A tax expert’s take on Budget 2016

The Budget 2016 presented in Parliament by Finance Minister Ravi Karunanayake has attracted attention from diverse groups. The Daily FT interviewed Suresh R.I. Perera, a tax consultant, on his perspective on certain significant Budget proposals presented in Budget 2016

Q: What is your take on the Budget proposals over all? 

A: Well, it has been formulated to address diverse issues. It was pointed out how the savings from many areas have been utilised to secure concessions for the benefit of the majority. Symbolic is the abolishment of the vehicle permits issued to minority of the society at a high cost to secure savings to divest to common good. 

The high water mark of the Budget proposals is the achievement of a “low tax regime” status in terms of the direct taxes. Both the low income earners as well as the affluent segment of the society have benefited due to the drastic increase of the tax-free allowance for the individuals. The flat individual income tax rate of 15% makes the country one of the lowest individual income tax rates in the world. The global average individual income tax rate is 31.2 % whereas the Asian average is 27.64% as per KPMG global tax survey 2015. This clearly manifest Sri Lankan 15% individual income tax rate is very low. But the downside is a flat income tax rate introduces “regressive” aspect to the income tax regime as well as has been pointed out by many others. 

The standard corporate income tax rate of 15% is also below the global average income tax rate of 23.64% as well as Asian average corporate income tax rate of 21.91%. Therefore obviously people are happy as their direct tax burden has come down. This means direct tax collection in the future will go down and with the increase of NBT rate to 4% which works in practice as a consumption tax coupled with VAT rate increment to 12.5% Sri Lanka’s direct to indirect tax ratio will further deteriorate beyond its current 19:81. The numbers indicate it would change to 15:85, deviating from the Economic Policy Statement’s expectation of achieving 40:60 ratio in the medium term. The bulk of the tax revenue is expected from NBT.

The Nation Building Tax which was temporarily introduced for a period of two years in 2009, and which should have been abolished in 2011, seems to have found infinite life in the current Budget proposal as the lion’s portion of revenue (40%) from the total Budget proposals is from revisions related to NBT. The NBT is a tax based on ‘turnover’, and is computed by applying 4% on the Turnover which leads to cascading in the areas it is levied on, other than on financial services where NBT is levied on the value addition.

Hence an increase in NBT (other than in banking and financial services), will give rise to the ‘tax on tax’ or ‘cascading effect’. Input NBT credit is available only for transactions between two manufacturers, whereas in invoice credit VAT mechanism VAT is only on value added by each party in the chain. 

The revision of income tax rates downwards result in disposable income of population rising for consumption-related activities. 

Q: How does the Budget impact the financial services industry? 

A: Banking and financial services sector will be paying more taxes, both direct and indirect taxes, to State coffers. The proposed income tax rate applicable to the sector will be 30% which is a 2% addition to the existing rate. It is likely the VAT rate increment to 12.5% will apply to business of provision of financial services as well in addition to NBT rate increment 4%. That’s approximately increase of 3.5% incremental indirect taxes! The doubling of ESC rate to 0.5% whilst removing the ceiling of Rs. 120 m will affect only those entities that will not have sufficient income tax payments to recoup the ESC within the revised time period of three years. 

Further, the qualifying payment relief granted to banks for the cost of acquisition or merger under the Central Bank financial consolidation process has been revoked and will impact the banks who have claimed the qualifying payment deduction. Private equity funds funding SMEs have also been granted 50% tax reduction for five years. 

From a non-tax perspective, the Government has requested the banks to cooperate and be part of the ‘Colombo International Financial Centre,’ drawing parallels to the ‘Dubai International Financial Centre’. Observers will wait with fingers crossed to see the progress of this move. 

Q: Would the tax changes applicable on traders and supermarkets result in changes in prices of consumer goods?

A: Trading companies will also be paying income tax at the rate of 30% in addition to tobacco, alcohol and betting and gaming companies. But I believe policymakers do not intend to extend this higher rate of 30% to small trading companies currently enjoying 12%. They should be liable only at 15%. Extra care is needed at the point of drafting the amending Act to ensure this. 

Though VAT has been removed from whole and retail sale, the sector will have an impact due to cascading NBT increment. The NBT liability threshold has been reduced again to Rs. 3 m per quarter so there will be additions to the number of traders who will be paying NBT also. It is interesting to observe how the supermarkets will adjust their prices from January 2016 in the context of VAT being removed and NBT rate increasing. 

