Tax rules for companies and individuals in Sri Lanka

This chapter outlines the framework of tax obligations for corporations and individuals in Sri Lanka. The Companies Act, No. 7 of 2007 provides for the registration of three forms of business organisations in Sri Lanka: an incorporated company; a branch office of an overseas company; and an offshore company.

Incorporated Company 

A company may be incorporated under the act as one of the following:

• Limited Company, wherein the holders of the shares in such company have to contribute to the assets of the company, as specified in the company’s articles.

• Unlimited Company, wherein the holders of shares in such company have an unlimited liability to contribute to the assets of the company.

• Company Limited by Guarantee, wherein the company does not issue shares and the members undertake to contribute to the assets of the company in the event of liquidation. This form generally applies to a business formed for promoting commerce, art, religion, charity, sport or any other useful object, and applies its profits in promoting its aims.

Private Company

A limited company can be incorporated as a private company, which is characterised by the following features:

• A prohibition on offering shares or other securities to the public.

• Limitation of the number of its shareholders to 50, including shareholders who are either employees of the company or former employees who became shareholders while being employed by the company and continued to be the shareholders after cessation of employment with the company.

Overseas Company (Branch Office)

An overseas company can establish a “place of business” within Sri Lanka, commonly referred to as a branch office. Registration of a branch office requires the following documents to be filed with the relevant authorities:

• Certified copy of the charter/statute or memorandum and articles of the overseas company;

• List of directors of the company; and

• Power of Attorney, authenticated by the company’s seal, authorising a person or persons resident in Sri Lanka to act on behalf of the said company. An overseas company registered under the Companies Act, No. 7 of 2007, may carry out any commercial, trading or industrial activity, other than certain specified activities, provided that prior permission has been obtained from the government of Sri Lanka or any other authority, such as the Board of Investment of Sri Lanka established to grant approval for foreign investments for the proposed activities.

Additionally, overseas companies may undertake any non-commercial, non-trading or non-industrial activity, such as those undertaken or carried out by a liaison office, representative office, regional office or other similar office, provided such activities do not provide any income – directly or indirectly – to the company.

Foreign Exchange Regulations 

The regulations applicable to branch offices are as follows:

• In the case of a “place of business”, such as a branch office, project office or similar office, invest a minimum of $200,000 or equivalent in other designated foreign currencies, out of remittances received from abroad and channelled through an inward investment account (IIA) opened with a licensed commercial bank in Sri Lanka to the credit of an account of the overseas company, and provide evidence of said remittance to the Department of Registrar of Companies, within 30 days of the registration.

• In case of a “place of a business”, such as a liaison office, representative office or similar office, remit the funds required for the setting up and maintenance of such place of business through an IIA, opened with a licensed commercial bank in Sri Lanka to the credit of an account of the overseas company. FILING: Every registered overseas company is required to prepare and file annual financial statements as if it were a company defined under the Companies Act.

Offshore Company 

The Companies Act, No. 7 of 2007 also makes provision for registration of an offshore company, wherein a company incorporated under the laws of any foreign country would, upon application to the Register General of Companies, be deemed to be incorporated in Sri Lanka, as if it has been incorporated under the Companies Act.

A foreign company may, accordingly, register itself as an offshore company if it intends to establish a presence in Sri Lanka for carrying on business outside Sri Lanka. For this purpose, a value-added operation carried on in Sri Lanka for overseas customers would be regarded as carrying on business outside the shores of Sri Lanka, provided there is no income arising in, or derived from, Sri Lanka.

Tax Registration 

Any company, whether an incorporated company or branch office, should apply to, and obtain from, the Inland Revenue Department (IRD), a Taxpayer Identification Number (TIN) upon commencement of business activities in Sri Lanka.

Corporate Income Tax 

The analysis that follows, is based on the provisions of the Inland Revenue Act, No. 24 of 2017 (IRA 24 of 2017), which will come into force on April 1, 2018.

Tax Residence 

IRA 24 of 2017 has specific rules on tax residence for corporates. A company is considered to be a Sri Lanka tax resident for a year of assessment (i.e., the period of 12 months commencing on April 1 of one calendar and ending on March 31 of the immediately succeeding calendar year) if:

• It is incorporated or formed under laws of Sri Lanka;

• It has its registered or principal office in Sri Lanka; or

• At any time during the year, the management and control of its affairs are exercised in Sri Lanka. A company that is not a resident of Sri Lanka is deemed a non-resident company.

