Budget 2026 imperative: Making housing affordable through tax reform

By incentivising private homeownership through tax relief, the burden shifts from public provision to empowered individual ownership

Housing is a fundamental human need. Yet, for many Sri Lankans, the dream of owning a home remains elusive due to rising property prices, volatility of interest rates, and limited access to affordable financing. In this context, it is both timely and necessary for the Government of Sri Lanka to reintroduce housing loan interest as a qualifying payment relief under personal income tax—reviving a policy that once existed in the Sri Lankan income tax Law.

Sri Lanka’s National Housing Policy, revised in 2017, recognises housing as a basic human right and emphasises the Government’s role as an enabler, rather than a sole provider, in facilitating access to adequate housing. The policy advocates for sustainable human settlements, public-private partnerships, and housing finance expansion to meet the growing demand across urban, rural, and estate sectors. However, despite these commitments, the country faces a housing affordability crisis, with demand outpacing supply and a significant portion of the population living in substandard or temporary housing. The Government’s limited fiscal capacity to construct homes for all citizens underscores the need for innovative policy tools, such as tax deductions on housing loan interest, to empower individuals to secure their own housing. This approach aligns with the policy’s enabling framework and supports the broader goal of inclusive, safe, and resilient human settlements. 

While the introduction of a tax deduction for housing loan interest is not a panacea for Sri Lanka’s housing challenges, it represents a pragmatic and implementable measure that can be introduced within a relatively short timeframe. In the broader context of housing reform, this policy tool offers immediate relief to borrowers and complements long-term strategies aimed at improving housing supply, affordability, and financial inclusion.

The 2002–2011 Policy Window and 2014 law changes

Sri Lanka previously recognised the importance of supporting homeownership through tax policy. The Inland Revenue (Amendment) Act No. 10 of 2002 introduced a provision as an amendment to Inland Revenue Act No. 38 of 2000, allowing individuals to deduct housing-related expenditures from their assessable income as a qualifying payment relief, subject to limits. Specifically:

• Section 31(i) permitted deductions for expenditure incurred (not funded by a loan) on the construction or purchase of a first house on or after 1 April 2001.
• Section 31(j) allowed deductions for repayment of capital on an approved housing loan for the same purpose.

An “approved housing loan” was defined as one obtained from the Government, licensed banks under the Monetary Law Act, Provincial Funds, local authorities, or institutions approved by the Minister of Housing.

This relief continued to apply under the Inland Revenue Act No. 10 of 2006 and its subsequent amendments until 1 April 2011.

The tax reforms introduced in 2011 were largely shaped by recommendations from the Presidential Taxation Commission, which had submitted its report to the President in 2010. While these reforms aimed to simplify tax administration and reduce the number of personal tax files—particularly by exempting individuals with employment, dividend, and interest income from filing returns due to withholding at source—the removal of housing loan interest relief was not a direct policy decision. Instead, it became an unintended consequence of the broader simplification agenda.

Though administratively efficient, the implementation overlooked the wider impact—effectively eliminating a key tax relief for a large segment of taxpayers without adequate parliamentary debate or public consultation. This policy gap stands in contrast to the principles outlined in Sri Lanka’s National Housing Policy, which emphasises enabling homeownership and financial empowerment. The removal of tax relief has placed a heavier financial burden on working professionals and wage earners, undermining efforts to make housing more affordable.

Interestingly, in 2014, targeted tax incentives were introduced for a select group— “defined professionals.” These included:

• A deduction on the capital repayment of housing loans under qualifying payments (Section 34(2)(w)). The provision read as follows;

(w) any expenditure incurred not exceeding six hundred thousand rupees for any year of assessment commencing on or after April 1, 2014 on the repayment of the capital of a loan obtained from any bank licensed under the Banking Act, No. 30 of 1988 or any finance company licensed under the Finance Business Act, No. 42 of 2011, of which the proceeds are utilised to construct a house or to purchase a house or a unit of a residential apartment complex, by an individual who is a professional and who furnishes a return under section 106, whether such individual obtained such loan alone or together with any other individual: Provided that, if such loan is obtained together with another individual or obtained for a co-owned property, such deduction shall not exceed the amount of expenditure attributable to such individual who obtained such loan

• A concessionary tax rate for banks (Section 59G), reducing their tax liability by 50% on interest earned from housing loans extended to these professionals, with the expectation that banks would pass on the savings through lower interest rates.

