Updates to the reformed Inland Revenue Act and Foreign Exchange Act in Sri Lanka

Following on from 2016 – which saw a number of important legislative reforms – 2017 was another particularly significant year in which several changes were legislated or initiated by Parliament. The two major developments in the legal landscape enacted by Parliament were the passage of the Inland Revenue Act and the Foreign Exchange Act.

Mangala Samaraweera, the minister of finance, initially proposed the introduction of a new Inland Revenue Act in the 2016 budget speech. Consequently, a new act was passed by Parliament on the September 7, 2017. The bill was then certified by the speaker on October 24, 2017.

Implementation 

In terms of the Inland Revenue Act, its provisions will be effective from the year of assessment – commencing April 1, 2018 – and it repeals the Inland Revenue Act No. 10 of 2006 (as amended), from that date. Notwithstanding such repeal, Section 203(2) of the new act provides that the Inland Revenue Act No. 10 of 2006, (as amended), will continue to apply with respect to events that have occurred prior to the date of commencement of the new Inland Revenue Act. Beginning April 1, 2018, the new act takes effect and overrides the provisions of the 2006 law.

William Foster, vice-president of the Sovereign Risk Group of international global ratings agency Moody’s Investors Service, told local press on September 12, 2017 that, “Sri Lanka’s newly revised Inland Revenue Act will augment the country’s extremely low level of government revenue by replacing the existing law with a more efficient, modern and broad-based tax framework.”

Local press reported that while presenting the bill in Parliament, Samaraweera said the Inland Revenue Act was set to result in a reduction of the rate of indirect taxes from 80% to 60% and was set to result in an increase in the rate of direct taxes from 20% to 40% to account for the indirect tax reduction.

Inland Revenue Act Changes 

The primary changes to Act No. 10 of 2006 effected by the updated Inland Revenue Act No. 24 of 2017, are summarised as follows:

• The various categories of income have been condensed and re-classified under four headings: employment, business, investment and other.

• Capital gains tax will be levied on gains arising from the realisation of certain assets and liabilities in certain circumstances. The rate of taxation is 10%.

• The rate of tax applicable to dividends and certain interest has been increased from 10% to 14%.

• Employment income has been removed and employment income will be taxed under progressive rates of multiples of 4% for each progressive slab of LKR600,000 ($3920) up to a maximum rate of 24%.

• In calculating the taxable income of a resident individual or entity, the aggregate of certain reliefs specified in the Fifth Schedule of the act must be deducted; these include LKR500,000 ($3260) and in the case of a person with employment income, LKR700,000 ($4570). Qualifying payment relief was previously extended to non-citizen, non-resident employees, but the concession will no longer apply to this class of employees.

• Capital allowance rates have been revised. Enhanced depreciation has been provided for certain investments in addition to the standard depreciation allowance.

• The new act restricts the utilisation of losses.

• Detailed provisions in regard to transfer pricing have been introduced.

• The scope of withholding tax has been expanded, and tax rates have been revised. Notably, service payments will be liable to withholding tax.

• Definitions have been provided for the terms “royalty” and “service fees”.

• The concept of “permanent establishment” has been introduced to ascertain the business income of a non-resident.

• Exemptions have been reduced and many institutional exemptions have been withdrawn.

• The time bar provision for the raising of assessments will be four years other than in certain cases.

• Provision has been introduced in regard to public rulings and the making of applications for private rulings.

Foreign Exchange Act 

The other significant act that was introduced in 2017 is the Foreign Exchange Act No. 12 of 2017, which was certified on July 28, 2017. The government considers this act to be a key part of its efforts to transform the economy and reduce regulatory controls.

