Closing loopholes: Why Sri Lanka must reform IRA to capture offshore indirect share transfers

The biggest challenge in taxing offshore transfers is enforcement. How does the Inland Revenue Department collect tax from a non-resident vendor selling to a non-resident purchaser in a foreign jurisdiction? 

Executive summary

Sri Lanka’s Inland Revenue Act leaves a major loophole that allows multinationals to sell offshore holding companies owning valuable Sri Lankan businesses without paying any local capital-gains tax. The most significant assets telecom licenses, market share, technology platforms and operational infrastructure escape taxation when transferred indirectly through foreign entities.  

India closed the identical gap after the Vodafone ruling by deeming foreign shares taxable when they derive substantial value from domestic assets. Its later Tiger Global decision further showed that a look-through rule must be paired with a genuine substance-based anti-avoidance test to defeat treaty shopping. 

Sri Lanka has yet to enact either reform. As a result, large capital gains generated by Sri Lankan economic activity continue to migrate untaxed to low-tax jurisdictions. The resulting revenue shortfall is met by heavier taxes on SMEs at the rate of 30% and individual taxpayers. This creates an inequitable tax gap that undermines both fairness and fiscal sovereignty. 

Three prospective amendments can close the gap: expanding the definition of domestic assets and source rules, introducing purchaser-led withholding tax with local company liability, and strengthening anti-avoidance rules against low-substance structures. These measures align Sri Lanka with OECD BEPS standards and international best practice. They would shift the tax burden toward value created inside the country rather than extracting it from vulnerable domestic segments. 

Policy makers should therefore introduce this reform package in the forthcoming Budget.

Analysis in detail 

In the high stakes arena of international taxation, the Vodafone case remains a seminal warning to developing nations. It exposed a fundamental vulnerability: the ability of multinational corporations to dispose of multi-billion-dollar domestic business interests through offshore “indirect” share transfers without paying a cent in local tax.

More recently, India’s Supreme Court ruling in the Tiger Global case has added a second warning: even where a jurisdiction captures indirect transfers on paper, treaty-shopping through low substance holding companies can still defeat the intent of the law unless anti-avoidance safeguards are built in alongside it.

For Sri Lanka, as it seeks to stabilise its economy and broaden its tax base, the Inland Revenue Act, No. 24 of 2017 (“IRA”), represents a modern framework, yet it contains a significant structural gap. To safeguard fiscal sovereignty, policy makers must now move to reform the IRA to explicitly capture the realisation of offshore assets that derive their value from Sri Lankan business interests, backed by a robust withholding tax mechanism on the vendor and a genuine substance based anti-avoidance test.

Anatomy of the loophole

The current tax regime primarily targets “domestic assets.” Under Section 195 of the IRA, a “domestic asset” is defined to include shares in a resident company and interests in immovable property (land or buildings) situated in Sri Lanka. Section 195(d) does attempt to cast a wider net by including a membership interest in a body where more than fifty per cent of the value of that interest is derived, directly or indirectly through one or more interposed bodies, from land or buildings in Sri Lanka.

While this provision is a commendable start, it is far too narrow. It only captures offshore entities where the underlying Sri Lankan value is tied specifically to real estate. In the modern digital and service-driven economy, the most valuable Sri Lankan business interests, telecommunications, logistics, manufacturing, and technology derive their value from licenses, market share, and operational infrastructure that do not qualify as “land or buildings.”

Under the current law, if a foreign parent company sells its shares in a Mauritian holding company that owns a Sri Lankan telecom operator, the transaction falls outside the definition of a domestic asset realisation, and the resulting capital gain escapes Sri Lankan taxation entirely.

Learning from Indian precedent: Vodafone and Tiger Global

The infamous Vodafone International Holdings B.V. v. Union of India case centered on a transaction where Vodafone acquired a Cayman Islands company from Hutchison Telecommunications. The Cayman entity’s sole asset was a majority stake in an Indian telecom operator. The Indian tax authorities claimed capital gains tax, arguing the underlying value was Indian. India’s Supreme Court initially ruled in favour of Vodafone, holding that the law did not explicitly cover indirect transfers of shares in foreign companies.

India responded by amending Section 9(1)(i) of its Income Tax Act in 2012, deeming shares in a foreign company to be situated in India where they derive their value substantially from Indian assets – the same “look-through” logic that Sri Lanka’s own Section 195(d) already applies, narrowly, to land-rich entities. (That provision now sits in India’s Income Tax Act, 2025, which replaced the 1961 Act from 1 April 2026.)