However, the practical impact of these measures has been limited. Many financial institutions did not adjust their lending rates, and professionals themselves often remain unaware of their eligibility. This disconnect points to a broader issue: the lack of effective communication and understanding of tax law—not just among the general public, but within the professional and financial sectors as well. It’s not the complexity of the law that’s the barrier, but the failure to communicate its benefits clearly. 

Thereafter, the Inland Revenue Act of 2017 was introduced, repealing the Inland Revenue Act No. 10 of 2006. 

Tax relief landscape under Inland Revenue Act No. 24 of 2017

When evaluating whether property-related expenses are eligible for tax deductions, the key determinant is the intended use of the asset—whether it’s for personal occupancy or income generation.

If a house, apartment, or land is acquired and subsequently leased to earn rental income, the interest paid on the loan used to finance the purchase can be claimed as a deductible expense against that rental income. However, the initial cost of acquiring the property itself is not deductible. Additionally, if the rental income is categorised as investment income—typically the case when the individual owns only one leased property—capital allowances (depreciation claims) on the building are not permitted. That said, a standard deduction of 25% on rental income is allowed as a rent relief.

In contrast, if the taxpayer can demonstrate that they are engaged in a business of leasing, the tax implications would change. 

On the other hand, if the property is purchased for personal use, such as a residence, neither the acquisition cost nor any related expenses (including loan interest) are deductible for income tax purposes (currently).

While the introduction of a tax deduction for housing loan interest is not a panacea for Sri Lanka’s housing challenges, it represents a pragmatic and implementable measure that can be introduced within a relatively short timeframe. In the broader context of housing reform, this policy tool offers immediate relief to borrowers and complements long-term strategies aimed at improving housing supply, affordability, and financial inclusion

Under the Inland Revenue Act No. 24 of 2017, housing loan interest was allowed as expenditure relief, between 1 January 2020 and 31 December 2022. Sri Lanka’s tax law allowed resident individuals to claim expenditure relief up to Rs. 1.2 million per year (and Rs. 900,000 for the nine months from April 2022 of the 2022/23 Year of Assessment). This relief covered a range of personal expenses, including interest paid on housing loans, health and education costs, pension contributions, and investments in listed securities. However, this provision was temporary and not classified as a qualifying payment, and it was discontinued after 31 December 2022. Its removal has left a gap in tax support for individuals financing their homes, especially amid rising interest rates and inflation.

While general housing loan interest deductions have been discontinued, the Inland Revenue Act currently provides a specific expenditure relief for individuals who invest in solar panels. Effective from 1 April 2021, resident individuals may deduct up to Rs. 600,000 per year of assessment for the cost of solar panels fixed on their premises and connected to the national grid. This relief also applies to loan repayments made to banks for acquiring such panels. Though commendable for promoting sustainable energy, this provision is narrow in scope and does not address the broader financial burden of homeownership faced by most Sri Lankans.

Accordingly, currently under the Inland Revenue Act No. 24 of 2017 for a person purchasing a house for his/her personal use is not eligible for a tax deduction on housing loan interest or on capital expenditure for constructing a house. 

Why housing loan interest should be granted as a tax deduction/qualifying payment relief?

The Government should take proactive steps to empower individuals in their pursuit of homeownership. One such measure is to allow a tax deduction on housing loan interest for properties purchased for personal use—whether a house, apartment, or land. While this alone may not resolve the housing affordability challenge, it can significantly ease the financial burden on aspiring homeowners and make the goal of owning a home more attainable.

Beyond individual benefits, such a policy would have a multiplier effect on the economy. Increased demand for housing would stimulate activity in the real estate and construction sectors, leading to job creation across a wide range of industries—from building materials and interior design to legal and financial services. This ripple effect would contribute to GDP growth, enhance investor confidence, and support the development of sustainable urban infrastructure.

1.Housing is a public good

The Government is not in a financial position to provide housing for all citizens. By incentivising private homeownership through tax relief, the burden shifts from public provision to empowered individual ownership.

2.Encourages formal borrowing

Recognising housing loan interest as a qualifying payment encourages individuals to borrow from regulated financial institutions, promoting transparency and financial discipline.