The tax residence of companies in Sri Lanka is largely determined on the basis of its place of incorporation. The term “management and control” is not defined in the IRA 24 of 2017 and, therefore, location of management and control would be a question of fact to be determined in the light of all the relevant facts and circumstances. It is generally considered to be the place where corporate decision-making at the highest levels occurs, and is broadly similar to the double-tax treaty concept of “effective management”.

General Rules of Company Taxation 

The following apply to tax-resident companies:

• A company shall be liable to tax separately from its shareholders.

• All business activities of a company shall be treated as conducted in the course of a single company.

• Dividends distributed by a resident company shall be taxed in hands of the company’s shareholders, while those of a non-resident company shall be included in calculating the income of the shareholders.

• Gains on disposal of shares in the company shall be included in the income of the shareholder.

• A non-resident company shall pay remittance tax on the profits earned and remitted within the year of assessment. (“Remitted profits” means the amount remitted or retained abroad out of the profits and income of the non-resident company subject to income in Sri Lanka, and any amount received outside Sri Lanka by conducting business in Sri Lanka, excluding dividends paid by a resident company to the non-resident company.) TAXABLE BASIS: Taxable basis with respect to a company is determined for each year of assessment on the assessable income from business, investment and other sources:

• In the case of a resident (company), wherever the source arises; and

• In the case of a non-resident company to the extent that the income arises in, or derived from, a source in Sri Lanka. Business includes a trade, profession, vocation or isolated transaction with a business character however short the duration of the arrangement. A past, present or prospective business and also includes:

• Gains from the realisation of capital assets;

• Amounts derived on realisation of depreciable assets of a business;

• Gifts received in respect of the business. Investment income includes dividends, interest, discounts, charges annuities natural resource payments, rents, premium and royalties, and also includes:

• Gains from realisation of investment assets;

• Winnings from lotteries, betting and gambling; and

• Gifts received in respect of the investment. Other sources constitute a person’s gains and profits from any source for the year of assessment, excluding profits of a casual or non-recurring nature.

Section 73 of IRA No 24 of 2017 provides a detailed list of payments that have a source in Sri Lanka.

Calculating the Tax Base 

The basis for corporate income tax is the taxable income earned from the business or investment activities of a company, which shall be the net income. This is derived from the following formula: The total income from all sources – with income from each source determined separately – less qualifying payments and costs and expenses (other than expenses of a capital nature) to the extent:

• They are incurred during the year of assessment; and

• Related to the production of income from such sources. Additionally, in the case of calculating the income of a business, deducting therefrom:

• Any unrelieved loss of the company from any other business; and

• Any unrelieved loss of the company for any of the six preceding years of assessment from the business or any other business. Furthermore, in the case of calculating income from investment, deducting therefrom:

• Any unrelieved losses from such investment; and

• Unrelieved losses from business income deductions. Finally, deducting any depreciation allowances that apply to the company, by applying the depreciation rates provided in the IRA 24 of 2017 to the cost of the fixed assets acquired and used in the business.

Depreciation allowance: An annual allowance for depreciation for wear and tear of fixed assets is deductible, by applying to the cost of the fixed assets depreciation rates provided in the IRA 24 of 2017.

Additionally, a person, who invests in Sri Lanka (other than in the expansion of an existing business) during a year of assessment shall be granted enhanced depreciation allowances, in addition to the aforesaid standard depreciation allowances. The standard rates, based on the serviceable life of the assets, and the schedule of enhanced rates are shown in the table on this page.

Thin capitalisation rules: Thin capitalisation rules provide that, in deducting financial costs on payment of interest to calculate income, the excess of a debtor company’s interest over the specified ratio of debt to capital and reserves will be disallowed in calculating debtor company’s profits and income.

For manufacturing companies the debt-to-equity ratio is 3:1. For all others it is 4:1. Any disallowed interest amount may be carried forward and treated as incurred in any of the succeeding six years of assessment, subject to the aforesaid limitation. Reserves exclude those arising from a revaluation of assets.

Interest expense: Interest expense incurred on a debt obligation shall be deductible in calculating a company’s profits and income to the extent that borrowed money is used during the given year or was used to acquire an asset that is used during the year in the production of income. In any other case, the expense is deductible if the debt obligation was incurred in the production of income.

Allowance for trading stocks: In calculating business income, an allowance for trading stock shall be deducted. The deduction is calculated as the opening value of the trading stock of the business for the year, plus expenses incurred during the year that are included in the cost of the trading stock, less the closing value of trading stock.

