Exploring Sri Lanka's legal environment and investment climate

Immigration-related challenges often create a deterring effect for foreign investors and for the activities of foreign-owned businesses in Sri Lanka, which certainly are necessary to integrating the country into global value chains. Obtaining a visa in Sri Lanka is a difficult process involving administrative procedures that vary depending on the sector. Foreign individuals are prohibited by law from engaging in any employment, paid or unpaid, or from engaging in any business or profession without having the relevant visa and work permit.

The Board of Investment (BOI), which previously had a minimum investment requirement of $50,000 to qualify for a BOI-approved investor visa, currently only issues letters of recommendation for a project that has been approved under Section 16 of the BOI Law with a minimum investment threshold of $250,000. BOI approval is only granted to an enterprise, which is defined as a locally incorporated company in which the foreign investor has a share. As a result, the vehicle invariably used by foreign investors when investing in Sri Lanka is that of a private limited liability company.

Companies Act

The Companies Act No. 7 of 2007 – which replaced the Companies Act No. 17 of 1982, which was in most aspects identical to the UK’s Companies Act of 1948 – governs the incorporation and operation of a company in Sri Lanka. The new Companies Act follows certain aspects of Canada’s Corporation Act and New Zealand’s Corporation Act. Since 2007 it is no longer necessary to have a memorandum of association, and the 2007 Companies Act only provides for the incorporation of companies with articles of association, with the previous ultra vires rules having now been abolished. The act also defines articles of association as rules that govern the internal affairs of companies and deal with matters such as the powers of the board of directors and shareholders.

The convening of shareholder meetings is governed by the mandatory provisions of law contained in the 2007 Companies Act as reflected in a firm’s articles of association. The board of directors is empowered to manage or direct the business affairs of a company. Directors owe their primary duties to the firm and are required to act and exercise their powers for a proper purpose and in the best interests of the company as a whole, and not for their personal interest. It is for this reason that directors of public companies, or subsidiaries of public companies, are required to abstain from voting on certain matters that involve the directors or persons connected to the directors.

Even though the board of directors is charged with the responsibility of managing the business affairs of a company, there are certain matters, such as major transactions, that require specific approval from shareholders. Section 185 of the 2007 Companies Act also provides a definition for major transactions. Given that major transactions require shareholders’ approval by way of special resolution, in order to secure absolute control a foreign investor or shareholder should hold at least 75% of the voting shares of a company.

Exchange Control

The Exchange Control Act prohibits the issue or transfer of shares in companies incorporated in Sri Lanka to persons who are non-resident, except with the permission of the Central Bank of Sri Lanka. Since 1994 this general prohibition has been more or less liberalised by a general permission that has been granted for non-resident investment in the equity of companies carrying out economic activities in certain areas of the economy. Additional sectors were opened up to non-resident investment in 2002. The result of this liberalisation has been that non-resident investment of up to 100% is now possible for companies in most areas of the economy. To date certain sectors of the economy remain excluded, restricted, limited or subject to ceilings on non-resident investment.

Tax Incentives

Sri Lanka’s corporate tax rate is, in most cases, 24%. Value-added tax (VAT) is presently levied at a rate of 12.5%. The 2016 budget proposals contained numerous suggestions in regard to taxation, and implementing legislation is awaited. Apart from corporate income tax payable by Sri Lankan-resident companies, other direct taxes, such as stamp duty, are payable on the acquisition of immovable property. There is no capital gains tax except in certain exceptional situations. Indirect taxes include VAT, Customs import, excise and export duties.

Until several years ago, tax incentives and holidays were provided by the BOI to enterprises approved under the terms set out in Section 17 of the BOI Law and in accordance with regulations gazetted under the BOI Law. This provided a guarantee for foreign investors that such concessions could not be amended or altered. Recently, the BOI announced that it would continue to enter into agreements in line with Section 17, pursuant to which concessions will be granted in accordance with the parameters laid down in the 2006 BOI Regulation. This regulation is now under review.

Alternative Model

In place of this mechanism, in recent years the policy of the previous government appears to have been to provide for tax exemptions and incentives each year through amendments to the Inland Revenue Act, which is an act of parliament under and by which direct taxation of profits and income is carried out. There are many holidays and concessions granted under the Inland Revenue Act. It remains to be seen what the statutory effect will be given the proposals contained in the 2016 budget speech by Ravi Karunanayake, the minister of finance in regard to tax breaks by means of amendment to the Inland Revenue Act. This will only be known with certainty once enabling legislation has been enacted.

