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Withholding tax on service providers


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By Suresh R.I. Perera

What is Withholding Tax? 

‘Withholding Tax’ is not a distinct tax. It’s a mere collection mechanism. The party making the payment is called upon to collect the tax due from the recipient by way deduction from the consideration/fee paid to the service provider and remit the same to the tax office. Therefore, this is the tax of the recipient and not the payer. The payer is acting as the Withholding Agent. There are different types of withholding taxes. In addition to the Income tax withholding tax on service providers there is WHT on interest, dividend, royalty, rent, management fees and WHT by the employer on employees’ income. In the past Sri Lanka implemented WHT on VAT also but it has been abolished now.

What is the exact law pertaining to withholding tax applicable on 

service providers?

  • Recipient – Resident Individual 
  • First and foremost 5% WHT rule is applicable when the payment is being made to a resident individual. It is not applicable if the payment is to a company, partnership, an association, club, trust or a non-resident individual. 
  • Recipient – Non Resident Persons

If a non-resident person is paid a service fee or an insurance premium (with a source in Sri Lanka) the applicable withholding tax rate is 14% unless it could be reduced due to the application of the double tax treaty. 

The withholding deduction should be made on the gross amount of the invoice value inclusive of taxes other than VAT.

Is there any further tax to be paid by the recipient 

of service fees?

The WHT 5% applicable to resident individuals is not a final withholding tax and such recipients are required to gross up such income and pay tax according to the-normal progressive slab rates and claim a credit for the 5% tax deducted at source. 

Payment to non-resident service providers who have a source in Sri Lanka are subject a WHT of 14% (or subject to a lower tax rate applicable under Double Tax Treaty Agreement (DTTA) will be a final tax. 

Is withholding tax on services a new concept?

Under the aegis of Specified Fees (the concept of withholding from service providers) was prevalent prior to 1/4/2011 at the rate 5%.

As per previous law any person (including an individual and company) partnership, body of persons was required deduct from any specified fee payment to a person (including an individual and company) partnership, body of persons and remit such tax to the Inland Revenue Department. The WHT on specified fees did not include rent. The WHT on rent was 10%. As experienced, the previous law was structured and was broader in nature capturing both individuals and corporates. It required payments to both individuals and corporates to be subjected to WHT.

It is significant that current withholding provision of 5% on specified fees under the new Inland Revenue Act 2017 (IRA 2017) is only applicable to payments made to resident individuals. The rationale seems to be that policy makers are comfortable that companies, partnerships, bodies of persons such as trust are within the tax network hence there is no requirement for taxes to be collected at source by way of WHT mechanism. 

What types of payments under the New IRA are subjected to the withholding tax of 5%?

The Act identifies the payments to following types of resident individuals as liable for 5% WHT. 

  • Teachers, lecturers, examiners, invigilators/supervisors at examinations, resident insurance, sales and canvassing agents, endorsement fees. 

When payments are made for purchase of articles through a contract via tenders/quotations to 5% WHT should be deducted. 

The recent Gazette uploaded on 30 April (dated 1 April) extended the 5% WHT categories to include the following also. 

a) Independent Service Providers such as doctors, lawyers, accountants, software service providers, engineers, researchers, academics & similar service providers 

b) Construction, janitorial, security, event organizers, designers, caterers, dress makers, tour guidance, entertainers, agency functions, management services 

c) Vocational services provided as independent service providers 

Though the Gazette identifies specific type of service providers, one must take cognisance that above list is not exhaustive due to the wording used in it. 

The payment of specified fees should be exceeding Rs. 50,000 a month to be subject to the 5% withholding tax.

Similar to the IRA 2006, under the new IRA 2017 also rent is not considered as a specified fees but a return from investment and is subject to withholding tax rate of 10%. WHT on rent applies to any resident person and not limited to individuals as the specified fees.

A Withholding Agent is required to prepare and serve a withholding certificate in the form specified to cover a period of one calendar month setting out the amount paid to the withholdee during the period and the amount withheld as tax. Withholding certificate must be served on the withholdee within 30 days from the end of the calendar month. 

Are there any exceptions 

to the WHT 5% rule?

The Act lays down circumstances where WHT deductions should not be carried out by the payer. WHT deduction is applicable only if the payer is carrying on a business. An individual who is not carrying on a business is not required to deduct 5% or 14% when making payments to resident individuals or non-resident persons respectively. In addition the above 5% and 14% WHT is not applicable if the payment is exempt and not liable for income tax. If the recipient of the payment furnishes a certificate to confirm the payment would be subject to Economic Service Charge (ESC) too, the law permits the payer to refrain from making WHT deduction. The withholding agent should obtain a certificate from the recipient issued by the Commissioner General of Inland Revenue Department if the recipient qualifies for exemptions or is subject to ESC.

Are there any areas for reform in relation to WHT on specified fees? 

Though the Gazette issued to prescribe the extended categories of service providers who would be subjected to 5% WHT is dated 1.4.2018, it was uploaded to the website only on 30 April 2018. Therefore from a strict legal perspective, all the payments that were made after 1.4.2018 are subject to the WHT. Hence failure to deduct in the eyes of the law could amount to a violation to be penalized. On the other hand in relation to the categories of services mentioned in the Gazette which was uploaded on 30 April would amount to the law being effective retrospectively from 1 April which is unjust and unfair (notwithstanding a circular being uploaded on 18 April 2018). To date a press notice has not been issued in this regard. Hence the operative date of the Gazette should be postponed to a day after the 30 April 2018 in relations to categories listed in the Gazette. Policy makers should bear in mind that businesses need adequate notice to modify their IT systems to comply with the WHT requirements.

Further as in the case of any newly implemented law, there are complications in the transition from previous provisions to new provisions in case withholding of 5% rule also. For example, payments made after 1 April 2018 but in lieu of services rendered prior to April (e.g. in March 2018), and where the service provider following accrual basis has accounted for the income prior to 1 April 2018, if 5% WHT is deducted at the point of payment after 1 April, he/she would be deprived of the right to claim credit for such taxes withheld. Thus to avoid this anomalous status ideally the law should have contained a specific provision to exclude such payments from 5% WHT as a transitional provision. 

While the law is silent in this aspect, the position of the Tax Office seems to be ambiguous. In order to create certainty it would be a welcome measure for the policy makers and tax office to take prerequisite measures to legalise it as a transitional provision that such payments will not attract WHT. On the other hand withholding of such payments would result in unjust enrichment for the Inland Revenue Department at the expense of the service provider as the person subject to tax at source may not be able to obtain the credit for it.

 


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