Tax incentives for Sri Lanka's IT industry drives innovation and foreign investment

With national ICT policies and development dating back to the early 1980s, Sri Lanka’s IT sector stands at the regional forefront today, and is slated for further expansion on the back of both the government and the private sector’s intensifying focus on expanding exports and employment within the sector. Although unable to compete with its regional competitors in terms of size and volume, Sri Lanka’s ICT sub-segments – most notably business process outsourcing (BPO) – have risen to become major employers and economic strengths, with the country targeting niche services in a bid to expand its global IT reach.

Internet penetration, still low by developed market standards, is also rising rapidly in the country, while its low mobile and data tariffs, well-educated and digitally literate population and comparatively low wages and real estate prices have seen investment in the sector soar. This has enabled a number of domestic and multinational firms to flourish in recent years, and created significant space for future growth, particularly at the design level of both the product and services development cycles.

Successive governments have long recognised the need for ICT development, with the country unveiling its first federal ICT policy, the National Computer Policy, in 1983, and later moving to launch its e-Sri Lanka Development Project (eSLDP) in 2003. In the same year the sector’s main governing body, the Information and Communication Technology Agency (ICTA) of Sri Lanka, was formed with the promulgation of the Information and Communication Technology Act No. 27 of 2003, or the ICT Act.

The ICTA is mandated to take all necessary measures to implement policies formulated by the Ministry of Telecommunications and Digital Infrastructure’s IT-related policies, in addition to assisting the Cabinet of Ministers in formulating new policies.

The Sri Lanka Association of Software and Service Companies (SLASSCOM) is another important actor in the country’s ICT landscape, acting as a sector-specific chamber of commerce. Formed by major IT companies operating in Sri Lanka, the organisation provides a space for private and public stakeholders to discuss significant issues, promotes investment in the sector and provides guidance to the public sector on critical policy issues.

Transformation

The ICTA’s first task on establishment was to implement the eSLDP. The project aimed to address the country’s underdeveloped and uncoordinated IT policies and programmes, in addition to enhancing the sector’s legal framework, addressing low ICT literacy rates, low levels of governmental ICT usage, and a lack of affordable ICT products and services. Key strategies to address these problems included modernising government services to improve access to information, infrastructure and services, with the World Bank providing technical assistance for the programme, and declaring it largely successful on completion in 2013.

Quantitative evidence supports the World Bank’s assertion – IT industry export revenues rose by 238% between 2007 and 2013 to reach $720m, or 6.47% of total export revenues, and are forecast to have hit $850m in 2014, while employment in the sector rose by 123% over the same period to reach 75,100, and a projected 82,850 in 2014, according to SLASSCOM data. In its 2014 “Computer Literacy Statistics” report, the Department of Census and Statistics found that desktop computer ownership rose from 3.8% in 2004 to 16.6% in 2014, and from 10.5% to 25.8% in urban areas, while ICT literacy, defined as the ability to use a computer without assistance, rose from 16.1% in 2007 to 25.1% in 2014, and from 25.1% in urban areas to 34.6% in urban areas.

Internet Usage

Internet usage has also soared on the island in recent years, with the Telecommunications Regulatory Commission of Sri Lanka (TRCSL) reporting that fixed broadband connections rose from just 2504 in 1996 to 25,535 in 1999, 85,500 in 2003 and 234,000 in 2008. Fixed broadband services have continued on an upwards trajectory since, rising to hit 302,000 in 2010, 359,000 in 2011, 423,194 in 2012 and 507,845 in 2013, before crossing the 600,000 threshold for the first time in 2014, and hitting 630,000 subscribers in 2015.

Mobile broadband has shown even more impressive growth, rising from 91,539 subscribers in 2009 to 485,000 in 2011 and 1.66m in 2013. Mobile broadband connections witnessed a sharp 68.6% year-on-year increase in 2014 to reach 2.8m total subscribers, according to the TRCSL. By 2015 penetration had hit an estimated 115%. Driven in large part by rapid smartphone uptake, mobile broadband is expected to continue rising over the near-term, while new fixed 4G LTE broadband services continue to drive growth in the fixed internet segment.

Targets

Going forward, the industry has targeted $5bn in exports, increasing employment to 200,000 jobs, and the creation of 1000 new start-ups by 2022, while the government has unveiled a host of new initiatives in recent years aimed at further developing the sector, most notably plans to deliver universal internet access, increase digital literacy to 90% by 2020, build a national fibre-optic backbone connecting government buildings and residences to high-speed internet, and a national cloud storage project to boost network capabilities and capacity.