As there is specific exemptions for turnover in the NBT Act for distributors and wholesale and retailers, the effective rate of NBT will differ from standard NBT (4%). Distributors will be liable at an effective rate 2% while wholesalers and retailers (other than a distributor) will be liable at 1%.

Supermarkets also have a large number of VAT exempt products. At present there is a VAT rule that ensures that super markets are called upon to pay VAT on exempt products from their pockets under the concept of “deemed VAT liable supplies” if the value of exempt supplies exceed 25% of the total supplies. Therefore these are tax considerations that would have an impact on pricing. But they will also take into consideration the expected rise in electricity bills due to NBT (electricity not liable for VAT) and other services which will be liable for VAT at 12.5%. So, we might have to wait and watch how supermarkets will react to these changes.

An analyst should also bear in mind that the supermarkets did not change prices in 2013 January substantially notwithstanding the introduction of VAT for the first time. There is a tendency to keep the prices fixed. 

Q: In your view, how do you think the foreign investors will view this Budget?

A: The abolition of the Land Lease Tax and the statement that foreigners will be allowed to acquire land for investment will have a positive impact on Foreign Direct Investment. One needs to observe the manner and methodology of granting permission for foreign acquisitions. So far no indication has been given. Use of the provisions of the new ‘Investment Act’ addressing this issue is also a possibility apart from amending the existing Act. 

Whilst lauding the policymakers for addressing two issues pertaining to the Land (Restriction on Alienation) Act, one would have expected a fair solution for the issue pertaining to a resident company exceeding 50% direct or indirect foreign shareholding (after acquisition of land ) being deprived to the title to the land being addressed. This issue has a policy consideration as well as an impractical mechanism couched in the existing Act. Whilst amending the Act one may hope this important issue would also be addressed in the Amending Act. The time taken for drafting the new Investment Act and amending the Land (Restriction on Alienation) Act is crucial. 

Indications are that the Strategic Development Act will not be used for granting tax holidays in the future nor would the BOI be exercising its powers to grant tax holidays. Foreign investors should also see the moves to abolish dividend withholding tax on dividends payable to foreign shareholders on listed company shares as well as abolition of share transaction levy favourably. Drafters have to be cautious when amending the laws to ensure that sale proceeds of listed shares would continue to be exempt from income tax and stamp duty. 

Restriction of the income tax exemption of interest only if the foreign loan has been granted by a foreign financial institution should be relooked at in the context the country is encouraging foreign borrowing. I think policymakers failing to extend the ECB scheme is an oversight. This should also be addressed in order to facilitate foreign borrowings. 

Although not a tax proposal, there is also a reference to abolishing the Securities Investment Account and to allow investors to bring in money to Sri Lanka through any bank account existing in the banking system. The key feature of SIA is that the investors have the assurance that money brought via the SIA can be remitted back also through the SIA without any requirement for exchange control approval. It is questionable whether the banks can provide the same assurance to investors and also this may be an additional burden for the bank monitoring and compliance as well. Hope this proposal will have a positive effect as expected by the Minister rather than a negative effect. 

Further, it is indeed good news that the Minister of Finance confirmed that the Super Gains Tax will not be imposed in future. This would assist in establishing investor confidence. However, the Government should be mindful not to introduce any retrospective taxes in future (not only SGT) as this causes a massive impact on investor confidence. 

There is also reference to examining non-traditional bond markets and reference to Sukuk bonds as well, which is a welcome move and a move in the right direction. Sukuks will assist to attract FDI and it will also contribute to mega infrastructure development.

Q: What is the impact of the Budget on the real estate industry?

A: No doubt the property developers would welcome the move to exclude the condominium units from the Mansion Tax as this would strengthen their marketing efforts to attract investments into high-end condominium units. 

The elimination of the Land Lease Tax payable up front on lease of lands including condominium units certainly provides relief to developers and expatriates alike. However the prohibition on foreigners acquiring free hold title of the units located in the first three floors are expected to continue without a change. As I mentioned earlier, there is opportunity for identified investments that foreigners would be permitted to acquire land though there are no details provided as yet.

