Sri Lanka’s Rs. 2.1 trillion tax arrears: Collect, resolve or remove

Sri Lanka has made significant progress in rebuilding government revenue following the economic crisis. Tax revenue increased from 7.3% of GDP in 2021 to 15.4% in 2025. Yet, behind this recovery lies an uncomfortable figure. Approximately Rs. 2.1 trillion is reported as taxes in default at the end of 2025, as per the findings published in IMF’s revenue administration diagnostic report. 

The obvious question is why the Government is not simply collecting this money? However, the Rs. 2.1 trillion should not be viewed as cash waiting to be collected. Approximately Rs. 1.6 trillion is under dispute, while IMF’s report also raises concerns over the composition and collectability of older arrears.

Before embarking on another collection drive, the Government therefore needs to establish what the Rs. 2.1 trillion actually represents.

Clean the arrears book first

The Inland Revenue Department should undertake a comprehensive internal analysis of the arrears stock, categorising liabilities by age, tax type, dispute status, recovery action already initiated, and likelihood of recovery.

Particular attention should be given to older debt. Section 161 of the Inland Revenue Act No. 24 of 2017 provides that: “Institution of action under this Chapter shall be commenced within five years of the date on which the taxpayer was in default.”

This does not necessarily mean that every tax debt disappears automatically after five years. The critical question is whether the required recovery action was commenced within that statutory period. Nevertheless, where five years have elapsed without such action, the legal recoverability of those amounts needs to be established.

If an amount is legally or practically unrecoverable, there is little merit in allowing it to remain indefinitely within the headline arrears figure. Such amounts should be moved into a separate doubtful or potentially unrecoverable basket and, following appropriate legal review and statutory processes, written off or extinguished where appropriate.

The objective is to arrive at a figure far more useful than Rs. 2.1 trillion: Sri Lanka’s net collectible tax arrears.

Resolve the Rs. 1.6 t dispute mountain

With around three-quarters of reported defaults under dispute, Sri Lanka has a dispute-resolution problem as much as a collection problem.

Cases should be segmented according to value, age, complexity, and prospects of recovery. Large, long-standing cases should receive priority, while relatively straightforward computational and interpretational disputes should be fast-tracked.

There may also be scope for a pragmatic, time-bound settlement program.

For both the Government and affected taxpayers, long-standing disputed arrears have effectively become a sunk cost. The Government has not received the cash, while taxpayers continue to carry unpaid or disputed liabilities. Pursuing the full amount for another five or ten years may produce less value than securing a substantial portion today.

The Government could therefore explore a carefully structured, one-off settlement window. Under this arrangement, taxpayers would receive a defined concession or discount, potentially on accumulated penalties and interest, in return for withdrawing disputes and settling the agreed liability within a short period. Any broader compromise of disputed principal tax would, of course, require a clear legal basis and safeguards.

Sri Lanka has experimented with tax amnesties and settlement measures in the past. The objective should not be another blanket amnesty that rewards non-compliance. Any new arrangement should come only after the arrears analysis, target identified legacy debts, include strict eligibility criteria, and operate for a limited period.

Done properly, this could produce a genuine win-win. Taxpayers could clear legacy liabilities and move forward, while the Government could convert ageing paper assessments into immediate cash. That cash could then support debt reduction, essential government expenditure, or productive economic activity rather than remaining trapped for years in disputes.

Lessons from elsewhere

International practice also demonstrates the value of distinguishing taxpayers who cannot pay from those who will not pay.

Australia permits payment arrangements for taxpayers experiencing financial difficulty, while retaining stronger recovery options where necessary. Compliance history and taxpayer engagement can influence the collection approach.

Canada illustrates the potential of digital debt management. Its tax administration enables taxpayers to arrange payments electronically. 

New Zealand similarly provides instalment arrangements for taxpayers unable to settle immediately and encourages early engagement where payment difficulties are anticipated.

The common principle is simple: intervene early, facilitate payment by viable taxpayers, and act decisively against deliberate defaulters.

Prevent the next Rs. 2 t

Cleaning up historical arrears addresses only part of the problem. Sri Lanka must simultaneously prevent another stock of uncollectible debt from accumulating.

The Rs. 2.1 trillion is not a static stock. It changes continuously as disputes are resolved and fresh assessments create new arrears. This makes the quality of assessments as important as collection. The central issue is whether new assessments represent genuinely recoverable tax or amounts generated through arbitrary or inadequately supported positions. To limit the future build-up of disputed and uncollectible debt, significant assessments should be subject to documented technical and legal review. High-value or high-risk cases should be cleared by a senior-level committee before being issued.

The strategy for addressing the Rs. 2.1 trillion should therefore be straightforward: collect, resolve, or remove.

Collect what is legally enforceable and economically recoverable. Resolve disputed liabilities quickly, including through carefully designed settlements where appropriate. And remove from the headline figure amounts that, following proper legal scrutiny, cannot realistically be recovered.

Sri Lanka has already asked compliant taxpayers to make a substantial contribution towards fiscal consolidation. Further gains should come from making the existing tax system work more effectively.

 (The author is Partner, Head of Tax, Deloitte Sri Lanka and Maldives)