Regarding the changes, in mid-2017 Eran Wickramaratne, the state minister of finance, stated at an economic summit held by the Ceylon Chamber of Commerce that the ministry is doing away with the Exchange Control Act. “It is a conceptual move away from controlled exchange management, from the government thinking it is the owner of hard-earned foreign exchange of exporters to exporters being the owner,” Wickramaratne said regarding the change. “The new law has removed criminalisation of violations of the Exchange Control Act and associated prison sentences. Those with pending cases and violations can regularise them by remitting and paying a penalty. Even that penalty is not applicable if remittances are to government securities.”

On November 17, 2017 three sets of regulations made under Section 29, read with Section 7 of the Exchange Control Act, were published in the Government Gazette and came into operation on November 20, 2017, which was also the date on which the Foreign Exchange Act came into effect.

The “Capital Transactions in Foreign Exchange Carried on by Authorised Dealers” sets out the classes of capital transactions which are permissible under the following conditions:

• Capital transactions undertaken outside of Sri Lanka by a person resident of Sri Lanka subject to such limits, terms and conditions specified in Schedule I to the regulations;

• Capital transactions undertaken in Sri Lanka by a person resident outside Sri Lanka subject to such limits, terms and condition specified in Schedule II to the regulations;

• Capital transactions undertaken under any approval (general or special) granted under the provisions of the repealed Exchange Control Act, subject to such limits, terms and conditions specified in Schedule III to the regulations; and

• Other capital transactions specified in Schedule IV to the regulations shall be carried on by licensed commercial banks as authorised dealers and licensed specialised banks deemed to have been authorised to deal in foreign exchange under Section 4(1)(d) of the act and licensed specialised banks which may be authorised by the central bank to deal in foreign exchange under Section 4(1)(c) of the act, as authorised dealers, subject to such limits, terms and condition as specified in Schedule IV.

Foreign Exchange Actors 

The “Opening and Maintenance of Accounts for the Purpose of Engaging in Capital Transactions” recognises the following persons as having the authority to open and maintain foreign-exchange accounts or Sri Lanka rupee accounts, in the name of any person to deal in any capital transactions:

• Any licensed commercial bank as an authorised dealer;

• Any licensed specialised bank which is deemed to have been authorised by the central bank under Section 4(1)(d) of the act to deal in foreign exchange for the purposes specified in such authorisation; and

• Any licensed specialised bank as may be authorised by the central bank under Section 4(1)(c) of the act to deal in foreign exchange for the purposes specified in such authorisation.

Redesignation 

The updated foreign-exchange regulations required redesignation of the following by January 1, 2018:

• All existing securities investment accounts and special foreign investment deposit accounts opened and maintained in foreign currencies and in Sri Lanka rupees under the provisions of the repealed Exchange Control Act, as inward investment accounts; and

• All existing non-resident rupee accounts, nonresident blocked accounts and migrant blocked accounts as capital transactions rupee accounts.

Allowed Accounts 

The “Opening and Maintenance of Foreign Exchange Accounts” allows the following types of accounts to be opened and maintained by an authorised dealer or a restricted dealer:

• Personal foreign currency accounts;

• Business foreign currency accounts; or

• Any other category of accounts that may be permitted to be maintained in terms of the directions issued by the central bank from time to time.

Authorised Dealers 

The regulations also provide that all authorised dealers and restricted dealers must redesignate the following by April 1, 2018:

• All existing non-resident foreign currency accounts, resident foreign currency accounts, resident non-nationals’ foreign currency accounts and non-resident, non-national foreign currency accounts opened and maintained under the provisions of the repealed Exchange Control Act (Chapter 423), as personal foreign currency accounts; and

• All existing foreign exchange earners’ accounts, inward remittance distribution accounts and foreign currency account for agents of foreign shipping lines or airlines as business foreign currency accounts.

Labour Unions 

The year 2017 was also significant for the working people of the country. Sri Lankan trade unions have been bracing for a fresh struggle with the government over moves that have been occurring since mid-2015 to prepare labour law reforms, claiming that the workers and their representatives as stakeholders need to be more involved in these discussions.