Repair & improvements: Expenses for the repair or improvement of depreciable assets shall be deducted, irrespective of whether they are of a capital nature, but subject to the following limitations:

• In case of repair or improvement to a depreciable asset realised before the end of the year of assessment not exceeding 5% of the written down value at the end of the said year of assessment.

• In all other cases 20% of the written down value of the asset at the end of the year of assessment.

R&D and agricultural start-up expenses: Research and development and agricultural start-up expenses may be deducted, irrespective of whether they are of a capital nature.

Qualifying payments relief (QPR): QPR is available as a deduction in arriving at the taxable income of a company for donations to:

• Government and local authorities;

• Higher educational institutions;

• Specified funds, established by the government, provincial councils and local authorities; and

• Approved charitable institutions, which have been established for provision of institutionalised care for the sick and needy.

Foreign Tax Credit 

Foreign tax credit may be claimed by a resident person (company) on any tax paid outside Sri Lanka in respect of profits and income arising outside of the country. Such credit should not exceed the amount of Sri Lanka tax payable in respect of such profits or income.

Tax Rates for Companies 

For any year of assessment, commencing on or after April 1, 2018 a three-tier rate schedule applies as follows: 1. Standard rate of 28% on the taxable income, other than gains from the realisation of investment assets which is taxed at 10%. 2. Lower rate of 14% is applied in the case of following:

• Small and medium-sized enterprises;

• Company predominantly conducting a business of exporting goods and services;

• Company predominantly conducting an agricultural business;

• Company predominantly providing educational services;

• Company predominantly engaged in an undertaking for the promotion of tourism; or

• Company predominantly providing IT. 3. Higher rate of 40% applies in the case of a company with income from a business consisting of betting and gaming, liquor and/or tobacco. Transitional rates: Gains and profits for three years of assessment will be taxed at 14% in respect of an insurer conducting the business of life insurance, or any person who has entered into a power purchase agreement with the Ceylon Electricity Board to provide electricity using renewable energy. Furthermore, a 0% rate will be applied in respect of an institution in an international network relocating its headquarters or regional head office in Sri Lanka, as specified by Commissioner General of Inland Revenue, by gazette notice.

Withholding Tax Rates 

Any person (company), making a payment of income, shall pay a withholding tax at the prescribed rates, listed below, at the time of such payment, and the amount so withheld should be remitted to the IRD within 15 days after the end of the calendar month in which the tax has been withheld. Withholding tax rate schedule:

• Withholding tax on interest (i.e., interest or discount paid by banks and financial institutions): ◊ To a resident person (except senior citizens): 5%; ◊ All other cases, including a non-resident person: 14%; ◊ Withholding tax deducted from interest paid to a resident individual, or a charitable institution is a final tax.

• Dividends paid by a resident company: 14%.

• Remittance of after-tax profits by non-resident company (remittance tax): 14%.

• Rent ◊ Paid to a resident person: 10%; ◊ All other cases, including a non-resident person: 14%.

• Service fee and contract payments on an amount exceeding LKR50,000 ($326) per month to a resident individual: 5% (no deduction if such payments are chargeable with the Economic Service Charge).

• Royalty premium: 14%.

• Winnings from a lottery, reward, betting and gambling: 14%.

• Service fee or an insurance premium with a source in Sri Lanka to a non-resident person: 14% (no deduction if such payments are chargeable with the Economic Service Charge).

• Partner’s share of any partnership income (withheld by the precedent partner): 8%.

• Sum payable to a seller on sale of gems to the National Gem and Jewellery Authority: 2.5%.

Taxation of Capital Gains 

Capital gains derived by a person (company) will be taxable, effective from April 1, 2018. On change of ownership/realisation of an asset, a capital gain would represent the excess of the consideration received over the cost of the asset, while a capital loss would represent the excess of the cost over the consideration received.

As the gain arises over the whole period of ownership of the asset, the gain is taxed:

• As on the date of realisation/change of ownership of the asset;

• On the appreciation of the asset, reckoned from the base date of September 30, 2017; and

• With relief by way of a lower tax rate of 10%.

Filing Compliance 

Every company chargeable with income tax shall file a return of income not later than eight months from the end of the relevant the year of assessment.

All companies with a taxable income from the realisation of an investment asset should file a capital gains tax return no later than one month after the realisation of that asset.

Every return of income or capital gains filed should include a self-assessment of tax.