But India’s more recent experience shows that closing the domestic-law gap is not the end of the story. In January 2026, the Supreme Court of India ruled in Authority for Advance Rulings v. Tiger Global International II, III and IV Holdings, a case arising from Tiger Global’ s 2018 sale of its stake in Flipkart Singapore, worth roughly INR 14,439 crore, to a Luxembourg entity as part of Walmart’s acquisition of Flipkart.

The Tiger Global entities were incorporated in Mauritius, held valid Tax Residency Certificates, and had offices, staff, and bank accounts there. On the strength of the India–Mauritius tax treaty, they claimed the resulting capital gain was exempt from Indian tax. India’s Authority for Advance Rulings disagreed, finding in 2020 that the structure was a conduit lacking genuine commercial substance, since effective control and decision-making sat with a US-based fund manager rather than in Mauritius. The Delhi High Court reversed that finding in 2024, treating a valid Tax Residency Certificate as conclusive proof of treaty entitlement.

The Supreme Court then reversed the High Court, holding that a Tax Residency Certificate alone does not immunise a structure from scrutiny, that treaty protection under the India–Mauritius DTA was intended for direct transfers of Indian company shares rather than indirect transfers of an offshore holding company deriving its value from India, and significantly  that India’s domestic General Anti-Avoidance Rule could apply even to investments made before 2017 if the taxable exit occurred after GAAR came into force.

The lesson for Sri Lanka is twofold. First, as Vodafone shows, domestic law must be amended to explicitly capture indirect transfers deriving substantial value from local assets, Section 195(d) cannot remain confined to real estate. Second, as Tiger Global shows, that reform is incomplete unless it is paired with a substance based anti-avoidance test, so that a vendor cannot simply interpose a treaty favoured, low-substance holding company between itself and the Sri Lankan asset to claim treaty exemption on a gain the IRA is trying to tax.

The answer lies in extending the mandatory withholding tax framework to the vendor’s gain, remitted by the purchaser. The IRA already possesses a sophisticated withholding and Advance Income Tax framework under Division II of Chapter VIII: Section 84 requires withholding agents to deduct tax from payments such as dividends and interest made to non-residents. A reform to capture offshore indirect share transfers should build on this existing infrastructure

Case for sourcing rules and fiscal sovereignty

The fundamental principle of the IRA is that residents are taxed on worldwide income, while non-residents are taxed only on Sri Lankan-source income. Sections 72 to 74 define the source of payments, treating amounts received in respect of the realisation of a domestic asset as Sri Lankan-sourced. But by limiting the definition of domestic assets to resident company shares or land-heavy entities, the IRA effectively ignores the reality of global corporate layering. When a foreign investor disposes of a Sri Lankan business interest through an offshore vehicle, it is realising value derived from the Sri Lankan market, the Sri Lankan workforce, and Sri Lankan infrastructure. Failing to tax this gain is a surrender of fiscal sovereignty.

Two amendments would close this gap. Section 73 (Source of Income) should be amended to insert an explicit deeming clause: gains from the realisation of shares or interests in a foreign entity would be deemed to have a Sri Lankan source where that entity derives, directly or indirectly, substantial value for example, at least 50 percent from underlying assets located in Sri Lanka. Section 36 (Calculation of Gain or Loss on Realisation) should then be amended to set out a clear valuation formula, so that tax is levied strictly on a proportional basis taxing only the share of the capital gain reasonably attributable to the Sri Lankan underlying value, not the vendor’s worldwide gain.

Implementing the “Vendor WHT”: Ensuring collection

The biggest challenge in taxing offshore transfers is enforcement. How does the Inland Revenue Department collect tax from a non-resident vendor selling to a non-resident purchaser in a foreign jurisdiction? The answer lies in extending the mandatory withholding tax framework to the vendor’s gain, remitted by the purchaser. The IRA already possesses a sophisticated withholding and Advance Income Tax framework under Division II of Chapter VIII: Section 84 requires withholding agents to deduct tax from payments such as dividends and interest made to non-residents.