The Smart Sri Lanka and OneGov 2020 initiatives were launched recently to achieve these goals. Smart Sri Lanka, developed as a follow-up to the eSLDP, intensifies the government’s focus on e-government services, improving the local business environment, job creation, and improving e-literacy, connectivity and affordability, particularly in rural areas.

OneGov 2020

The OneGov2020 project, meanwhile, seeks to create a strong legal, policy, institutional and strategic framework for ICT development as an instrument of socio-economic development. It aims to use ICT to improve social integration, peace, economic growth and poverty reduction through development of citizen-centred, transparent e-government services. OneGov2020 also followed the ICTA’s Re-Engineering Government Programme (Re-Gov), which aimed to improve e-government efficiency and delivery, with the agency reporting that although many of Re-Gov’s targets were achieved, the government was still short of achieving the necessary transformation and level of connected, efficient electronic services. Under the programme, ICTA will utilise new technology including mobile government, cloud computing and social media to improve on previous successes under a “whole of government” approach.

Broadband

The International Telecommunications Union (ITU) reports that Sri Lanka’s broadband market is dynamic, with both fixed and mobile operators providing a host of broadband technologies including WiMAX, ADSL and HSDPA on both a pre- and post-paid basis, while the country became the first in the region to introduce 3G and 4G mobile broadband services, when Dialog Axiata rolled out its commercial 3G network in 2006 – well ahead of India, which did not offer 3G services until 2011, and 4G in 2013. However, the ITU notes that although Sri Lanka’s broadband infrastructure is becoming increasingly well developed, further efforts are needed to drive demand, as broadband penetration in both the fixed and mobile segments remains relatively low. To help narrow the supply-demand gap, the government has rolled out an ambitious universal internet scheme, with a number of private companies joining its efforts, most notably Google, which began trials of its “Project Loon” helium balloon internet project commercially in Sri Lanka. The scheme is expected to expand high-speed broadband coverage to 100% of the country (see analysis).

Fibre Optic

Universal connectivity efforts come on the heels of the government’s successful completion of its National Broadband Network (NBN) plan, a backhaul fibre-optic network covering all 329 administrative divisions in Sri Lanka by 2018. In 2013 the government awarded incumbent operator Sri Lanka Telecom (SLT) the role of “national backbone service provider,” with the first phase of the project, completed in November 2014, consisting of a 20,000-km, high-speed, dense wavelength division multiplexing fibre network delivering 8 TB of capacity, and offering the full range of broadband technologies, including ADSL2+, VDSL2, FTTx, carrier-grade Wi-Fi and 4G LTE, with download speeds of up to 100 Mbps.

The next phase of the project will see SLT deploy Wi-Fi hotspots in public and under served rural areas across the country, with the company announcing it had partnered with equipment manufacturer Ruckus Wireless and vendor Alepo to deliver Wi-Fi services in July 2015 (see analysis).

BPO

Supportive government policies and rapid growth in digital literacy have allowed Sri Lanka to become a regional leader in delivery of IT services and products. Nowhere is this more evident than in its vibrant BPO sector, which is increasingly referred to as business process management (BPM) owing to its sophistication, with firms offering niche services including offshore legal services, medical diagnostics and architectural drawings, in addition to traditional call centre support. Sri Lanka’s BPO industry benefits from a number of competitive advantages, including a highly educated, bilingual workforce – nearly 50% of students who finish higher education are trained in technical and business disciplines, and literacy rates in the country are the highest in all of South Asia – with the country holding the second-highest concentration of accountants certified by the Chartered Institute of Management Accountants, after the UK – allowing companies to provide high-end accounting and financial analytics services to large multinational clients and regional players.

Recent Growth

According to a 2012 report published by AT Kearney, BPO companies established operations in Sri Lanka in the 1980s, with the industry expanding rapidly over the following three decades to comprise 300 companies employing more than 60,000 people, and generating $400m in export revenues annually. A number of well-known international companies including HSBC, IFS, Motorola, Pearson, RR Donnelley, WNS and HP subsidiary MphasiS have established operations in the country, while domestic firms provide advanced services to high-end global clients including Google, Lenovo, Microsoft, Nokia, JPM organ, the London Stock Exchange, Santander Bank and Emirates Airlines.

