The tax changes included in the Inland Revenue (Amendment) Bill propose to make major revisions to Sri Lanka’s corporate tax structure and interestingly, to substantially reduce the income tax rate on the so-called sin industries.
The amendments propose to reduce the corporate income tax rate on liquor, tobacco, betting and gaming to 28 percent, from April 1, 2020, from the current 40 percent. At the same time, the standard tax rate on trading, banking, finance, insurance, etc. is proposed to be reduced to 24 percent.
Thus, the difference between the standard corporate tax rate and the tax rate charged on the sin industries is proposed to be reduced to just 4 percent, from the earlier 12 percent.
The government plans to continue with the 14 percent corporate income tax rate on exports, tourism, education, medicare, construction and agro processing.
However, a new corporate income tax tier is proposed to be introduced for the manufacturing sector, at 18 percent.
As of now, Sri Lanka’s corporate income tax structure has three tiers—40 percent sin tax, 28 percent standard tax and 14 percent tax on exports, tourism, construction, etc.
Apart from slashing of corporate income taxes, the amendments cover a wide range of tax cuts while proposing to abolish certain taxes, such as the Economic Service Charge (ESC).
The bill is to be presented to Parliament for approval, shortly.
The economic stimulus package introduced by the new administration also includes lowering the Value-Added Tax (VAT) rate to 8 percent, from 15 percent for most sectors, increasing the turnover threshold for VAT by fourfold and removing the 2 percent National Building Tax (NBT).
Both Fitch and S&P have already revised down Sri Lanka’s credit outlook over the tax cuts, citing increased risks to debt sustainability, due to a possible hole in government revenue amid clear deviation from the revenue-based fiscal consolidation path.
The Inland Revenue (Amendment) Bill could also jeopardise Sri Lanka’s relationship with the International Monetary Fund (IMF), which counts the Inland Revenue Act enacted in 2018 as a key achievement in improving the country's fiscal settings.
Fitch said its preliminary estimates showed the VAT rate change, scrapping of NBT could alone lower government revenue by as much as 2 percent of GDP. VAT accounted for 24 percent of government revenue in 2018.
Moody’s, which said the tax cuts were credit negative, estimates the hit from the tax reductions to government revenue to be around 1 to 1.5 percent of gross domestic product (GDP).
The tax cuts are also expected to expand Sri Lanka’s budget deficit by 0.8-1 percent.
However, the government maintains that the tax cuts would augment the aggregate demand in the economy and thereby boost economic growth and the offsetting measures undertaken would largely meet any revenue loss.