According to local press reports in September 2017, representatives of the Ceylon Federation of Labour (CFL) said that the federation was concerned with what it called “the government’s indecent haste” to bring about the labour market reforms desired by US Agency for International Development (USAID) and the Ministry of Development Strategies and International Trade.

In the statement issued in September 2017 the CFL took up the position that the Working Committee the Ministry of Development Strategies had established to propose labour market reform “lacks legitimacy and credibility, as it has not received endorsement of the unions and includes only those acceptable to the government”. The statement from the CFL reportedly further stated: “We insist that the decisions the government has taken to go along with the USAID project to reform the labour market should not proceed without a proper and constructive engagement with the people, more especially the working people, in the country. It needs to be a transparent process and the public made aware through the media both electronic and print. Pursuing any other course would be fraught with disappointing consequences.”

The Ceylon Mercantile, Industrial and General Workers Union (CMU) reportedly stated that the government, led by the Department of Labour, was attempting to curtail certain standards in terms of workers’ rights protected under law. Furthermore, it stated, this was being carried out in a manner prejudicial to the welfare of workers.

According to local press, Bala Tampoe, the secretary-general of the CMU, said that the proposed overarching changes included 42 days’ leave and cost of living, among others. Furthermore, in the event someone is fired from their job, and that person believes that this was done on wrongful terms, he or she can institute proceedings before a Labour Tribunal to seek reinstatement and compensation for unjust termination. According to Tampoe, a proposed alternative to this system is one in which employees are not reinstated, but rather only compensated, when this occurs.

The Ministry of Development Strategies and International Trade has, however, argued that certain existing labour laws, some of which originate from the colonial or early post-independence period, are archaic and therefore must be reformed, with a focus on attracting foreign investments from international investors who are considering establishing operations in Sri Lanka, but who are deterred from doing so due to the present legal regime, and industrial and investment climate.

Capital Market Change 

The year 2017 was also one of significant developments for the legislative and regulatory framework of the Sri Lankan capital markets. The International Organisation of Securities Commissions’ (IOSCO) carried out a country review in June 2017, finding in its report that, “Sri Lanka’s capital market is small, relatively illiquid and somewhat unsophisticated.”

The report stated that Sri Lanka’s market capitalisation and the value of market turnover have fluctuated between 25% and 30% of GDP in recent years, which is significantly less than other jurisdictions in the region. It further noted that the key to building deep and liquid capital markets is establishing investor trust and confidence in those markets, which remains a challenge for the country.

With the objective of building investor trust and confidence, the Securities and Exchange Commission (SEC) Bill was tabled in Parliament on December 6, 2017. According to a statement of approved Cabinet decisions, which was issued in March 2018, the SEC Bill is anticipated to strengthen the independence of the commission with the implementation of a stringent governance structure.

According to the statement, the concept paper was created based largely on the examples of laws and experiences in neighbouring regional countries such as Malaysia, Singapore and Hong Kong. The bill provides a framework for the SEC’s powers, duties and functions of the chairperson and staff; market and market institutions; the establishment, operation and regulation of exchanges, clearing houses, central depositories; the issue and trading of listed and unlisted securities; the protection of clients’ assets; and the recognition and regulation of market intermediaries.

The bill also widely defines market misconduct and insider trading, lists prohibited conduct, provides funding for the commission and for the allocation of compensation to investors, and outlines provisions relating to the institutional framework and enforcement mechanism. Another important feature of the new SEC Bill is the vesting of powers in the state to initiate civil action against alleged capital market offenders.

Anti-dumping & Countervailing Duties 

This act provides for the investigation and imposition of anti-dumping duties, countervailing duties and safeguard measures with regard to products imported into Sri Lanka. It is a fundamental component of the government’s new trade policy.

Code of Best Practice 

The Code of Best Practice on Corporate Governance 2017 was released by the Institute of Chartered Accountants of Sri Lanka on December 13, 2017. Since its last update in 2013, several key changes have been made to the code, including guidance in regard to board composition, board meetings, the role of the board, audit committee and corporate reporting.

