‘Recent Tax Reforms’ – An-in depth analysis

Wednesday, 8 January 2020 00:00 -     - {{hitsCtrl.values.hits}}


The KPMG Academy is organising a discussion forum on ‘Recent Tax Reforms’ to expound on the changes which are taking place in the Sri Lankan tax regime. The forum will be held on 14 January at Ramada Hotel, Colombo where the key presentation will be delivered by Suresh R.I. Perera, Principal – Tax and Regulatory, KPMG. 

Suresh R I Perera  Principal, 

Tax and Regulatory, KPMG

The Government has proposed a tax relief package covering concessions in relation to both direct and indirect taxes including Income Tax VAT, NBT, ESC, and PAL. Any tax amendment has its associated technical complexities and appreciating and grasping such issues is vital for all the stakeholders.   

Some of the quandaries created by the recent reforms are detailed below and will be discussed in extent during the forum. 

VAT return for taxable period ending December

Due to the VAT rate reduction from beginning of December as well as the increase of the threshold post December, the calculation of the accurate VAT liability for the taxable period ending December 2019 and filing the return on 20 January 2020, inevitably would be a challenging and a tedious task for many VAT registrants.

It’s critical to quantify the relevant input tax attributable to supplies and imports that qualify for input VAT claims in the taxable period ending in December in accordance with the VAT rules governing the input VAT claims. The taxpayer should also be in a position to justify the claims with input VAT invoices and customs declarations to substantiate the claims.

For SMEs that would be departing from the VAT system ( whose registration would be inactivated with effect from January), the VAT return for the taxable period ending December would be the final opportunity to claim input VAT entitlement under the Act as these taxpayers would not be eligible to file VAT returns in the future. 

Issues pertaining to VAT 

The reduction of the standard VAT rate of 15% to 8% with effect from the beginning of December 2019, has raised a plethora of associated issues such as the right to claim input VAT pertaining to stocks purchased with 15% VAT, services performed prior to December 2019 but pending invoicing, installments payable after December 2019 in relation to legal contractual obligations created prior to December 2019 including operating leases, deposits and advances paid prior to December in relation to goods and services to be delivered on or after December 2019, the impact on the condominium industry and the real estate is also worthy of analysis, not only in relation to the VAT but on abolition of the NBT as well.

Concept of ‘inactivation’ of VAT registration vs. ‘cancellation’

The term used by the IRD in its notification dated 27 December 2019 to inform the VAT registrants with regard to respective consequent status from beginning of January to implement the Government’s proposal to increase the VAT liable threshold to Rs. 75 m a quarter, is the ‘Inactivation of the registration’ and not the ‘Cancellation of registration’. The two terms are not synonymous and both are distinct statutory terms under the VAT Act carrying differing consequences under the VAT Act. 

The list of inactive registrations include organisations from different industries such as travel, restaurants, construction, packaging, energy, ceramics, garments, hardware, real estate, banks etc.

Small and Medium Enterprises and SVAT

The Inland Revenue Department by notification dated 1 January 2020 informed all Registered Identified Purchasers that if they fall below the threshold of Rs. 75 m per quarter, the SVAT registration will also be inactivated. The notification also required the RIPs (who are below the threshold) to surrender the credit voucher book and to refrain from issuing any credit vouchers post 1 January 2020. This has a major impact on the exporters and indirect exporters alike.

This is one area policy makers may have to revisit whilst considering the plight of the SMEs that may face disadvantages due to moving out of the VAT scheme. Whilst moving out of the VAT net may provide an advantageous position to certain SMEs, this may not be true in all cases. Some SMEs may experience a great disadvantage by moving out of the VAT scheme in that they may miss out on the opportunity to win tenders where a VAT registration is a prerequisite.

SMEs that cannot recoup VAT paid at the point of importation or to suppliers may be compelled to increase the prices or squeeze the profit margins in order to remain competitive in the market. In order to prevent the SMEs being exposed to a disadvantageous position due to the increase of the VAT liable threshold, to become a VAT registrant, the solution that the policymakers should be considering is to permit a ‘voluntary registration scheme’ under the VAT Act. 

