Industry leader warns of “digital isolation” as new VAT threatens to derail Sri Lanka’s ICT sector

By Nishel Fernando

With Sri Lanka’s new 18 percent Value Added Tax (VAT) on foreign digital services now a settled policy taking effect this October, focus has sharply shifted to its potential economic fallout. 

A stark warning from Lanka Rating Head and former LankaPay Chairman Dr. Kenneth de Zilwa is now resonating through the tech community, highlighting the severe “downside risks” that he argues could stifle innovation, burden businesses and potentially lead to “digital isolation” for the island nation.

While the impending tax has been public knowledge for months, Dr. de Zilwa’s recent analysis has crystallised the anxieties of many within the country’s vital information and communication technology (ICT) sector. The levy is a key component of Sri Lanka’s fiscal strategy, under its agreement with the International Monetary Fund (IMF).

Effective October 1, 2025, the policy compels non-resident digital service providers from global software giants to specialised cybersecurity platforms to register with the Inland Revenue Department and apply the VAT if their local turnover exceeds the prescribed thresholds. The tax covers a vast range of B2B and B2C services, including cloud computing (SaaS, PaaS, IaaS), software licences, streaming subscriptions and online marketplace services.

Dr. de Zilwa’s detailed breakdown highlights several specific threats the policy poses to Sri Lanka’s economic engine. These include the crippling costs for start-ups, small and medium enterprises and freelancers, who form the backbone of the tech ecosystem and rely heavily on global tools, facing a direct hit to their operational costs. 

For the nation’s tech exporters, a crucial source of foreign currency, the rising input costs for the essential software and platforms will directly squeeze their margins and blunt their competitive edge in the global market. 

The analysis also warns of the potential for international providers to either geo-block Sri Lanka or exit the market entirely, to avoid the complexities of tax compliance, isolating the country from essential digital infrastructure. 

The cumulative financial burden and reduced access to cutting-edge tools could deter investment and put significant pressure on the innovation crucial for the sector’s and country’s future. 

Finally, the policy may inadvertently encourage businesses and consumers to seek workarounds via VPNs or offshore payments, fostering a larger digital grey market.

“While this reform aligns with the IMF revenue targets, Sri Lanka must strike a careful balance between fiscal discipline and digital opportunity,” Dr. de Zilwa stated, articulating the core dilemma facing the policymakers. 

He urged the government to consider mitigating measures to protect the industry.

“Incentives, exemptions for exporters or transitional support may be essential to cushion the blow to a sector driving jobs, foreign exchange and global integration,” he proposed.