The SEC, on the recommendation of the Colombo Stock Exchange (CSE), directed the implementation of a risk-based capital adequacy requirement of 1.2 times the risk requirement for stockbrokers subject to a minimum liquid capital requirement of LKR35m ($229,000). The Capital Adequacy Requirement Rules are applicable to all stockbroker firms excluding those licensed to deal only in debt securities, having taken effect beginning March 1, 2017.

According to a statement issued by the SEC, “The current rules on minimum net capital applicable to stockbroker firms do not address the different risks these firms are exposed to. In the light of the foregoing limitations of the present rules and in keeping with international standards a dire need to establish a risk-based capital adequacy requirement was felt. Having considered the capitalisation of stockbroker firms, their current activities and capital adequacy requirement regimes implemented in regional markets, the CSE together with the SEC developed the methodology for the rules.”

New CSE Rules 

In August 2017, having deliberated on the adequacy of the current listing rules of the CSE relating to the enforcement procedures applicable to listed public companies, the SEC decided to adopt a more stringent policy of enforcement of listing requirements.

The directive, among other things, directs the CSE to incorporate the new rules and enforcement procedures drafted into the listing rules. These will be in relation to:

• Violations of rules on corporate governance by listed public companies;

• Late submission or non-submission of interim financial statements by listed public companies;

• Late submission or non-submission of annual reports by listed public companies;

• Incidence of modified audit opinions in the audited financial statements of listed public companies; and

• Incidence of emphasis on matters of ongoing concern in the audited financial statements of listed public companies. The CSE was also directed to put enforcement procedures into effect from January 2018.

Public-private Partnerships

Yet another important initiative undertaken by the government is the establishment of the Public-Private Partnership (PPP) Agency within the Ministry of Finance. This initiative was timely since funding available from the Consolidated Fund and the capacity of the public sector to implement the increasing number of infrastructure projects is limited. The government is therefore exploring other avenues of obtaining of funds while ensuring an efficient infrastructure service delivery and maximising value for money. PPPs are currently considered to be a positive means to achieve development.

The government has determined that facilitation and encouragement of PPPs is a way to enhance the provision of public services. Both the government and private sector can benefit significantly from PPPs, but development of these projects must be done carefully, and both must work under clear rules to properly allocate the risks, benefits and responsibilities associated with such projects. Existing PPP Law: There is no specific PPP legislation in force. PPPs were and are being implemented pursuant to the 1998 Guidelines on Private Sector Infrastructure Projects Part II under the original procurement guidelines, and the Guidelines on Government Tender Procedure, which were revised in 1997. Although the original 1998 guidelines were replaced by the Government Procurement Guidelines of 2007, they remain unpublished and have no force and effect. Various circulars have since been issued on the 1998 PPP Guidelines Part II, including the guidelines used by line ministries and/or government agencies when dealing with unsolicited or standalone development proposals. One important Circular (Supplement 23 issued in 2011), which has since been withdrawn, provided very broad conditions under which the PPP projects (Category II) could be awarded without a competitive bid.

At its meeting held on August 9, 2016 the Cabinet of Ministers recommended and the Department of Public Finance – in consultation with the National Procurement Commission of Sri Lanka – decided that when dealing with unsolicited proposals presented by private proponents on their own initiative without tenders being called by the government, such proposals should be dealt with in accordance with the Swiss challenge procurement method, which requires the government agency to publish a request for proposals and invite counter proposals from interested parties on development projects or services. The Swiss challenge procurement method is currently being used in Sri Lanka by all ministries, government departments, public corporations, local authorities, any business or other undertakings vested in the government and companies registered or deemed to be registered under the Companies Act, Law No. 7 of 2007 in which the government, a public corporation or any local authority holds more than 50% of the shares, as set out in the Swiss Challenge Procedure Guidelines.

