Tax policy, administration, and erosion of public trust

When a tax system is complex, opaque, and subject to arbitrary changes, it becomes a fertile ground for corruption, allowing politically connected individuals or businesses to secure preferential treatment and avoid their fair share of contributions to the public finances

•  Sri Lanka’s ongoing struggle with “Corroding Interrelation”

Sri Lanka’s ongoing struggle with “Corroding Interrelation” - the intricate link between economic crimes, human rights violations, and the pervasive challenge of accountability finds its battleground within a legal framework that is both aspirational in its international commitments and, paradoxically fragmented and limited in its domestic application. The lack of domestic grounding has created a compliance paradox: the state adopts international terminology, yet the actual statutory mechanisms remain fragmented, allowing Politically Exposed Persons to exploit the distance between global standards and local enforcement. The recent economic crisis starkly revealed the human cost of this gap. The legal framework acts less as a deterrent and more as a fragmented shield, where it fails to address the deep-seated statutory breakdowns that facilitate state capture in Sri Lanka.

Transparency and simplicity of the tax system are paramount to detect corruption vulnerabilities

Governance and corruption vulnerabilities

Beyond the financial sector, the governance and corruption vulnerabilities inherent in Sri Lanka’s tax policy and administration represent a critical dimension of the “Corroding Interrelation”. Historically, Sri Lanka’s total tax revenue collections have been significantly below international averages, a situation that dramatically worsened following major tax cuts in 2020. While average collections in comparator groups hovered around 15% of GDP, Sri Lanka’s tax to GDP ratio plummeted to mere 7.5%. This severe erosion of the tax base directly undermines the State’s capacity to fund essential public services, thereby directly impinging upon economic and social rights such as access to healthcare, education, and social safety nets. Even in recent reversal or partial reversal of most of these tax cuts, securing sustained revenue generation requires more fundamental changes in the tax policy process.

Sri Lanka’s tax system has been subjected to constant changes, driven by shifting political beliefs and leading to a multitude of sector and taxpayer specific exemptions. The repeated repetition of tax amnesties, coupled with retrospective imposition of additional taxes on compliant taxpayers, has severely eroded taxpayer trust and predictability. This chaotic approach deters long term investment, distorts economic decisions, and complicates tax administration, creating a ripe environment for abuse of power. When a tax system is complex, opaque, and subject to arbitrary changes, it becomes a fertile ground for corruption, allowing politically connected individuals or businesses to secure preferential treatment and avoid their fair share of contributions to the public finances.

The opaque, fragmented, and the discretionary nature of the tax system provides fertile grounds for corruption, undermining revenue generation and eroding public trust. Addressing this “Corroding Interrelation” requires comprehensive and sustained reforms across these critical areas: empowering independent institutions, simplifying and transparently administering tax laws

Transparency and simplicity

The 2020 tax cuts dramatically increased the variation of Corporate Income Tax (CIT) rates across sectors, further facilitating tax avoidance and complicating administration. By introducing zero-rate or highly reduced rates for specific sectors like export services and IT, and then adding new reduced rates for construction, healthcare, and renewable energy, the system created significant economic distortions. Such differential treatment misallocates resources, drawing capital and labour into undertaxed sectors rather than sectors with highest societal productivity. Moreover, it creates increased opportunities for tax avoidance through domestic profit shifting by multi-sector companies, imposing additional social and administrative costs. Transparency and simplicity of the tax system are paramount to detect corruption vulnerabilities. Where numerous fees and taxes apply without clear rationale, and where large segments of the taxpayer population benefit from incentives, the justification for differential treatment becomes obscure. This complexity not only fosters rent seeking and abuse of power but also erodes investor confidence due to unpredictable and untransparent policy interventions. Conversely, a rules-based tax system, grounded in clear and universally understood principles with uniform application, significantly limits opportunities for officials to leverage their authority for personal gain. While the Income Tax Act of 2017 introduced modern anti-corruption provisions, other tax acts lack similar deterrents, creating loopholes.

