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Govt.’s Interim Budget’s tax proposals and impact on business: Part 1

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The Institute of Certified Management Accountants of Sri Lanka (CMA) recently held a useful seminar on the new Government’s Interim Budget’s tax proposals and impact on business. The event saw key insights shared by two separate panels dealing with a wide range of issues. Panel I comprised CMA President Prof. Lakshman R. Watawala, Gajma& Co. Senior Partner N.R. Gajendran, Ceylon Chamber of Commerce Secretary General/CEO Mangala Yapa, Power and Energy Ministry Secretary Dr. B.M.S. Batagoda, Institute of Policy Studies Executive Director Dr. SamanKelegama, Sri Lanka Tourism Development Authority Chairman Paddy Withana, The Employers Federation of Ceylon Deputy Director General KanishkaWeerasinghe and Daily FT Editor Nisthar Cassim (Moderator). Following are excerpts from the first panel session. The report on second panel discussion will be published later.

                By Charumini de Silva Q: Will the Super Gain Tax be chargeable on taxable profit or on taxable income? Banks paylevy to the Treasury, in addition do banks have to pay the Super Gain Tax according to taxable profit? Gajendran: Adam once asked, ‘Lord, why is Eve so beautiful?’ The Lord replied, ‘Because then you can love her.’Then Adam said, ‘But Lord,she’s stupid. The Lord replied, ‘That’s because she can love you.’In the past what happened was, politicians loved the people and people were stupid to fall into the false promises of politicians. But listening to the Minister today, it felt like this has turned the other way round. Politicians love us, but in turn we don’t love them. If you look at this Budget, there are two key elements. One is that indirect prices have come down, essential goods prices have come down and a salary hike has been given. All these cost the Government about Rs. 100 billion. Therefore, it was important to match this gap with some revenue. Almost 50% of the revenue is generated from the Super Gain Tax. What was proposed in the Budget was that every company whose profit is Rs. 2 billion or more has been called on to pay this 25% one-off tax. Everything will be clear once the law is enacted. Subsequently there is a concern of bringing the group also into the picture. If the group profit is more than Rs. 2 billion, then every company under the holding company and subsidiary company will be called on to pay. Now in order to determine who’s liable to pay this tax, we must first identify the person to impose the tax, determine the tax base. These two have to be done independently or together. The tax base could be identified on audited accounts or taxable income of all the groups together. Liability tax will be on taxable income. As long as there is a profit over Rs. 2 billion and taxable income,banks will be liable to tax.                     Q: What is the impact to the economy from the measures taken via this Interim Budget? Dr.Kelegama: The bulk of the measures taken in the Budget was to stimulate demand in the economy. For example, reduction of various taxes applicable for essential goods, public sector wage increase, applying moral suasion on the private sector to play a similar part corresponding to the increases; added to that, the external development, with reduction of oil prices and inflation levels remaining low. All these will basically increase the people’s purchasing power and consumption. Hence, it is a demand stimulus budget. When this happens, what we see is that credit growth in the economy gets further stimulus. Already if you look at the credit growth of the economy, it was 8.8% in December 2014. That’s a pick up from early 2014 and that trend will now continue. So, with the increase in credit growth, what we will see is that there will be pressure on interest rates to rise, however this pressure will be mitigated to a great extent by cost lowering, like international price reductions and inflation. The other angle we saw in this Budget was the impact on the exchange rate. How? Because the people’s purchasing power is increasing due the demand-led growth, we will see an increase in demand for imports. With imports increasing, the trade deficit will also increase because the export increase will not match the import increase. So the trade deficit would create pressure on the exchange rate to depreciate. In fact, if you look at the behaviour of the exchange rate during the last three months, you can see the pressure to depreciate. As the Minister explained, now the Government has negotiated with the IMF for an additional relief package and the World Bank is also supporting various technical projects. There will be capital inflows, which will put pressure on the exchange rate in the other direction. Managing the interest rate and the exchange rate will be the major challenges in the coming months, especially when there’s demand stimulus economic growth.       Q: Although it is too early, as the private sector do you see the economy growing on a demand-led path? Yapa:The Budget is a stimulus for demand and that’s a big positive factor. But on the other hand, there are some other taxes that have been imposed. I think what is important to understand from the private sector perspective is that this was not a budget for the whole year, and it was a mini budget to meet certain situations. Throughout the election promises were made and some of them have been delivered. As Gajendran mentioned, the Government requires some additional revenue because of reduction of prices, salary increments. There is a lot of opportunity, discussion and engagement, which is quite positive. This being a one-off tax and short-term measures, we must make use of these opportunities. What’s important is to look at these measures and opportunities ahead of us to make a better environment to broaden the tax base and simplify the tax system to get to a more sustainable long-term system. While there are some negatives and positives,we must try and solve some critical issues the private sector has been facing over the years. I think this is the thinking of the larger business community.       