Typically, such legislation would be enacted by no later than the end of March or around the beginning of April in the year following the one in which the budget speech is delivered. From the perspective of encouraging foreign investment, concessions should be granted by means of an allowance contained in a Section 17 agreement pursuant to regulations under the BOI Law, since this will be perceived by foreign investors as providing a guarantee that tax concessions cannot be unilaterally changed by the government.

Immovable Property

The current legal framework regime that governs the acquisition of freehold and/or leasehold interests in immovable property is extremely discouraging to foreign investment. Two categories of immovable property in Sri Lanka may be distinguished:

• Privately owned land; and
• State-owned land.

Absolute ownership of privately owned land is possible only for Sri Lankan citizens, and leasehold interests are also possible. However, until October 2014, this was not the case. Prior to the enactment of the Land (Restrictions of Alienation) Act, a foreign citizen could only acquire ownership of land in Sri Lanka subject to a payment of a 100% tax on the value of the land. However, the Land Act No. 38 of 2014 now prohibits the transfer of title for any parcel of land in Sri Lanka to a foreigner, a foreign company or to a company with foreign shareholding (direct or indirect) that is 50% or more.

Foreign Ownership

In order to maintain the legal validity of a transfer or land to a company with less than 50% foreign shareholding, the stake of the foreign shareholder(s) must remain less than 50% for a minimum period of 20 consecutive years from the date of transfer. If during the 20-year period the stake of the foreign shareholder(s) exceeds 50% due to a change of ownership in the shares of the company (directly or indirectly) or consequent to the death of a shareholder(s), the transfer of land shall be considered void with effect from the date of the increase in foreign shareholding. If a company is listed on the Colombo Stock Exchange and takes steps to reduce its foreign shareholding to less than 50% within a period of 12 months from the date of the increase in foreign shareholding, or if an unlisted company takes steps to reduce its foreign shareholding to less than 50% within a period of six months from the date of increase, the transfer of land shall be legally valid. Exemptions to the restrictions are provided for the following:

• International, multilateral or bilateral organisations;
• Condominium parcels on or above the fourth floor of a building;
• Any land for which the title was transferred to a foreign investor prior to January 1, 2013;
• Land that is transferred by intestacy, gift or testamentary disposition to the owner’s next of kin, who is a foreigner;
• Land transferred to a dual citizen of Sri Lanka;
• Land transferred to a bank or finance leasing institution at the discretion of relevant government ministers and the Cabinet;
• Certain projects deemed Strategic Development Projects (SDPs) under the Strategic Development Projects Act of 2008, particularly in sectors such as banking, financial services, insurance, maritime, aviation, advanced technology and infrastructure development;
• Diplomatic missions; and
• Relocation of global and regional commercial headquarters.

Land Lease Tax

The leasing of land to a foreigner, to a company with foreign shareholding (direct or indirect) of more than 50% or to a wholly foreign-owned company is still possible, but can only be effected subject to the payment of the land lease tax. The law imposes a maximum tenure for leases that cannot exceed 99 years. The land lease tax imposed is 15% of the total rent payable for the entire duration of the lease. The land lease tax is 7.5% of the total rent payable for the entire duration of the lease in cases where:

• The company has been in active operation in Sri Lanka for a consecutive period of at least 10 years immediately prior to the lease’s date of indenture;
• Land is leased to a subsidiary of a holding company in which the shareholding of the holding company is 50% or more; or
• Foreign shareholding in the holding company is 50% or more, but the company has been active in Sri Lanka for at least 10 consecutive years. In instances where the shareholding of a holding company in the subsidiary falls below 50% the land lease tax shall be 15% for the balance period of the lease with effect from the date of reduction in shareholding. The 7.5% land lease tax rate is also applicable to the following:
• Condominium parcels situated on or above the fourth floor of a building where the period of lease is less than 35 years;
• Condominium parcels situated below the fourth floor of a building where the period of lease is no more than 99 years; and
• Land situated within a licensed zone as declared under the BOI Law, a declared tourist development area, an industrial estate or an area declared by the relevant minister to be an area for which the reduced tax is applicable.

