Implementing tax

The passage of the new Inland Revenue Bill is a crucial element of wide-ranging tax reform promised by the Government. The legislation has already been hailed for being simpler and easier to understand but its real test will be compliance. 

People have to pay taxes to fund crucial public welfare needs such as healthcare and education but improving governance will be a critical part of expanding compliance.   

Tax evasion is one of the most common economic crimes, and has been present since the introduction of taxes. The fundamental role of the Tax Administration is to render quality taxpayer services and to encourage voluntary compliance of tax laws, and also to detect and penalise non-compliance. The extent of success of the Tax Administration in its role should be reflected through a higher level of tax compliance and a lower level of tax evasion. 

An adequate tax compliance model is essential for every Tax Administration. The model is based on two elements: attitude to compliance and compliance strategy. The strategy of the Tax Administration should be to create pressure down, or in other words to use the compliance strategy to help taxpayers to pay taxes on one side and to fight against tax evasion on the other. Namely, the vast majority of taxpayers want to comply with their taxation obligation. This is very important because the Tax Administration has to take an adequate compliance model in this respect.

Tax policy and tax administration are the most important part of every tax system reform.

Facilitating compliance requires improving services to taxpayers by providing them with clear instructions, understandable forms and assistance and information as necessary. Monitoring compliance requires the establishment and maintenance of taxpayer current accounts, management information systems that cover both ultimate taxpayers and third-party agents (such as banks) involved in the tax system, and appropriate and prompt procedures to detect and follow up on non-filers and late payments. 

Improving compliance requires a judicious mix of both these approaches as well as additional measures to deter noncompliance, such as establishing a reasonable risk of detection and the effective application of penalties. Successful reform strategies require an appropriate mix of all these approaches.

In Sri Lanka people pay more to evade taxes than to pay them. Poor public financial accountability, especially by politicians and institutions, create a drastic loophole system where people feel justified evading taxes because they feel they are not gaining any benefits. As with fighting corruption the most effective way is to catch large-scale tax evaders to prove to the public that the system is working and it does not only apply to small fry.   

Services to taxpayers that facilitate reporting, filing and paying taxes, or that impart education or information among citizens about their obligations under the tax laws are often as or more cost-effective in securing compliance than measures such as auditing and penalties, which are more directly designed to counter noncompliance. 

The taxpayer service perspective emphasises reducing taxpayer uncertainty by clarifying legal ambiguities, often about issues as simple as the tax rate applicable to certain transactions, communicating clearly what the law is and ceasing to change it so often that no one quite knows what it is.  

With the new legislation in place Sri Lanka will hopefully start a new chapter in inclusive development.