Further there is reference to introducing listed Real Estate Investment Trusts (REITs) and also to eliminate Stamp Duty. This is a good move towards infrastructure development but we hope Parliament can implement the proposed Stamp Duty elimination as it requires concurrence from provincial councils. 

Q: There is reference to simplification of the tax system in the Budget speech, apart from the changes in the tax rates; what are the other areas that would contribute to simplification?

A: Well, the Minister referred to amalgamating certain taxes and levies and also elimination of ‘non relevant nuisance taxes’ as collecting levies from more than 35 taxes and levies is complicated. Such ‘nuisance taxes’ have been identified as Share Transaction Levy, Construction Guarantee Fund Levy, Luxury and Semi Luxury Motor Vehicle Levy and Tourism Development Levy. The loss of revenue from elimination (excluding TDL) is Rs. 5.8 b. Interestingly, no loss of revenue is referred to in the revenue proposals 2016 due to the abolition of TDL. Further, there is reference to RAMIS being implemented from 1 January 2016, which should simplify the tax compliance and administration. We can expect a simplified tax return early next year.

However the Budget proposals 2016 introduces approximately nine new levies – Company Annual Registration Fee, Voluntary Liquidation Fee, Vehicle Valuation Certificate Fee, Fee for Unregistered Vehicles to be Registered, Emission Levy, Environmental Fee, Charge on Sale of International Tickets issued by Airline. 

It seems the Government, apart from NBT, is focusing on collection of revenue through collection of levies and charges as well. Almost Rs. 74 b is expected to be collected from levies and charges.

Q: What is the impact of the Budget on the tourism and hotel sector?

A: All hotels are expected to register with the Tourism Development Authority by 1 June 2016. From a tax perspective, the 1% Tourism Development Levy has been removed. However, the increased rate of VAT and Nation Building Tax would affect the service charges of the hotel. It is noted that hotels are encouraged to establish training schools for skill development of staff and such cost would be given a triple deduction.

There was also reference to provision of State land and granting of half tax holiday for 10 years to establish leisure activities and regions for tourism development in lagging regions. Further as an encouragement to companies engaged specifically in ‘Meetings, Incentives, Conferencing and Exhibitions,’ a 50% tax holiday for five years is proposed. Further, in order to encourage tourist spending, the Port and Airport Development Levy was reduced to 2.5% on certain electronic items.

Another significant proposal that may have an impact on the tourism sector is the abolition of the NBT threshold of Rs. 25 m. This would ensure the small guest houses and rest houses (the informal sector) being liable for NBT.

 

Q: You referred to a fee which companies must pay on annual basis. Your observations on this fee?

A: Yes, it is proposed that private companies will be charged an annual fee of Rs. 60,000 and quoted companies Rs. 500,000 while other companies would have to pay Rs. 100,000. For a small private company the annual fee of Rs. 60,000 may be significant. This proposal should be revisited at least only in relation to small private companies. This fee may be a disincentive for a small businessman to incorporate the business. A company once incorporated must also incur an annual fee for auditors and this would be an additional fee on top of that. 

In relation to this proposal one must appreciate at present tax incentives are being offered to small companies to be listed for the purpose of development of capital market. But moment the company is listed it’s being subjected to a Rs. 500,000 fee payable as annual fee to the registrar of companies. Therefore these two measures are at cross purposes. The solution probably would be to provide a grace period of three years from the date of listing for the application of this annual fee. 

Q: Are there any other proposals pertaining tax issues that could be reviewed?

A: There is a proposal pertaining to imposing a restriction on tax deductibility of research and development expenditure. In developing countries special focus is being given for promoting research by providing tax incentives. Sri Lanka too currently is providing a triple deduction for expenses on research. The proposal seeks to grant the tax deduction only if the expenditure results in technology advancement or yield enhancement. This is a severe disincentive for engaging in research. The nature of research is that it may be successful or not result in favourable outcome at all. But the deduction should not be denied on this ground. 

On the other the expense may incur in a particular year and the results may yield in few years thereafter. By that time the return of income would have been filed for the year in which the expense was incurred and the tax payer would not be in a position to claim the deduction. This proposal should also be re visited prior to being legislated.

In addition, the Budget proposals could have addressed the issue of an Inter-Governmental Agreement with the US Treasury pertaining to Foreign Account Tax Compliance Act (FATCA). This would have provided positive signals to Sri Lankan financial institutions affected by FATCA.