A reform to capture offshore indirect share transfers should build on this existing infrastructure. The law should mandate that where a non-resident acquires an interest constituting a “deemed domestic asset,” the purchaser is recognised as a withholding agent, required to withhold a percentage of the gross consideration, for example, 10 per cent and remit it to the IRD. This shifts the compliance burden to the purchaser, who in a multi-million-dollar acquisition has every incentive to secure tax clearance to protect the new investment. Without that clearance, the underlying Sri Lankan subsidiary could be held jointly and severally liable for the unpaid tax, ensuring enforceability even when the transaction itself occurs entirely offshore.

This only works, however, if the IRD actually learns that an offshore restructuring has taken place. Chapter XI (Tax Returns and Information Requirements) should therefore be amended to require Sri Lankan target companies to notify the IRD of any change in their direct or indirect upper-tier shareholding  within, say, 30 to 60 days  with the same joint-and-several liability applying against the local operating company or resident purchaser where the non-resident transferor defaults.

Addressing direct vs. indirect disparity

Under current rules, if a foreign investor sells shares of a resident Sri Lankan company directly, the gain is taxable. If the investor instead sells the shares of that company’s offshore parent, it is not. This creates an absurd disparity where tax liability turns on the legal form of the transaction rather than its economic reality.

The IRA already applies transfer pricing rules to ensure transactions between associated non-residents are conducted at arm’s length, requiring detailed Master File, Local File and Country-by-Country Reporting documentation to track how value moves within multinational groups. Extending this same “substance over form” logic to indirect transfers is the natural next step. If the IRD is already equipped to ascertain the arm’s length pricing of service fees and royalties between associated non-residents, it is equally capable of ascertaining the value derived from Sri Lankan assets in an offshore share sale.

Like India’s experience with Vodafone and Tiger Global, this is not merely a technical amendment; it is an assertion of the principle that profits generated from Sri Lankan resources belong, in part, to the Sri Lankan people. The task now falls to policy makers at the Ministry of Finance to ensure that when a corporate investor exists, the nation that helped make that value possible shares in it fairly

Closing treaty-shopping route

A wider deeming rule is not, on its own, enough Tiger Global shows exactly how such a rule can be routed around. Section 35 of the IRA already contains a general anti-avoidance rule, but its mere existence is insufficient without active enforcement and clear administrative guidance. The IRD should issue binding guidance applying Section 35 to offshore indirect transfers, drawing on the substance-over-form approach the Indian courts ultimately adopted in Tiger Global.

Section 75(2) should be amended to expressly provide that gains from offshore indirect transfers deriving their value principally from Sri Lankan assets are taxable in Sri Lanka, and that Section 35 applies to arrangements that use intermediary entities or treaty shopping structures to circumvent that charge. Without this, a vendor holding a Sri Lankan business interest through a treaty-favoured jurisdiction could claim exemption on the strength of residency documentation alone, even where the holding company has no real commercial presence precisely the argument Tiger Global made, and ultimately lost, in India.

Balancing investment with fair taxation

Policy makers often fear such reforms will deter foreign direct investment. But international investors prioritise certainty and clarity over loopholes, and global standards driven by the OECD’s Base Erosion and Profit Shifting initiative are moving firmly toward taxing gains where value is created. To remain competitive and legally sound, Sri Lanka’s reform should be prospective, not retrospective, applying only to transactions occurring after the amendment date, to avoid the protracted legal turmoil India faced; calibrated against Sri Lanka’s treaty network, with the substance test described above rather than a passing assurance that DTAAs will be respected; and threshold-based, applying only to substantial interests for example, where the vendor holds more than 10 per cent of the offshore entity so that small-scale portfolio investors are not caught in the net.

Conclusion: Call for reform

As long as offshore indirect share transfers remain outside the net, the most significant capital gains generated by Sri Lankan business activity will continue to migrate to tax havens untouched. By broadening the definition of domestic assets to include any entity deriving substantial value from Sri Lanka, introducing a purchaser led withholding mechanism to make that right enforceable, and closing the treaty shopping route that cases like Tiger Global expose, Sri Lanka can close this multi-million-dollar gap comprehensively rather than partially.

Like India’s experience with Vodafone and Tiger Global, this is not merely a technical amendment; it is an assertion of the principle that profits generated from Sri Lankan resources belong, in part, to the Sri Lankan people. The task now falls to policy makers at the Finance Ministry to ensure that when a corporate investor exists, the nation that helped make that value possible shares in it fairly.

(The author was awarded Tax Practice Leader of the Year 2024 (ASPAC) by International Tax Review (ITR) and was a top-four finalist for Tax Litigation and Disputes Practice Leader of the Year (ASPAC))