Evolution of rules for taxation of individuals

Many are aware that a major overhaul in taxation took place in relation to the taxation of individuals when the Inland Revenue Act No. 24 of 2017 was introduced effective 1 April 2018.  The changes in the scope of taxation of individuals in the last few years is an interesting study. 

The tax liability of an individual depends on variable factors and fixed rules.  The variable factors that affect the tax liability of an individual are income earnings, amounts of deductible expenses, gains on disposal of assets, etc. The fixed rules one needs to be mindful are the Income Tax slabs, tax rates, tax free allowances now granted in the form of reliefs, rules pertaining to qualifying payments, exemptions, etc. In calculating the taxable income of an individual, expenses incurred subject to deductibility rules provided in the Act could be deducted by individuals other than individuals in employment.

This article attempts to focus on the transition of certain fixed rules (i.e. tax slabs, tax rates, tax free allowance/personal relief) in the last few years and the impact stemming from such changes.  

The fixed rules applied in Y/A 2017/18 stemming from IRA 2006

Under the Inland Revenue Act No. 10 of 2006 (IRA 2006), one may recall that the taxation of individuals could be classified broadly into three categories – employees, professionals in practice and self-employed/others. 

Each category experienced different tax treatments either by way of the tax slabs, tax rates or tax-free allowance and these had evolved over the years. If we consider the rules in the year 2017/18 which was the last year governed by the IRA 2006, the professionals in practice and individuals in employment were taxed at varied progressive rates but subject to the highest slab tax rate of 16%, while for others the highest slab tax rate was 24%. 

For comparative purposes if we consider a professional in practice and an individual in employment there was significant disparity in the application of the fixed rules. A person in employment enjoyed a tax-free allowance of Rs. 750,000 p.a. (including the general tax-free allowance of Rs 500,000) in Y/A 2017/18 and was taxed at the slabs of Rs. 500,000 at rates of 4%,8%,12% and 16%. Accordingly, a person in employment was taxed at the highest rate of 16% for income above Rs. 2.25 million a year.

A professional in practice enjoyed much more benefits based on the wider slabs provided in the Law. The tax-free allowance was Rs. 500,000. Thereafter the applicable rates for income up to Rs. 1 million (in Rs. 500,000 slabs) were 4% and 8%. The similarity in tax slabs ended there. The next slab was Rs. 24 million at 12% and next 10 million was taxable at 14%. Any income thereafter was subject to tax at the rate of 16%. Accordingly, a professional in practice would need to pay at the highest slab rate of 16% only if income exceeded Rs. 35.5 million. 

The individuals falling within the category of self-employed/other was entitled to a Rs. 500,000 tax free allowance and was subject to tax on Rs. 500,000 slabs at the progressive Income Tax rates of 4%,8%,12%,16%,20% and 24%.

Introduction of the new Income Tax Law in April 2018 

The Inland Revenue Act No. 24 of 2017 (IRA 2017) introduced with effect from 1 April 2018 introduced a framework of equal slabs and rates to all individuals. The personal relief (formerly known as tax free allowance) was Rs. 500,000 p.a. for all individuals (other than nonresident-non citizens) and an individual in employment was entitled to an additional employment relief of Rs. 700,000 p.a. 

Application of certain tax reliefs under the IRA 2017 varied as per the individual’s status of residency for Sri Lanka tax purposes. Income Tax at progressive rates from 4 to 24% was applied on tax slabs of Rs. 600,000 for all irrespective of whether they were employed, self-employed or professionals in practice. These changes had a major impact on the professionals in practice since the width of the slab was slashed drastically when compared to the laws under the IRA 2006. Hence one may concur that with the introduction of the 2017 Income Tax Act, equality prevailed in relation to the application of tax slabs and tax rates for all individuals. 

Proposals as per web notifications 

Thereafter from 1 January 2020 further tax changes were notified in relation to personal income tax via web notifications issued by the Commissioner General of Inland Revenue (CGIR) where the Income Tax slabs were enhanced up to Rs. 3 million per annum and the tax rates were revised to 6, 12 and 18%. The personal relief was also increased to Rs. 3 million per annum and this applied to all individuals (other than a nonresident – non citizen). The employment relief is now embedded as part of the personal relief. So, from 1 April 2020 onwards any person who has income more than Rs. 3 million income will be subject to tax (if no exemptions apply) at the rate of 6%, more than Rs. 6 million at 12% and if more than Rs. 9 million they would be paying tax at the highest slab rate of 18%. 

One cannot deny that certain changes introduced such as the removal of final withholding status on interest, dividend and removal of senior citizens relief did impact severely on a certain cadre of taxpayers which warrants a separate study and maybe a subject for another article. 

The application of rules as dual regimes in Y/A 2019/20

The Year of Assessment 2019/20 where the extended time granted for filing of Return of Income falls on 28 February 2021 has the application of rules from dual regimes of Income Tax law. The tax computation for the Year of Assessment 2019/20 is indeed complex since it is a transition year and rules as per IRA 2017 as well as the rules proposed in the web notifications apply. For the nine months up to 31 December 2019 rules as per Inland Revenue Act No. 24 of 2017 would apply while for the three months from January to March 2020, the rules as per the web notifications issued by the Inland Revenue Department are followed. Hence the tax reliefs, tax slabs should be considered proportionately. 

In the last four years, the transition focus has been to gradually achieve a status where all individuals enjoy equal personal relief, tax slabs and tax rates. In addition, there are other reliefs such as rent relief, expenditure relief and qualifying payment reliefs also that one can enjoy. The Asian average for personal Income Tax is 28.67% (2020) while the global average is 31.16% (2020) as per the KPMG individual interactive tax rate tool. The individual tax rates of 6%,12% and 18% (progressive rates) are no doubt one of the lowest rates in the Asian region.  

There are many other areas in individual taxation such as exemptions, reliefs, qualifying payment reliefs granted which are not covered in this article as the focus is solely on the evolution of rules pertaining to Income Tax slabs, Income Tax rates and the tax-free allowance/ personal reliefs in the recent years across three regimes (i.e. IRA 2006, IRA 2017 and changes proposed via web notifications).

(The views expressed in this article are the author’s own and in her personal capacity. Rifka Ziyard (MBA, FCMA, CGMA, FTII, B Com) is the Director – Tax and Regulatory at KPMG. She is a Fellow Member of the Chartered Institute of Management Accountants, UK, Chartered Global Management Accountant (CGMA), Fellow member of the Sri Lanka Institute of Taxation, and holds an MBA from the University of Colombo and a Bachelor of Commerce from the same University.)