Payment Compliance 

A person, who pays income tax by quarterly instalments is required to pay such instalments according to the following schedules. For a person who makes of accounts to 31 March:

• First instalment: on or before August 15 in the year of assessment;

• Second instalment: on or before November 15 in the year of assessment;

• Third instalment: on or before February 15 in that year of assessment; and

• Fourth instalment: on or before May 15 of the next succeeding year of assessment. For a person who has obtained approval from the Commissioner General to makeup accounts to 31 December the schedule is:

• First instalment: on or before April 15 in the year of assessment;

• Second instalment: on or before July 15 in the year of assessment;

• Third instalment: on or before October 15 in that year of assessment; and

• Fourth instalment: on or before January 15 of the next succeeding year of assessment. The tax payable at each instalment is calculated using the formula outlined at the bottom of the next page.

Personal Income Tax 

The following outlines the framework for personal income tax in Sri Lanka.

Tax Residence 

According to IRA 24 of 2017, both resident and non-resident individuals are liable to pay taxes in Sri Lanka. An individual shall be deemed a resident in Sri Lanka for a year of assessment, if s/he is:

• A resident in Sri Lanka;

• Present in Sri Lanka for a period or multiple periods aggregating to 183 days or more in any 12 months;

• Is an employee or official of the Sri Lanka government, and his/her spouse is engaged in overseas service during that year;

• Is employed on a Sri Lanka ship within the meaning of the Merchant Shipping Act. The term “resides in”, refers to a person who has a “domicile in”. A person who is not a resident of Sri Lanka is deemed a non-resident for tax purposes.

Taxable Basis

Resident individuals are taxed on their worldwide incomes while non-resident individuals are taxed only on Sri Lanka-source income.

The income sources on which individual taxation is based are grouped in the following four categories:

• Employment;

• Business;

• Investment; and

• Other sources.

Employment

Payment in respect of employment shall have a source in Sri Lanka if it is:

• Derived in respect of employment in Sri Lanka, wherever paid; or

• Paid by, or on behalf of, the government of Sri Lanka, wherever the employment is based. Individual employment income: An individual’s income from employment includes:

• Wages, salary, annual leave pay, overtime pay, pension, commission, gratuity, bonus and other payments of a similar nature that have received in return for services;

• Allowances such as cost of living, subsistence, rent, entertainment or travel allowance;

• Payments providing discharge or reimbursement of expenses incurred by the individual or an associate of an individual;

• Retirement contributions on behalf of an employee and retirement payments received in respect of employment;

• Fair market value of benefits and other payments, including gifts received in respect of employment; and

• Market value of shares at the time allotted under an employee share scheme, including shares allotted upon exercise of an option under an employee share scheme, reduced by employee’s contribution for the shares. Income from employment excludes:

• Reimbursement of expenses incurred on behalf of the employer;

• Reimbursement of medical, dental or health insurance expenses, where the benefit is available to all full-time employees on equal terms;

• Value of a right or option to acquire shares at the time granted to an employee under an employee share schemes; and

• Contribution made by an employer to an employee’s account with a pension, provident or savings fund, approved by the Commissioner General of Inland Revenue. Sri Lanka-sourced employment income will constitute total remuneration paid to the employee concerned in relation to services rendered in Sri Lanka, irrespective of wherever paid – whether in Sri Lanka or outside – and in whatever currency. If some portion of the remuneration is paid in the home country of an expatriate employee in relation to services rendered in Sri Lanka, that component too forms part of the taxable remuneration liable to Sri Lanka income tax. Business income: See the definition given under corporate income tax. Investment income: See the definition under corporate income tax. Other sources: These constitute a person’s gains or losses from any source whatsoever for the year of assessment, excluding profits of a casual or non-recurring nature.

Calculation of Tax Base 

undefined Employment: Gross taxable income from employment is calculated as the aggregate of the all the income sources enumerated in the preceding section. Income of a person from employment that has a source in Sri Lanka should be calculated separately from income from that employment which has a foreign source. A person’s income from foreign employment should be Instalment of tax payable is calculated using the following formula: Current estimated tax payable for the year Tax paid by previous instalments and any withholding tax deducted Remaining number of instalments including current instalment calculated as that person’s worldwide income from that employment, less any in Sri Lanka source income from that employment.

Ordinary wage and salary income is taxable in relation to the period (month) during which the service was provided. Retirement income is taxable as at the date of termination of employment. Bonus income is taxable as at the date of receipt of said payment.