Q: Dr.Kelegama mentioned the impact on the exchange rate due to increased imports. With the reduction in fuel prices, is there a significant change in fuel consumption?  Is the Government aware of these challenges? Batagoda:Power and energy is an important sector in the economy as it reflects on the exchange rate, poverty, consumption patterns and so forth. The impact of the reduction in the fuel prices was huge on households with a significant amount of their monthly spending on fuel being saved by Rs. 15,000 to Rs. 18,000. At the same time we also noticed that the reduction of prices has also increased the consumption of fuel during the last month. The consumption of 95 octane petrol almost doubled last month. On one hand there is a huge saving for the people and on the other hand the import of fuel is increasing. Per year we use around 2,800 to 3,000 million litres and in 2014 our import bill was $ 3.4 billion, which is almost 30% of total exports. With the increased demand, this year we might end up with an oil import bill of $ 4 billion. We did some analysis and we are planning to bring in the pricing formula to avoid negative impacts on CPC balance sheets. The Government has also agreed on that. In future, based on the international prices, we will adjust to the situation.       Q: There were concerns about the pricing formula before as well. How confident are you that this pricing formula will work? Batagoda: Yes, in 2002 also that Government brought in a pricing formula and there were concerns. We understand the problem there. We will have to adjust according to world market prices. We are looking forward to bringing in a proper policy on this matter in a couple of weeks.       Q: What would the financial situation of CPC and CEB be? Will there be a reduction in electricity prices? Batagoda: We are actually planning to maximise the use of coal power and make sure the cost of production goes down. Unfortunately, the power plant is not working these days. But the idea is to maximise coal power production. At the moment, CPC produces a lot of furnace oil, which has no market. It exports most of it and the export market value is low. Thus, we are trying to negotiate with both CPC and CEBin trying to maximise profitability.  To answer the second question, I cannot say if the prices will come down, but we are working on a pricing formula for electricity tariffs as well.       Q: When the Government announced the salary increment on one hand and reduced the prices of commoditieson the other, people questioned the logic behind these moves. It was a double bonanza for public servants as on one end there’s low cost of living and on the other hand an increased salary. What’s the EFCstand with regard to private sector salary increments? Weerasinghe: Fundamentally, it’s true that these are completely different issues. Private sector wages are mainly determined on market forces; we could only impost legislation for a minimum wage on which we all agree. We have to look into the issues of imposing this in a proper structure. As you all are aware, the private sector has various mechanisms in increasing wages. These are mostly performance-based, but we must also look at profitability and competitiveness, because we have to look at the bigger picture as we compete with the regional countries in most cases.We cannot ignore these factors. Businesses have to be profitable and competitive and the method to do this is by increasing productivity. These are the fundamental issues that the private sector should look at when adjusting wages. Unfortunately, there have been some ad-hoc wage increases since 2005. As you know, the Government is insisting now that we consider adding something on top. This year too, the Government made a request with this new Budget.   At the EFC we have meetings with our members because we need to engage with them so there are lots of things that are happening. Sadly, people are expecting huge increases. For example, if minimum wages are increased by Rs. 2,500, itwill have a serious impact on the other mechanisms. We cannot forget that most companies give increments in January and another in April; all those systems will be upset by this. Companies determine their increases based on sustainability. How can you sustain when you have ad-hoc changes without looking at the industry’s affordability? There is another important manner of determining wages, which is used in the plantation industry. Traditionally, since 2000 the wages of the entire industry have been determined or the standard has been set by industry bargaining. Unlike in the Wages Board mechanism, herestakeholders are actually taken into account. A lot of the issues need to be addressed before we can give the wages. I cannot say that is an affordable way of doing it, but it’s a more equitable means of determining minimum wages. Over 400,000 people are directly employed by other companies and in this sector there are a lot of indirect employees; the smallholder community is huge and there are many people depending on this industry for their on livelihood. If we don’t give importance to imposing a minimum wage in this country, collective bargaining will be mandatory. The private sector has always been looked as the engine of growth, but I think I must share this with you all and I am sure the economists here will agree with me on this. In Germany in 2008, according to an interesting hypothesis they found that a 1% increase in jobs had a direct impact of 0.8% on the GDP, as against a salary increment impact, which is only 0.2% of GDP. Successive governments should not look at the private sector and increase wages on a mandated means. Let them create jobs, create wealth and look at our own system.       