Exemptions are provided for the land lease tax and include the following cases:

• Diplomatic missions;
• Condominium parcels situated on or above the fourth floor of a building where the period of lease is 35 years or more and the lease rental for the full period is paid in foreign currency on or prior to the execution of the relevant indenture of lease;
• Land leased to a dual citizen of Sri Lanka;
• Any land leased to a foreign investor in consequence of a decision of the Cabinet taken prior to January 1, 2013 and involving direct investment of foreign currency; and
• Land situated within a Bonded Area or Free Port.

The minister, with the approval of the cabinet, may exempt foreign entities engaged in banking, financial services, insurance, maritime, aviation, advanced technology or infrastructure development project identified as an SDP. The minister, with cabinet approval, may also exempt any foreign company engaged in international commercial operations where the land is leased to locate or relocate its operations or set up a branch office.

Employment Law

In terms of employment law, while there are some very progressive features related to superannuation and gratuity payments made to employees, the highly protective mesh of employment-related legislation, particularly in regard to termination, can result in a dampening effect on the enthusiasm of foreign investors. Sri Lankan employment law does not permit employers with 15 employees or more to terminate employment on non-disciplinary grounds without obtaining the permission of the relevant commissioner of labour. Employers are therefore often advised to enter into a fixed-term contract, at least initially, if the viability of the project is not known. However, care must be taken not to renew or enter into a new fixed-term contract upon the expiry of the previous contract, as a series of fixed-term contracts may be held by a labour tribunal to amount to a relationship of permanent employment.

Any termination of employment can be challenged by an employee on the grounds that it is unjustified. The Industrial Disputes Act governs industrial disputes and established a system of labour tribunals to hear and adjudicate employment disputes. An employee can seek relief from a labour tribunal in the form of compensation and/ or reinstatement. There are no clear statutory or other guidelines for the award of compensation for loss of employment – though decided cases reported do provide some indications.

Shop & Office Act

The Shop and Office Act regulates the terms and conditions for employment of persons employed in shops and offices, including hours of work, leave entitlement and maternity leave. Maternity benefits are provided for in the Maternity Benefits Ordinance, which is applicable to employees who are not governed by the provisions in regard to maternity leave contained in the Shop and Office Act.

Factories Ordinance

The Factories Ordinance contains separate provisions, and the Wages Board Ordinance provides for the establishment of terms and conditions of employment in various trades in respect of which wages boards have been established and have made decisions.

Employee Funds

The Employees’ Provident Fund (EPF) Act requires the following: payment by every employer covered by the provisions of the act of an amount equivalent to 12% of the employee’s salary to the EPF, and deduction of an amount equivalent to 8% of the employee’s salary to the EPF. Meanwhile, the Employees’ Trust Fund (ETF) Act requires the payment by every employer of 3% of the employee’s salary to the ETF.

Retirement & Wages

There is no general mandatory retirement age, and this is a matter for inclusion in the contract of employment. In addition to determining terms and conditions of employment, wages boards are given the power to establish minimum wages. In many sectors of the economy the actual wages which are paid are much higher than the minimum wage, since it would be nearly impossible for employees to find persons willing to be employed at minimum wage.

Bribery & Corruption

The importance of tackling the issues of bribery and corruption cannot be overstated. It is no exaggeration to state that the solicitation of payment by public officers is widespread in many cases, particularly when it comes to the grant of permits and licences and what should be routine renewals. In certain industries, such as tourism, these impediments and difficulties can have a serious impact on investment and erode investor confidence.

The importance of proper procurement processes being followed is another salutary measure proposed by Prime Minister Ranil Wickremesinghe to Parliament in November 2015, when he stated, “We will enforce a strict regulation in place for all state purchases. For the purposes of procurement and awarding of tenders and handling all purchases over and above the specific value assured, a central procurement secretariat will be established. There will be no room for unsolicited proposals being awarded government contracts without adhering to accepted tender processes. We will also establish a committee that will educate companies and contractors on the methodologies to be followed in applying for state tenders.”

In November 2015 Karunanayake further noted in his 2016 budget speech, “We now have a new bribery commission. Strengthening of the Commission to Investigate Allegations of Bribery or Corruption is a key objective of our administration given our strong commitment to eradicate corruption from our country. As such I propose to allocate a sum of LKR500m [$3.6m] for this purpose.” These measures are exceedingly important. Potential foreign investors will be deterred from investing in a country where the solicitation of bribes goes unchecked and there are no practical remedies.