3.Supports middle-income families

The deduction would especially benefit middle-income earners, who often fall between eligibility for public housing and affordability of private housing.

4.Stimulates the housing sector

Tax incentives can boost demand for housing, thereby stimulating construction, real estate, and related industries, contributing to GDP growth.

5.Aligns with global best practices

A tax deduction for the interest on housing loans is a common phenomenon in most countries to encourage housing for citizens. 

India offers substantial tax relief for homeowners under its old tax regime, including up to INR 200,000 per year (LKR terms 680,000 approx.) on interest payments (Section 24(b)) and INR 150,000 (LKR terms 510,000 approx.) on principal repayments (Section 80C). Additional deductions for first-time buyers were previously available under Sections 80EE and 80EEA. Joint borrowers can double these benefits if both are co-owners. However, under the new tax regime, it offers lower tax rates but removes most deductions, including those for home loan interest and principal repayment. The taxpayer has the right to choose either the old or new tax regime on an annual basis. 

South Korea provides income tax deductions for housing and long-term mortgage interest payments under its personal income tax system, primarily aimed at wage earners who either do not own a home or own only one house of a certain size. To qualify, individuals must also be subscribed to a government-recognised housing savings program. As of 2024, the maximum deduction for mortgage interest repayments is KRW 20 million per year (in LKR terms Rs. 4.2 million approx.)

Japan offers a robust Housing Loan Tax Deduction system, officially known as the Special Deduction for Housing Loan. Homeowners can deduct 0.7% of their year-end mortgage balance from their income tax and resident tax for up to 13 years, provided the loan is for purchasing, constructing, or renovating a home they occupy within six months. The loan must have a minimum repayment period of 10 years, and the property must meet specific floor area and energy efficiency standards.

Many other countries such as Malaysia, the Netherlands, Norway, Sweden, etc. also provide some form of tax relief for housing loan interest. 

While Singapore does not offer direct income tax deductions for housing loan interest, it provides generous housing subsidies through the Central Provident Fund (CPF) system. CPF contributions can be used to repay both principal and interest on housing loans, effectively reducing the financial burden without altering income tax liability.

Budget 2026 – policy recommendation

With the Budget 2026, announced on 7 November, the policy makers should deeply consider providing tax relief for housing loan interest. The above examples show that housing loan tax relief is a widely accepted policy tool across many foreign jurisdictions to promote homeownership, especially among middle-income earners. Sri Lanka can draw from these models to design a targeted and equitable tax deduction framework, aligning with its national housing policy and economic realities. This concession will help boost the real estate and construction industry as well.

In light of the evolving housing landscape and the need to promote equitable access to homeownership, it is imperative that policymakers revisit the tax treatment of housing loans under the Inland Revenue Act. The following measures are proposed to enhance affordability, incentivise investment in housing, and retain skilled professionals within the country:

• Introduce a deduction for housing loan interest: Recognise interest payments on housing loans as a qualifying deduction. The deductible ceiling should be periodically reviewed to reflect prevailing interest rates and property market dynamics, ensuring the relief remains meaningful and relevant.
• Reinstate concessionary tax incentives for financial institutions: Similar to the 2014 framework, offer a reduced tax rate or a tax credit to banks on the interest income earned from housing loans. This incentive should be structured to ensure that the benefit is passed on to borrowers through lower interest rates, thereby improving affordability without compromising fiscal prudence.
• Targeted relief for professionals: To acknowledge the contribution of the professional workforce and address the growing concern of brain drain, a tailored concession should be considered. This could include allowing both capital repayments (up to a defined limit) and interest payments on housing loans as deductible expenses for professionals. Such a measure would not only support homeownership among skilled individuals but also reinforce national efforts to retain talent.

These recommendations aim to strike a balance between fiscal responsibility and social equity, aligning tax policy with broader economic and housing objectives. A well-designed housing loan relief framework can serve as a catalyst for financial inclusion, professional retention, and sustainable urban development. Recognising housing loan interest as a qualifying payment is not just a fiscal adjustment—it is a social investment in stability, dignity, and economic growth.

(The writer is Principal – Tax and Regulatory, KPMG. The views and opinions expressed in this article are those of the author.)