Q: What’s the status of the $ 4 billion Kalpitiya project? What are your views on the minimum rate policy? Withana: In Kalpitiya, two islands have been given and constructed has started on one. The fact remains that there’s no infrastructure. What we are doing is looking at ways and means to develop the area and invite investors. There is another property in Kuchchaveli; the problem here was the initial price they asked was Rs. 20 million per acre. Minimum room rate is something we must maintain. But the authorities should take notice of the quality standards of Colombo city hotels. If you have a price, you have got to maintain that standard and quality of the service, otherwise it kills the whole industry. Over 1.5 million tourist have come in the last few years and there is an influx of tourists from China and India, apart from the traditional markets. With that in mind, we are trying to increase the number of tourists coming to Sri Lanka especially with these international exhibitions and expos coming up.  It is also important to get the European flights back as those are the markets that bring in the bulk of the revenue and make use of the European markets to improve the industry.       Q: If the fuel price formula is implemented, it will create uncertainty for business in terms of predicting prices. How will it affect the industries? Yapa: The Chamber has been advocating transparent, prudent mechanisms. We understand that world market prices are volatile, but we cannot hedge these against the Government. Dr.Kelegama: I agree with Mangala. The formula will help more transparency in price adjustments. We must always keep in mind that two items under fuel, kerosene and diesel,are subsidised in many countries. If you know how they are subsidised, that message will be conveyed by the formula, which will facilitate the private sector to take concrete decisions because it will then be aware of how these adjustments will takeplace according to international price fluctuations.       Q: What can you say about the debt situation of the economy and credibility of data? Dr.Kelegama: The strategy that Sri Lanka used from 2005 until end 2014 was a debt-driven and investment- and consumption-led growth strategy, so when the debts matured,to settle them we again borrowed, which is a debt roll. It was a highly-indebted economy that we had. Though it was announced that debt to GDP has decreased to 78%, the actual figure was around 88% to 89% of the GDP. That model of debt-driven economy was an unsustainable model. Because of that gradual transition towards depending on bilateral debt and debt-driven strategy, we moved to more multilateral debt where the IMF is in and switched the strategy to a more export-led, FDI-led, investment-led strategy, where the real sector will be involved. Those were the recent changes we saw with the new Government coming into power. Coming to the second question about data, there were quite a lot of problems related to data. For example, if you look at exports as a percentage,today it is 6.8%; it was around 30% in 2000. If you look at revenue as a percentage, in 1990 it was around 20%, but today it is around 11% to 12% of the GDP. Is it because the economy was artificially boosted that ratios have gone down? That still remains a question in this country. I think these data need to be fully investigated, because some say that our exports cannot reduce to such low levels and our revenues cannot be in such low levels. As you all know, in 2007, the Consumer Price Index was revised and in that revision we changed the outdated commodities we had in the basket. We changed the gravity given to the food basket, which was about 63% and it was reduced to some 40%. I think it was too much of a reduction. Then alcohol was removed from the index because of the ‘MathataThitha’ program, but we know that Sri Lanka is a high alcohol-consuming country. Now the Consumer Price Index also needs a revision and I understand that a new committee has been appointed to look at all this data. The committee submitted a report to the Prime Minister last week. Data is extremely important in making decisions, not only for the country as a whole but also for the corporate sector. I think it’s high time we put an end to bureaucrats satisfying politicians with wrong data.       Q: What are your growth predictions for this year? Dr.Kelegama: Basically, we have not made any major changes during this 100-day program. I think the target that was set by the previous year of 7% growth is still possible, because nowSri Lanka’s economy is at a stage where even without a government this economy can achieve an economic growth rate of 6% to 6.5%; governments come in only for that additional 0.5%.       Q: The buzz word for the way forward has become Public-Private-Partnerships (PPPs). How would you drive successive PPPs? Yapa: As you all are aware, there is a lot of engagement taking place with the Government and the private sector and if we can bring these discussions into good PPPs, then it would be a great achievement for the entire economy. Pix by Upul Abayasekara  

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