By S.S. Selvanayagam
In a written submission to the Supreme Court concerning the Inland Revenue Bill, the Attorney General has reiterated that the proposed Bill is a law enacted in furtherance of Parliament’s control over a source of public finance and does not violate any of the provisions of the Constitution.
Inland Revenue Head Office
Additional Solicitor General Farzana Jameel, with Senior Deputy Solicitor General Arjuna Obeysekere, State Counsels Suren Gnanaraj, Kaniska de Silva, Chaya Sri Namuni and Hashini Opatha, appeared for the Attorney General and Finance Minister Mangala Samaraweera. They made this submission on behalf of Minister Samaraweera and the Attorney General.
The written submission was made further to the oral submissions on the following matters: background to the present law and the need for a new law; the object and purpose of the new Inland Revenue Bill; the jurisdiction of the Supreme Court in respect of Bills concerning taxation; parliamentary control over public finance and impugned clauses of the Bill and why the arguments of the petitioners are misconceived
Background to the present law and the need for a new law
Income tax was first introduced to Sri Lanka in 1932 by the Income Tax Ordinance No. 2 of 1932 effective from 1 April 1932. This ordinance was amended 17 times between 1932 and 1949 when the new Act No. 1 of 1949 replaced it.
The next piece of legislation was the Income Tax Act No. 04 of 1963 which after some amendments was replaced by Act No. 28 of 1979. This was amended 18 times and replaced by Act No. 38 of 2000. This was amended six times and replaced by Act No. 10 of 2006, which is the law currently in force. These changes were necessary to reflect Government policy and fiscal policy.
The present Inland Revenue Act No. 10 of 2006, although relatively new, continues to contain some of the archaic features seen in the previous legislation dating back to 1932, and more importantly fails to provide for the changed economic landscape, the internationalisation of commerce, the consequences of digital commerce, the trade in services, and generally, the reality of cross-border transactions.
The ad hoc changes made to the income tax regime of this country have resulted in a complicated law which does not assist or guide either the officers of the Inland Revenue Department who are required to administer the law or the taxpayers who have to comply with its provisions.
If one looks at sections 7-14 of Act No. 10 of 2006, one would see that wide and far-reaching exemptions have been granted over the years (standing at more than 250 as at now), to several organisations and persons, with the result that an independent person looking at the said Act is bound to wonder if the norm in our taxing regime is to grant exemptions, and the exception, to charge taxes. It therefore goes without saying that having a wide list of exemptions is inimical to the primary purpose of an income tax statute, which is the collection of taxes.
Among the complaints of the taxpayers over the years is that the current Act is complicated and uncertain resulting in constant litigation where both the taxpayer and the authorities have been locked in litigation struggling to identify:
(a) The exact measure of taxes payable in the background of a myriad of exemptions and deductions
(b) The procedure that should be followed in regard to the collection and challenging of assessments
(c) The interpretations into what the legislative intent is
These disputes have been generated over the years not only due to the substantive changes made to the tax law but also due to the complicated language used in the law.
The reality is that the gaps and mismatches of the tax laws are exploited to artificially shift profits to low or non-tax locations, thus causing little or no corporate tax to be paid. The many tax exemptions and concessions given are abused so that tax is not paid. Thus, tightening these loopholes has been deemed essential to avoid the exploitation of the concessions given.
Need to strengthen and simplify the law
It is in this background that the need to simplify, modernise and re-write the Inland Revenue Act was recognised by the Government. Thus, the aim of the new legislation is to simplify the law and make it user- friendly so that the taxpayer can effortlessly understand the law with which compliance is required, as well as help administrators to administer the law in the spirit of the law. The simplicity and clarity to the legislation would ultimately ensure that the Government can achieve its goal of collecting taxes, which would contribute to the economic development of this country.
At present, Sri Lanka, which has a total population of 21.1 million people, has only 1.4 million registered taxpayers. This has a twofold negative impact in that the legislature has a tendency of continuously looking to existing taxpayers as a source of revenue and the exclusion of people who should otherwise pay tax, being kept outside the direct taxation system, thus creating a discriminatory tax environment among equals.
The new law therefore makes it imperative that all persons who have a taxable income (Clause 2) must register themselves and make their contribution to the revenue of the country (Clause 102) and thereby the development of our country.
In addition, the categories of taxpayers can be expanded by the Minister (with the consent of the Commissioner General) by recognising new categories of persons who become liable to pay tax (Clause 102(3)).
In strengthening and simplifying the law, the legislature has been mindful that a balance must be struck between protecting the rights of citizens from arbitrary actions by administrative officials on the one hand, whilst providing a lawful as well as effective and efficient means of recovery of taxes on the other.
The proposed law seeks inter alia to rationalise tax expenditure, strengthen the legal framework for tax incentives for investment and reform the avenues of raising revenue.
It has been drafted in such a manner with a view of achieving the following objectives:
(1) Facilitate understandability of the law on the part of the taxpayer
(2) Minimise avoidance
(3) Support the primary aim of greater revenue mobilisation
(4) Ensure international compatibility with new areas such as transfer pricing, treaty shopping and debt bias
In order to modernise the tax law and simplify the same in order to make it more understandable to taxpayers, the language of the new law has been simplified and reorganised. The provisions such as rules that have hitherto become dispersed have now been grouped together.