Abolition of WHT

Under the Inland Revenue Act, the concept of the WHT is applicable under three distinct sections of the Act. Section 83 to 85 of the IRA deals with Withholding by employer, Withholding on investment returns and Withholding on service fees respectively. Elements of the above sections have been subject to change due to the recent reforms. 

WHT on interest

Rules pertaining to the withholding tax on interest has undergone changes carrying impact on both the recipient of the interest and the withholding agents such banks and finance companies. Distinct rules will be applicable for the period January to end of March of 2020 and thereafter for the new Y/A 2020/2021. Moreover, tax liability attributable to the interest income is also to undergo a change. This would have an impact on individuals receiving interest income compared to the existing regime.   

Individual Income Tax 

Perhaps the most attractive feature of the tax relief package is the relief provided for taxes of the individuals. The reliefs for the individuals in employment will be implemented in two stages i.e. three months from January to March 2020 and the Year of Assessment 2020/2021 thereafter. 

The rules and the procedure for compliance applicable on taxes of persons who are in employment is to undergo a change.  Under the new scheme, all individuals in employment, irrespective of the quantum of the salary will be deriving benefit as per the analysis carried out.

The Inland Revenue Department has introduced tables A to E for deductions of employment tax for the three month period of January 2020 to March 2020. The liability arises for an employee if the ‘Aggregated Gross Payment’ (AGP) for the three-month period is more than Rs. 750,000. 

Table A refers to a ‘cumulative tax table’ to be applied for the excess income. However this is a ‘formula’ and not similar to the table with detailed remuneration and respective tax amounts applied till end December 2019. 

There are also changes in the coverage of each table. For example, the lump sum payments such as Bonus are now covered under ‘Table A’ along with regular profits from the employment. 

The WHT rates applicable for secondary employment has also been revised which will impact all who are working for more than one employer. 

The computation of the tax liability on terminal benefits are addressed in table B.

Income Tax concessions to industries

Income from agriculture, fisheries and livestock and information technology and enabling services are exempt from the Y/A 2019/20. The first tax payment for the Y/A 2019/20 was on 15 August 2019. Two tax installments have already been paid in relation to Y/A 2019/20, hence revisiting the compliance procedure is inevitable for all cooperate tax compliance officers.  This same status holds true in relation to the construction industry where the Income Tax rate has been reduced to 14% from 28% from Y/A 2019/2020.

The Income Tax applicable for the construction industry has also been reduced to 14% from 28% for the Y/A 2019/20.

In cognisance of the above, the Department of Inland Revenue should provide a mechanism to refund or setoff the taxes that have paid for the year.

Removal of taxes from the tax net

Nation Building Tax (NBT) which was introduced in 2009 for a limited period of two years, but continued to apply due to the failure to remove the same, finally departs from the tax net of Sri Lanka with the contemplated reform pending legislation.

NBT, which was a charge on importation, service provision, manufacturing and wholesale and retail sale, overlapped with VAT.  Hence the removal of NBT from the tax net is a rational move in streamlining the tax system when viewed at purely from the perspective of reforming the tax system if the cost of the elimination to the State is not considered.

Economic Service Charge (ESC), a tax on the turnover is distinct from other taxes in that under certain circumstances, it is available as a set off against Income Tax payable. 

In relation to the abolishment of ESC and NBT, there are transitional issues that warrant the attention of the taxpayers and the policymakers.  In addition to the abolishing of NBT and ESC, the Port and Airport Development Levy (PAL) rates have been revised and certain goods imported are now charged at 10% in order to incorporate the loss of revenue due to abolishment of NBT (on importation). The elimination of NBT on imports and the aggregation of the same with PAL may have an impact on manufacturers. The manufacturers who were previously making a claim for input credit under NBT are now faced with an increased tax cost since the tax paid on importation as PAL cannot be claimed unlike NBT. Most of the above changes are being administratively followed as instructed by the Ministry of Finance and the Inland Revenue Department and is pending legislation. Further the RAMIS system would have to be modified to accommodate all above tax reforms to ensure an effective online platform. 

For further information on the forum and registration, please contact the KPMG Academy on T: 011 5426 624 or E: [email protected]