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Finance Ministry responds to FT story

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The Finance Ministry yesterday sent the following Right of Reply in response to the Daily FT story titled “Clarion call for tax holidays for new investments” carried on Monday. 

The full statement is given below. 

Attention of the Ministry of Finance and Mass Media has been drawn to the contents of the news item published in your esteemed journal under the above headline on 2 July 2018. The Ministry of Finance would like to place on record the following response to the contents of the article and appreciate if you will kindly publish this clarification.  The Government decided to replace Sri Lanka’s tax holiday regime due to the significant fiscal leakage that occurred through an open-ended tax holiday regime. 

In 2015, for instance, the total tax expenditure (revenue foregone due to tax holidays, exemptions and concessionary rates) was 1.6% of GDP. Income tax concessions alone amounted to 0.6% of GDP in that year. Therefore, Sri Lanka’s investment incentive regime has come at a very high cost. This has been one of the factors that contributed to weak direct tax collection that has resulted in 82% of Sri Lanka’s tax revenue being indirect taxes – a highly inequitable outcome that places the burden of taxation on the poor. This Government has pledged to reverse this tax ratio to a 40:60 level, where 40% of tax revenue will be from direct taxes, such as income tax.

It is in this context that the Government, through the Inland Revenue Act, changed it from open-ended tax holidays to an incentive regime based on targeted capital allowances. It is false to claim that Sri Lanka no longer has any investment incentives. Targeted capital allowances provide the same outcome as a tax holiday, but it is based on clear, objective criteria targeting the actual level of investment – which is exactly what Sri Lanka needs to attract. 

The new investment incentive regime provides for a 100% capital allowance for investments in depreciable assets between $ 3 million and $ 100 million. This means that, in effect, income tax does not need to be paid until the cost of the investment is recovered. This would satisfy most genuine investors. For investments above $ 100 million, the capital allowance is 150%. This equates to a tax holiday of 10 years, if not more, for typical investments of that scale. As a transitionary measure for the next three years, a 100% capital allowance is also extended to investments below $ 3 million as well.

For investments in non-capital-intensive industries, such as the IT sector, a special incentive has been designed. Accordingly, an additional 35% deduction on employee emoluments has been included. This equates to a typical corporate income tax rate of 0-5% for such firms. There is also a double deduction allowed for investments in R&D. 

Identified strategic sectors, such as exports, agriculture, tourism, IT and education, are taxed at a concessional rate of 14%. Furthermore, all SMEs are taxed at a concessional rate of 14%. This covers a large segment of the Sri Lankan economy and areas of investment interest. It is clear that Sri Lanka’s tax regime provides a number of attractive incentives for global and local investors.  

The philosophy of this investment incentive regime is that the Government would take all efforts to reduce upfront costs of investment (including para-tariff removal) and support the investment process. But once an enterprise becomes profitable, it should meet its social obligations and pay its fair share of taxes.

Countries like Vietnam have been successful in attracting investment - not because of tax holidays, but due to stable macroeconomic policy, strong trade agreements, particularly in ASEAN, and access to factors of production. The Government is working on facilitating the investment climate through simplification of the business process, the results of which are now being seen. one example is that registration of companies can now take place within 24 hours at a single online destination.

The Government also recognises and accepts the fact that tax holidays are not the only reason for government revenue weakness. As such, steps have been taken to improve tax administration, particularly through better use of information technology. The implementation of RAMIS has already had excellent results in improving tax compliance. The new Inland Revenue Act and associated communication campaigns have also led to over 60,000 new tax files being opened in the last couple of months. Several other measures are being taken to improve tax compliance.   

Finally, the Inland Revenue Act has been in force for just 3 months. It is premature, to say the least, to pass judgment on the efficacy of a tax regime after such a short period. As such, the Government has no intention to change the prevailing income tax law. It is such constant chopping and changing of laws and regulations that undermine the investment climate and hinder investment. The Finance Ministry is, however, in the process of including certain clarifications and simplifications in the tax law based on stakeholder inputs to facilitate its implementation.

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