End of SVAT and transition to risk-based VAT system

After 14 years of operation, the Simplified Value Added Tax (SVAT) system will be replaced on 1 October by the typical VAT refund system like in most of the countries. For almost a decade, a number of Governments announced their intentions to abolish SVAT, but staunch opposition was expressed towards changing the status-quo by trade/business associations, especially the exporter community.

Ending more than a decade-old mechanism, which is strongly endorsed by the overwhelming majority of the island’s business community, is politically quite challenging and hence, the changeover was continuously delayed by one Government after the other in response to extensive appeals from business chambers. Nevertheless, repealing SVAT was intensely insisted by the IMF and undertaking the reform is considered as a key requirement of the Extended Fund Facility arrangement with the multilateral lender.

The outgoing system was introduced in 2011 with the objective of allowing businessmen to avoid paying VAT upfront during B2B transactions and then spending a considerable amount of effort and time to obtain refunds from the Inland Revenue Department (IRD), which is known for its lethargy and inefficiency. Due to the absence of an effective and credible mechanism for VAT refunds, trade chambers repeatedly opposed doing away with SVAT.

According to the IMF, VAT revenue performance in Sri Lanka remains persistently low, and it is well below regional averages. The Washington-based lender has repeatedly opined that SVAT, which is self-regulated by taxpayers, contributes significantly to the poor VAT revenue performance in Sri Lanka.

Meanwhile, the IRD had asserted that repeal of the SVAT will generate an estimated additional VAT revenue of Rs. 191 billion. The prime concern among the exporter community is whether the new system would cause undue delays in refunds, leading to additional financial costs. But leading officials of the IRD have vowed eligible exporters with low and medium-risk profiles will be able to recover their VAT refunds within an expedited 15-day period under the new risk-based refund system. 

However, the recent warning by the World Bank that Revenue Administration Management Information System (RAMIS), which was introduced in 2016 to modernise tax administration, was facing serious risks due to weaknesses in IT capacity, governance, and vendor management at the IRD would only heighten the fears of the exporters. The premier state revenue-collecting department has a very tainted reputation with regard to corruption. It was only few months ago a deputy commissioner at the IRD was arrested for allegedly soliciting a bribe of Rs. 50,000 from a businessman.

The island’s largest export sector – the apparel industry – expressed its strongest objection towards the abolition of SVAT on numerous occasions, pointing out various drawbacks the premier export industry would experience in a no-SVAT environment. Earlier, the Joint Apparel Exporters Forum (JAAF) remarked that exporters would stop buying local inputs and working with domestic subcontractors in the event SVAT is repealed as that would become more expensive than sourcing imported inputs or subcontracting for foreign factories. Moreover, the leading industry association cautioned that Sri Lanka’s export trading houses would move overseas to maintain competitiveness after SVAT is done away with.

To overcome the concern with VAT refund delays, exporters have urged the introduction of electronic invoicing (e-invoicing) like in countries such as Vietnam, Indonesia, and India to reduce manual bottlenecks and expedite refunds. Exporters fear that without e-invoicing, there could be a repeat of chronic VAT refund delays like in the past, undermining the competitiveness of the industry.

Revenue-based fiscal consolidation is critical as part of the IMF-backed economic reforms and repealing SVAT is a main component of the fiscal policy adjustments. Over the last two years, exports have demonstrated a strong rebound. Hence, the IRD needs to be mindful of the concerns of exporters about the transition to the new system and ensure that recovery of exports is not affected by VAT-related bottlenecks.