Recent market entrants include Australia’s Paycorp International, which launched an outsourcing unit in Sri Lanka in 2012, and Netherlands-based ISM eCommerce, which announced in February 2014 that it had invested $3m to establish a BPO and software development unit in Sri Lanka, serving clients including Royal Dutch Post, Seiko Watches, Akzo Nobel, Heineken and the UK’s Chelsea Football Club.

Services

Sri Lanka’s IT strengths extend well beyond the BPO sector, however, with a host of multinational and domestic IT service providers witnessing considerable international success since establishing operations in the country.

Notable players include the NASDAQ-listed Virtusa, which operates a technology centre in Orion City, providing IT services to over 1000 companies in the financial services, insurance, telecommunications, health care and capital markets sectors, and Sweden’s IFS, which employs more than 800 people in Colombo and Kandy, and offers enterprise asset and management solutions to clients including DuPont, Pepsi and the UK Royal Navy. An infrastructure outsourcing firm, 24/7 Techies, provides support for cloud-based applications for developers and business in the US, while Sri Lanka’s MAS, a major apparel manufacturer and exporter, established a dedicated IT subsidiary, Attune, the first such company globally to focus exclusively on systems, applications and products for the apparel and footwear industry. Attune provides consulting, software licensing sales and customer support to clients including Benetton, Burberry, Hanes and Tommy Hilfiger. More recently, UK-based Volume, a digital marketing applications firm, invested $1.4m to establish a new technology centre in Sri Lanka in March 2013, providing services to clients across multiple time zones.

Products

Although Sri Lankan engineers and IT professionals have garnered a reputation for sophisticated back-office support, the country is also active in developing and exporting IT products, with growth in this segment expected to drive the industry to the next stage in its evolution. “When we talk about competitive strengths, other countries have the physical size and manpower that comes with it. We’ve already established ourselves as value-oriented IT service providers in BPO, coding, testing and support services. Concepts and design are the future now, and we will see the industry moving more and more into project engineering, which encompasses the entire pyramid of IT development,” Hemantha Jayawardena, COO of Millennium IT, told OBG.

Millennium – arguably one of the most successful ventures to come out of Sri Lanka – is a supplier of trading, order routing, surveillance and depository IT products to capital markets including the London Stock Exchange, Milan’s Borsa Italiana, Bursa Malaysia, the Lima Stock Exchange, the Hong Kong Exchange, the Mongolian Stock Exchange and, most recently, the Johannesburg Stock Exchange.

Market Attractiveness

In addition to a well-educated and highly skilled workforce, the Sri Lankan market offers a host of additional competitive benefits, with the country rising five spots on the 2014 AT Kearney Global Services Location Index, which ranks the world’s best destinations for offshore service provision, to reach 16th place out of 51 markets surveyed. In its 2014 report on the IT and BPM industry, SLASSCOM noted that with the country’s knowledge services industry experiencing less demand growth compared to the global BPO hubs of India and the Philippines, Sri Lanka offers a competitive price point in terms of wages. SLASSCOM reports that the average annual wage for an IT programmer in Sri Lanka is $8996, compared to $10,170 in India, $11,291 in Vietnam and $11,371 in the Philippines, while wages for BPO analysts in Sri Lanka are $4104 annually, compared to $4200 in Bangladesh, $5451 in India and $10,398 in Malaysia.

Accountants’ annual wages stand at $5977 in Sri Lanka, compared to $8121 in the Philippines, $8194 in Egypt and $10,123 in India. AT Kearney notes that attrition rates for BPO workers are less than 20% in Sri Lanka, compared to 30-35% in India and the Philippines, with the majority of attrition in Sri Lanka driven by workers leaving to pursue either higher education or opportunities outside of the country, rather than moving between BPO companies.

Infrastructure costs are also among the lowest of all major BPO markets, with average rents standing at $227 per sq metre, according to SLASSCOM, 20% less than in Kuala Lumpur and Cairo, and at least 50% lower than in Guangzhou and Bangalore. Colombo offers roughly 232,000 sq metres of Grade A leasable office space, with an additional 765,000 currently under construction, which was projected to be finished by the end of 2015, and 557,418 sq metres of new office space planned for future development.

