3.75m ($27,000) per quarter or LKR15m ($108,000) per annum is required to register for NBT. NBT is currently imposed at the rate of 2% on the liable turnover. The NBT Act in its schedule provides a list of excepted goods and services where such business activities are given an exemption from paying NBT.

Economic Service Charge

An economic service charge (ESC) will be charged to every person in respect of every part of the relevant turnover of such person. Relevant turnover is defined as the aggregate turnover for the relevant quarter of trade, business, profession or vocation carried on or exercised by such person in Sri Lanka. ESC is charged at a standard rate of 0.25% on the relevant turnover and will apply only if the relevant turnover for a quarter exceeds LKR50m ($360,000).

ESC is similar to an advance payment of income tax (as well as a minimum income tax if income tax is not payable due to an exemption or tax loss) and can be set off against income tax and any excess can be carried forward for four years.

However, ESC will not be charged if the company has a taxable income from trade or business in the prior year of assessment.

Import Taxes

Imports tariffs and taxes in Sri Lanka are based on the valuation of all goods, wares and merchandise imported into Sri Lanka or exported from Sri Lanka.

The following taxes are levied at the point of import/export: Customs duty, excise duty, VAT, port and airport development levy, NBT, special commodity levy, and the cess levy.

Land Lease Tax

The Land (Restrictions on Alienation) Act No. 38 of 2014 has imposed a prohibition on the following categories of persons on the transfer of title of land in Sri Lanka: a foreign individual; a foreign company; or a company incorporated in Sri Lanka where any foreign shareholding, either directly or indirectly, is 50% or above. In addition to the restriction on transfer of land, a land lease tax was levied on any foreign individual, foreign company; or a company incorporated in Sri Lanka where any foreign shareholding, either directly or indirectly is 50% or above.

The standard rate of the land lease tax is 15% on the total rent payable for the entire duration of the lease. This tax was to be paid upfront at the point of entering into the lease agreement by the lessee. A concessionary rate of 7.5% is also afforded in certain circumstances.

Pursuant to a proposal announced in the government’s budget for 2016, this tax was expected to be removed effective from January 1, 2016.

Stamp Duty

Stamp duty is charged at the rates specified by the minister of finance by order published in the gazette on every specified instrument executed, drawn or presented in Sri Lanka. Different rates may be determined in respect of different classes or categories of instruments. Specified instruments are identified in the act and include the following: a policy of insurance; a bond or mortgage for any definite and certain sum of money affecting any property; a promissory note; a lease or hire of any property; and a receipt or discharge given for any money or other property.

Telecoms Levy

The telecommunications levy is a consumption tax charged and levied from every person receiving any telecommunications service. The levy is collected at the rate of 25% on the value of the supply of telecommunications services provided by the operator. The levy is collected by the operators licensed under section 17 of the Sri Lanka Telecommunications Act.

Betting & Gaming Levy

A betting and gaming levy is levied upon a person who carries on the business of a bookmaker or the business of gaming. A person who is carrying on the business of a bookmaker or business of gaming within Sri Lanka, either lawfully or unlawfully, is chargeable to tax at the respective rates specified in the act.

If the business is carried on in different places by the same person, he is required to pay the levy for each individual place.

Incentives

The Board of Investment of Sri Lanka (BOI) is the state agency which facilitates foreign direct investment into Sri Lanka.

The BOI grants approval for projects under two sections in the BOI Law No. 4 of 1978, namely section 16 and section 17.

The approval under section 16 is granted for foreign investments which are permitted without any fiscal concessions. These projects are governed under the normal laws of the country and are subject to Inland Revenue laws, Customs laws and exchange control regulations.

Under section 17 the BOI is empowered to approve projects and enter into agreements with enterprises and grant exemptions from laws such as Inland Revenue, exchange control and Customs, subject to fulfilling the minimum investment criteria and other specified requirements.

Standards

The Sri Lanka Accounting and Auditing Standards Act No. 15 of 1995 authorises the Institute of Chartered Accountants of Sri Lanka to issue Sri Lanka accounting standards and requires specified business enterprises to prepare and present their financial statements in compliance with Sri Lanka accounting standards.

Sri Lanka accounting standards comprise accounting standards prefixed both SLFRS and LKAS. SLFRS refers to Sri Lanka Accounting Standards corresponding to international financial reporting standards, and LKAS are Sri Lanka Accounting Standards corresponding to international accounting standards. Sri Lanka accounting standards are commonly referred to as SLFRSs.

In addition Sri Lanka has also adopted all International Financial Reporting Interpretations Committee and Standard Interpretations Committee pronouncements, issued by the International Accounting Standards Board.

Sri Lanka accounting standards further comprise of statements of recommended practices, statement of alternate treatment and financial reporting guidelines, which are issued by the Institute of Chartered Accountants of Sri Lanka.