Treatment of the sources of income for purposes of tax have been separately addressed, technical provisions are distinguished from tax expenditures, procedural rules have been separated from the substantive rules, taxation of special categories have been addressed separately and where necessary, details have been left to be enumerated by way of regulations.
The clear codification of incentives and exemptions improves transparency and will reduce the likelihood of conflicting and overlapping provisions in other laws. This will ensure that different branches of Government do not offer conflicting tax exemptions which can have an adverse effect on the taxpayer and investor.
Specific provisions have been put in place to recognise international agreements relating to double taxation, and provide for international cooperation (Clause 199). Provisions have been added to avoid double taxation of individuals as well as to prevent the abuse of cross-border service arrangements that are presently used to avoid paying taxes and prevent treaty-shopping.
Bringing the Sri Lankan tax regime on par with international norms
The declared policy of the Government is that foreign and local investment to Sri Lanka must be encouraged and that if Sri Lanka is to make the leap to the international arena, it needs to upgrade a plethora of laws, with the fiscal statutes taking the foremost place.
Viewed from that perspective, the proposed Bill contains many features hitherto unseen in the revenue laws of this country but which are prevalent in the corresponding laws of other jurisdictions.
International norms such as taxing residents on worldwide income based on the residence principle and non-residents on the domestic source of income based on the source principle are seen in the existing tax framework of the Sri Lanka.
However, there are no clear definitions of “permanent establishment” (PE) of foreign companies within our jurisdiction. The improvement and strengthening of the laws in relation thereto would be necessary to protect the income tax system from base-erosion. The proposed law therefore brings in the vibrancy required to optimise revenue collection by covering new areas created in a dynamic economy and ensures the law is free of loopholes.
Another important feature is that foreign experts and other non-residents have also been made tax liable under the new law. This reflects the new policy to expand the tax net to include highly-paid foreign professionals who have hitherto worked in Sri Lanka and made tax-free profits.
Consultative process in the drafting of the Bill
The process towards having a new income tax regime was initiated by the Ministry of Finance through a consultative process with the participation of all stakeholders. The Officers of the Inland Revenue Department had been consulted during the entire drafting process, with their views, suggestions and concerns incorporated into the draft Bill. The all-important taxpayer was also consulted, through the numerous Chambers of Commerce in Sri Lanka, as well as through professional organisations and bodies, thus ensuring that the Bill is comprehensive and reasonable.
Purpose of the new Inland Revenue Bill
This Bill seeks to give effect to the Government’s fiscal policy as set out in the 2017 Budget Proposals, which were presented by the Government and approved by Parliament in December 2016.
The jurisdiction of the Supreme Court in determining the constitutionality of a Bill is set out in Article 121 read with Article 123 of the Constitution.
The Legislature has the greatest freedom of classification in tax matters. In view of the fact that the Bill for determination before the Supreme Court is a fiscal statute, the SC will appreciate that the contents of the Bill ought to be viewed and reviewed in the light of the Special Determinations in respect of fiscal statutes.
They submitted that the court has, in a series of Special Determinations, consistently and unequivocally held that in taxation matters, the Legislature has the greatest freedom of classification to determine which category or class of persons should be granted concessions or on whom liabilities should be imposed.
In these circumstances, they submitted that it is not open to the petitioners to allege discrimination on the premise that certain tax exemptions or deductions previously enjoyed by a class of taxpayers has now been removed in the impugned Bill, or that a certain class of taxpayers would now be required to pay taxes at a higher rate under the proposed Bill when compared with the present law.
In other words, there can be no presumption of arbitrariness or unconstitutionality based purely on the contention that the Bill excludes concessions and deductions permitted by the present law.
They submitted that the State has the widest discretion to determine which class of persons it would tax, the applicable tax rates and the exemptions and deductions to which a taxpayer may be entitled. Such provisions as are contained in the impugned Bill would therefore not be inconsistent with Article 12(1) of the Constitution.
In any event, Article 15(7) of the Constitution permits a restriction of the application of Article 12(1) of the Constitution by law, where the ultimate object and purpose of such law is to generate revenue for the State and thereby meet the just requirements of the general welfare of democratic society.
The Legislature enjoys a wide discretion in formulating policy on economic matters. The SC has consistently maintained that matters of policy are best left to such authorities in whom such policymaking power has been vested by law. The Court has therefore been reluctant to intervene in matters of policy unless such policy has been found to be manifestly unreasonable.
Parliament’s control over public finance
It is common ground that the power to impose taxes falls within the scope and ambit of Parliament’s control over public finance, as provided for in terms of Article 148 of the Constitution.
In SC Determination 03/2008 [Annex ‘H’], the Supreme Court determined that there are three vital components that constitute Parliament’s “full control” over public finance under Article 148 of the Constitution, namely control over the sources of finance i.e. imposition of taxes, levies, rates and the like and the creation of any debt of the republic; control by way of allocation of public finance to the respective departments and agencies of Government and setting of limits of such expenditure; control by way of continuous audit and checks as to due diligence in performance.
The respondent submitted that the proposed Inland Revenue Bill was therefore a law enacted in furtherance of Parliament’s control over a source of public finance, and that the Bill as a whole did not violate any of the provisions of the Constitution.