In January 2017 a Cabinet paper was submitted by the minister of finance along with the minister of development strategies and international trade to set up a PPP Agency within the Ministry of Finance. A unit was established in April 2017 comprising 17 professionals from finance and legal backgrounds.

The current challenge that PPPs are facing is the unavailability of a proper legal and regulatory framework governing PPPs. Due to the lack of a clear and well-defined legal framework, the project-specific PPP contract in Sri Lanka currently serves as the legally binding document for all PPP projects. New proposed framework: The establishment a new and comprehensive PPP framework – including a policy, an act, regulations and guidelines – would be a lengthy task, as approvals would have to be obtained from Parliament.

In its “Report on Sri Lanka’s Current PPP Environment and Recommendations for Future PPP Strategy”, Nathan Associates recommended an action plan, which is composed of short-, medium- and long-term actions. In the short term, the consultant recommends that the government of Sri Lanka create a solid contract in line with international best practices that could stand alone without any PPP legislation, while the PPP Policy and following legislation are being drafted and approved by the Cabinet of Ministers and passed through Parliament.

They further recommend that in the short term, the government should continue to follow the preparation and implementation process set forth in the 1998 PPP Guidelines II. In addition, the authorities should re-establish both the Cabinet Appointed Negotiating Committee (CANC) and a temporary PPP Unit, such as the Bureau of Infrastructure Investment under Board of Investment (BOI), which functioned in the past, or another existing institution. In the longer term the report recommends that these institutions should be formally established in the new PPP guidelines and/or legislation based on international best PPP practices.

In the short to medium term the BOI and active PPP line ministries should be provided with the necessary resources to hire the necessary advisors. The consultants also suggest that in order to meet medium-term needs, the government should create new PPP guidelines within the executive branch or amend the current 1998 guidelines taking into account the recommended PPP Policy.

Lastly, the long-term action plan contains various recommendations – which should also be considered in the short and medium term where possible – that encompass the legal, institutional and financial components of a national PPP framework.

The report recommends that the authorities first develop and approve a clear and comprehensive PPP Policy. Once the policy is in effect the relevant government bodies could begin carrying out additional recommended actions. Such actions include: the development of a national PPP Act, PPP Regulations and PPP Guidelines; the creation of both a National PPP Unit to replace the BOI and a PPP Committee to replace the CANC; and the definition of sources for Project Development and Viability Gap Financing.

Land (Restrictions on Alienation) Act

Undefined Another important reform proposal was contained in the 2018 budget speech, delivered by the minister of finance in Parliament in November 2017. The budget speech for 2018 contains a proposal that the prohibition imposed by the Land (Restrictions OBG would like to thank John Wilson Partners for its contribution to THE REPORT Sri Lanka 2018 on Alienation) Act (the Land Act), which sets out rules on acquisition of land by foreign-controlled companies and prohibits acquisition by foreigners of condominium units below the fourth floor of a building, should be reformed.

It was proposed that listed companies with foreign ownership would be permitted to acquire ownership of land and that foreigners would be permitted to purchase condominiums below the fourth floor of a building. Implementing legislation will have to be passed if such changes in the Land Act are approved before the reforms can come into force.

Employment Visas

Lastly, a complete overhaul of the procedure for obtaining visas and work permits in the country is under consideration. Draft regulations were prepared in 2017, but the time frame for the necessary legislative changes has not yet been announced.

The government has moved towards implementing a complete overhaul of the system for the granting of permission to work to non-nationals. New regulations which provide for employment visas and procedures, including minimum salary levels to qualify, have been drafted. The draft provides that employment visas may be applied for, in respect of:

• Senior management personnel;

• Professionally qualified persons;

• Skilled workers;

• Semi-skilled workers; and

• Temporary workers. A notable feature of the draft regulations is that the prescribed authority may grant the visa if it is satisfied that the proposed employment of the person is in accordance with government policy on the employment of foreign nationals. It remains to be seen what will be explicitly specified as state policy.