No deductions are allowed for medical or travelling expenses or payment of insurance costs in determining employment income subject to tax.

Business & Investment

Refer to the calculation of tax base under the corporate income tax section.

Qualifying Payments & Relief 

No qualifying payment relief is granted in calculating taxable income from employment. However, qualifying payment relief is allowable in arriving at the taxable income of an individual (other than an employee) in relation to donations made to:

• Government and local authorities;

• Higher education institutions including Buddhist and Pali University;

• Funds established by the government, provincial councils and local authorities; and

• Sevena Fund, Api Wenuwen Api Fund, National Kidney Fund.

Tax Reliefs 

A tax-free allowance (threshold) of LKR500,000 ($3260) is granted to a resident individual or citizen of Sri Lanka for each year of assessment. However, this allowance cannot be claimed in respect of gains from realisation of an investment asset.

A number of other tax reliefs are also available for specific groups and on specific types of income as outlined in the following list:

• Additional relief of LKR700,000 ($4570) – on top of the tax-free allowance of LKR500,000 ($3260) – is granted to an employee, up to but not exceeding the total of his/her employment income for the year of assessment.

• An amount equal to 25% of rental income, being a relief for the repair, maintenance and depreciation, is granted to an individual.

• Senior citizens are entitled to a relief of LKR1.5m ($9790) on interest income derived.

• Resident individuals or partners of a partnership with income earned in foreign currency from rendering any service in or outside Sri Lanka to be utilised outside Sri Lanka is entitled to relief not exceeding LKR15m ($97,900), up to the total of such income for a year of assessment. Non-resident individuals are subject to pay taxes only on income earned in Sri Lanka.

Foreign Tax Credit 

Foreign tax credit may be claimed by a professional or other individual in respect of any tax paid outside Sri Lanka on profits and income earned outside Sri Lanka. The tax credit should not exceed the amount of Sri Lanka tax otherwise payable on such profits and income.

Tax Rates for Individuals 

A progressive rate structure applies with respect to taxation of an individual. For any year of assessment commencing on or OBG would like to thank PwC for its contribution to THE REPORT Sri Lanka 2018 after April 1, 2018, tax will be applied at the following rates for taxable income:

• On the first LKR600,000 ($3920): 4%;

• On the next LKR600,000 ($3920): 8%;

• On the next LKR600,000 ($3920): 12%;

• On the next LKR600,000 ($3920): 16%;

• On the next LKR600,000 ($3920): 20%; and

• On the balance: 24%. The following exceptions apply:

• Gains from the realisation of investment assets: 10%.

• Income from a business consisting of betting and gaming, liquor and/or tobacco: 40%. The rate for the deduction of tax from an employee’s termination benefits where the period of contribution is 20 years or less will be as follows:

• On the first LKR2m ($13,100): Nil;

• On the next LKR1m ($6530): 5%; and

• On the balance: 10%. Where the period of contribution is more than 20 years, the rate of tax will be:

• On the first LKR5m ($32,650): Nil;

• On the next LKR1m ($6530): 5%; and

• On the balance: 10%.

Withholding Tax & Capital Gains 

The withholding tax rate schedule, as given in respect corporates (outlined under Corporate Income Tax) also applies to individuals. For for capital gains tax, please see the Corporate Income Tax section.

Pay-as-you-earn (Paye) Tax Scheme

Under the PAYE tax scheme, all employers are statutorily required to withhold monthly the income tax due from the total taxable remuneration of each employee at the time of payment of such remuneration, and pay over the tax so deducted to the account of the Commissioner General of Inland Revenue on or before the 15th day of the immediately succeeding month.

The tax deducted on the employment income of an employee is a final tax, and no further tax on such income is payable. Furthermore, an employee whose tax has been deducted under the PAYE tax scheme is not required to file an annual return of income, unless s/he has income from other sources.

An employer is required to file an annual declaration detailing the remuneration and the tax withheld in respect of each of employee.

Payment Compliance 

Any individual, other than an employee, is required to pay tax on his/her income on a self-assessment basis in quarterly instalments. The instalment payment schedule is the same as that outlined in the corporate income tax section.

Filing Compliance 

Every individual chargeable with income tax shall furnish a return of income for each year of assessment no later than eight months from the end of the year of assessment. The Commissioner General may, upon an application, grant an extension of the time limit specified for filing a tax return, but such extension does not obviate the requirement to pay the taxes on the scheduled dates.