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Why the Super Gains Tax should be avoided

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In January, the Sri Lankan business community was obviously unhappy with the imposition of the Super Gains Tax (retrospective tax plan) on large companies through the 100-day Government’s Interim Budget and also with the statement that there are a few companies/businesses in Sri Lanka which have earned super normal profits during the last several years with the undue patronage of the previous Government at the expense of the development of many other companies/businesses in the country. 

This kind of one-off tax is not a new phenomenon and there are several precedents in the world. In 1997 when the Labour Government returned to power in the UK, they targeted the utilities privatised by the Conservatives who were considered to have made ‘excessive’ profit based on the agreed pricing formula. A mechanism was used to compute what this excess was and a 23% tax was imposed on the gain. xf

Analysts however were quick to point out that some of those companies mentioned by the Government for making excessive profits would still not get caught up in the proposed net. For many top listed companies this tax is imposed on their past profits and therefore be a big cash flow issue in the short term. 

This new tax proposal to impose a retrospective tax of 25% on the taxable income of companies/groups having a profit before tax which exceeds more than Rs. 2 billion during the financial year 2013-14 will certainly have a big impact on those companies that have already dished out their dividends. Therefore, companies will have to deal with the real adverse impacts on cash flows, profit after tax, earnings per share, return on equity, etc. 

While the proposed tax has been referred to as a retrospective tax, it is the basis of measurement that is retrospective. The cost will have to be borne prospectively with the present shareholders of these entities bearing the cost. 

Companies like John Keells Holdings, Distilleries Company of Sri Lanka (DCSL), Ceylon Tobacco Company, Carsons, Bukit Dara, Aitken Spence, Nestle, Overseas Realty, Access Engineering, Lanka India Oil Company (LIOC), Lanka Lubricant, AHPL, HHL and Tokyo Cement fall within this tax net. There are also possibilities of banks like Commercial, Hatton National, Sampath, DFCC, Seylan, Nations Trust (NTB), National Development (NDB) banks and Ceylinco Insurance Company, Central Finance, People’s Leasing will certainly fall under this new tax scheme (chart shows the tax each listed corporate will have to pay, and the per share analysis – BRS Research).

In addition, among these companies some of them have already paid 28% as corporate taxes, if this 25% is added then they would end up paying 53%. However, not so long ago many of these companies were in effect paying taxes around or in excess of 50%. It is noted that at present Sri Lanka is considered to be one of the countries with low tax rates in the region and is attractive for investors. 

Furthermore, Sri Lanka does not have the group taxation unlike in the UK, each company is taxed separately, if the Government imposes the super gains tax the biggest loser would be the banks. Because, the retrospective taxes will have an impact on their capital buffers. Furthermore, those entities are already subject to the financial services VAT. Sri Lanka is probably the only country that imposes such a tax, which brings the tax on financial services to above 40%. Without group taxation the work of the tax authorities will be further complicated and lead to more tax disputes.


Impact of the retrospective tax plan 

There is no doubt that this tax would affect investor confidence in the short term, and add to all this the Colombo Stock Market since January has lost over Rs. 180 billion. However, if one is take an objective view this Super Gains Tax has been introduced to cover the short-term revenue needs of the Government and this is a one-off tax and would not be applicable in the future. But certainly this proposal does not totally take out the impact set by this precedence and policy inconsistency to long-term investors and also could be viewed as a penalty for being efficient and delivering good returns to the shareholders.


Preserve investor confidence

The proposal to impose additional taxes on the wealthy is not a new thing. In many markets the threshold for levying higher tax rates vary and apply to both those who have acquired wealth through inheritance of family property and cash, and the super new-rich, a growing breed of businesspersons who have acquired wealth in recent times though technology ventures or state patronage. 

However the packaging of such taxes should be done professionally and those who are suggesting should know the world is now a different place and there are many innovative ways of collecting revenue for the government. 

Finally, ad hoc and one off taxes are not good for business, but if political and fiscal realities make them necessary even such bad taxes should be applied in an equitable and sustainable manner. For example, impose the tax on the incremental profit above the threshold and not on the total profit. It would be inequitable if a company/group that made taxable profit of Rs. 1.95 billion makes no payment, but one that made taxable profit of Rs. 2.1 billion were asked to pay 25% on the taxable income on the excess. In addition, double taxation of income should be avoided; e.g.: most dividend income are derived from after tax profit and a further tax is paid at the point of distribution and tax exempt companies should not be subject to this tax, this is necessary to preserve investor confidence in the Government. 

(The writer is a senior company director.)

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