The fragmentation and lack of centralised decision making within the tax system design and administration exacerbate corruption risks. Multiple Government bodies, including the Department of Fiscal Policy (DoFP), Inland Revenue Department (IRD), Excise Department, Customs Department, and the Board of Investment (BOI), all play roles in shaping and administering taxes. Their often-competing objectives mean that sustained revenue mobilisation is not a consistent priority across all stakeholders. The absence of a centralised, impartial, data driven tax policy unit, with sufficient authority to evaluate and explain the rationale behind all tax policy changes, allows decisions to be made without comprehensive consideration of their social and fiscal welfare implications.

A particularly egregious vulnerability is the reliance on Gazette notifications for implementing major tax policy changes. In principle, primary tax acts, enacted by Parliament, should contain all substantive provisions, with subsidiary instruments merely providing technical details. However, in Sri Lanka, tax rates, the scope of existing taxes and even tax incentives can be altered overnight by ministerial signature through Gazette notifications. The infamous example of the Special Commodity Levy reduction on sugar in October 2020, was alleged to have caused Rs. 16 billion in revenue losses within 5 months, unequivocally demonstrates how this opacity enables large scale economic crimes at the expense of public funds.

Furthermore, the Strategic Development Projects Act (SDPs Act) continues to grant wide ranging tax exemptions without adequate scrutiny. These projects are selected by the BOI and approved by the Investment Ministry, often without clear criteria for “strategic relevance” and without the involvement of DoFP in evaluating the forgone revenue against potential benefits. This lack of transparency and evaluation creates immense potential for corruption, diverting significant public resources to private entities under opaque methods. The abolition or suspension of the SDPs Act is critical until transparent, rules-based criteria are established and comprehensive evaluations of forgone revenue are systematically conducted and published.

Finally, the fragmentation of tax expenditure management and the perceived rampant corruption within Sri Lankan revenue administration further compound these issues. Despite acknowledging widespread corruption, particularly at the points of interaction between revenue officials and the public, there is a striking absence of accountability and consequences for unethical behaviour. The lack of robust internal affairs units, the failure to operationalise codes of ethics, and the rarity of cases against corrupt tax officials, despite widespread allegations, signify a profound breakdown in integrity.

The cumbersome tax return and refund assessment processes, characterised by excessive manual verification and discretionary negotiations between taxpayers and officials, further magnify issues. The failure to fully leverage digitalisation and streamline online filing processes, which could significantly reduce human interaction and discretion, only exacerbates these vulnerabilities.

A rules-based tax system, grounded in clear and universally understood principles with uniform application, significantly limits opportunities for officials to leverage their authority for personal gain

Conclusion

The pervasive economic crimes and human rights violations in Sri Lanka are deeply intertwined with fundamental weaknesses in tax policy administration. The opaque, fragmented, and the discretionary nature of the tax system provides fertile grounds for corruption, undermining revenue generation and eroding public trust. Addressing this “Corroding Interrelation” requires comprehensive and sustained reforms across these critical areas: empowering independent institutions, simplifying and transparently administering tax laws. Only through such concerted efforts can Sri Lanka hope to break free from this cycle of corruption, rebuild its economy, and uphold the fundamental rights of its citizens.

The direct human cost of this impunity, vividly exemplified by the 2022 crisis and confirmed by the Supreme Court’s “Economic Crisis Judgement”, underscores the urgent need for comprehensive reform. To truly dismantle the “Corroding Interrelation”, Sri Lanka must undertake holistic measures. Only through such decisive and sustained actions, Sri Lanka can rebuild public trust, restore economic stability, and genuinely uphold the fundamental rights of its citizens.

In Sri Lanka, tax rates, the scope of existing taxes and even tax incentives can be altered overnight by ministerial signature through Gazette notifications

(The author is an Assistant Manager - Tax Advisory at Bakertilly UAE, holding a LL.B (Honours) degree from University of London. With prior Sri Lankan taxation experience at EY and Bakertilly in Sri Lanka, and later as a UK Tax Consultant, Sheron brings cross jurisdictional expertise in Corporate, VAT, and International Taxation. Her legal experience includes collaborations with various Barristers and Solicitors in England for legal research and practice)