Orion City

Some major private players have established their own dedicated BPO operations, such as HSBC’s 2000-seat campus, built on the outskirts of Colombo, while others, including services provider Virtusa, Pearson, WNS and Exetel, have established operations at the country’s sole dedicated IT park, Orion City, which offers space to companies on a plug-and-play basis. Orion City is spread across 16 acres, offering 51,097 sq metres of developed space, with over 6000 employees working out of the park. However, an influx of companies to Orion City have seen vacancy rates fall to nearly zero, with authorities now moving forward on an ambitious expansion project which includes construction of Orion Towers, three new buildings adding 46,500 sq metres of office space and with room for 210,000 new personnel. Construction of the first tower is slated for completion in 2017. This tower will offer 22 levels of prime office space, as well as retail and commercial facilities, a boutique hotel, recreational facilities, meeting venues and a business centre. To bridge the gap, a smaller six-story Bellatrix Building, with 9200 sq metres of rentable space will be ready for occupation in October 2016.

“Orion City tends to win out on IT real estate over other commercial property developers. The park offers value for money, sophisticated infrastructure and has many of the global IT giants based in the Park. In addition, a food court, international food chains and other ancillary services make it a great environment for fostering a start up culture,” Jeevan Gnanam, CEO of Orion City, told OBG.

SLASSCOM also reports that the government is building a new 17-acre IT park roughly 30 km north of Colombo in Katunanayake, while the planned Hambantota IT/BPO Park received parliamentary approval in 2012, and is expected to provide 100,000 new jobs – including 40,000 direct IT and BPO jobs – in the Southern Province, while an additional 44.5 ha have been earmarked for IT development in Biyagama in the Western Province.

Incentives

Tax incentives for IT companies are also considerable, with the government moving in 2011 to reduce corporate income tax rates to 28%, from previous levels of 35%, and offering incentives to BPO and IT companies which effectively reduce the tax rate to zero for most investors. In 2012, new firms with investments in excess of $250,000 were eligible for four-year tax holidays, while investments exceeding $2m are granted additional tax-free years. This has been the case with Virtusa, which was granted a 12-year tax holiday expiring in March 2019 as a result of meeting investment and employment requirements outlined by the Board of Investment.

In the 2014 budget, the government extended tax holidays for new IT firms to five years, and capped the maximum corporate tax rate for IT companies at 16%, according to SLASSCOM. Companies also benefit from some of the lowest telecommunications and data tariffs in the world, with the ITU reporting that only Bangladesh offered lower mobile and data tariffs in 2014 (see Telecoms overview).

Start-Ups

With opportunities for product design and development expanding significantly, the government and private sector are increasingly focusing on domestic start-ups in a bid to support local innovation and increase IT investment.

For example, SLASSCOM launched a national incubator programme, Global Startup Labs, in partnership with Massachusetts Institute of Technology (MIT) in January 2014. With funding from Brandix, the country’s largest apparel exporter, provided until 2019, the programme offers six-month incubation programmes twice a year to Sri Lanka’s most innovative undergraduates and recent graduates.

The first network of angel investors, Lankan Angel Network, comprises individual investors, venture capitalists and angel investors and works closely with Blue Ocean Ventures, one of the country’s largest venture capital firms, with a portfolio of notable commercial players including Takas.lk, a leading e-commerce sites, tour operator Trekurious, Sri Lanka BPO Academy and Ridgecrest Group, a software services firm.

Research & Development (R&D)

R&D activities are also on the rise. Sri Lanka is home to 29 research institutes and 119 science and technology institutions, although expenditure on R&D remains low, at 0.16% of GDP, according to a 2014 report published by the Ministry of Technology and Research. The private sector has increasingly moved to meet public spending shortfalls. Motorola Solutions operates one of its global R&D centres in the country, focusing on embedded software development for its enterprise services division, while Zone 24x7, based in the US but operating out of Sri Lanka, provides hardware designs and new technology to vendors and banks, many of which are Fortune 500 companies.

Outlook

With IT development increasingly targeted by the public sector as a pillar for overall socio-economic development in Sri Lanka, generous incentives on offer to new ICT firms and an ongoing evolution from service provision to product development, the IT sector is poised for rapid and significant expansion in the coming years. As internet penetration and digital literacy continue to improve, the sector is well on its way towards meeting its $1bn export goal, with the next phase of its development expected to see increasingly large international firms establish operations in the country, allowing the industry to retain its top talent, and keeping it at the forefront of the region’s technological innovation.