Sri Lanka’s digital tax shift: Balancing revenue needs with innovation and growth

Overregulation without parallel incentives may inhibit Sri Lanka’s ability to build a globally competitive digital economy

Sri Lanka is in the midst of a critical transition as it begins to reshape its tax system to reflect the realities of a growing digital economy. With rapid digital adoption across sectors from e-commerce and online advertising to streaming platforms and software-as-a-service providers it has become clear that the country’s tax regime must evolve to capture this expanding domain. In recent years, the Government has initiated a series of steps to bring digital platforms under its tax net, aligning with international trends and the country’s urgent domestic revenue needs.

One of the most notable changes was the extension of Value Added Tax (VAT) to digital services provided by foreign companies to local consumers. Global giants such as Facebook, Google, Netflix, Spotify, and Amazon Web Services are now required to register for VAT in Sri Lanka if their services are consumed domestically. This move brings Sri Lanka in line with more than 80 countries that have introduced some form of indirect tax on cross-border digital services.

Effective 1 October 2025, Sri Lanka’s Inland Revenue Department, under the Value Added Tax (Amendment) Act, No. 04 of 2025, is implementing a mandatory VAT regime for non-resident entities providing digital services to Sri Lankan consumers via electronic platforms. The goal was to ensure that digital businesses especially foreign-owned companies operating without a physical presence contribute fairly to the national tax base, just like their local counterparts. At the same time, there has been increased scrutiny on Sri Lankan freelancers, social media influencers, digital marketers, and small-scale online businesses, particularly as many of these individuals generate foreign exchange earnings via global platforms.

Broader implications 

While these measures are intended to address fairness and raise much-needed revenue, the broader implications for the country’s digital economy are complex. Taxing foreign digital players creates a level playing field for local service providers and strengthens the legitimacy of Sri Lanka’s tax regime. Until recently, Sri Lankan tech startups and advertising agencies were taxed while foreign platforms were not. This imbalance placed domestic businesses at a disadvantage and encouraged capital outflows. Correcting this through fair taxation is a necessary step to protect local enterprise and encourage reinvestment within the economy.

Moreover, there is a significant fiscal rationale behind taxing the digital economy. Sri Lanka is under pressure to boost tax revenues, with the country’s tax-to-GDP ratio hovering around 9%, one of the lowest in South Asia. By comparison, India’s tax-to-GDP ratio is approximately 11.7%, while Thailand stands at around 16.5%. Expanding the tax base to include digital services particularly high-volume foreign providers could yield meaningful revenue. For example, India collected over INR 4,000 crore ($ 480 million) from its Equalisation Levy on digital companies in 2021–2022 alone. If Sri Lanka structures its framework efficiently, even a fraction of that revenue could significantly contribute to its digital infrastructure, education, and e-governance projects.

Challenge lies in implementation

However, the challenge lies in implementation. Poorly designed digital taxes could discourage investment, stifle innovation, and increase costs for consumers. One immediate concern is affordability. If foreign companies pass the VAT burden onto end users, services like Netflix, YouTube Premium, online advertising, cloud storage, and e-commerce platforms may become more expensive for ordinary Sri Lankans. With a large youth population depending on digital platforms for education, entertainment, and small business operations, even a marginal price hike could impact accessibility and usage.

Startups and SMEs could be especially vulnerable. Many local digital entrepreneurs rely on cost-effective access to platforms such as Google Ads, Meta, Amazon Web Services, and Zoom to operate and scale. If these costs rise due to taxation, small businesses may be forced to cut back on digital investments, reducing their competitiveness. Additionally, new compliance obligations could overwhelm small freelancers and micro-entrepreneurs who lack accounting expertise, potentially pushing them back into the informal economy.

The bigger concern is that overregulation without parallel incentives may inhibit Sri Lanka’s ability to build a globally competitive digital economy. The country has set a goal of achieving a $ 15 billion digital economy by 2030. Achieving this target requires not only fair taxation but also policies that nurture innovation, reduce barriers to entry, and encourage entrepreneurship. If digital taxation becomes punitive or complicated, it could slow the very sectors that are expected to drive future growth.

Global examples provide critical lessons

Looking at global examples provides critical lessons. India offers perhaps the most relevant regional comparison. In 2016, India introduced a 6% Equalisation Levy on online advertisements sold by non-resident companies. This was expanded in 2020 to include a 2% levy on e-commerce transactions by foreign entities. These steps have helped generate consistent revenue, but also brought friction. The United States Trade Representative launched an investigation, accusing India of unfairly targeting American firms. India, however, stood by its position and later aligned with the OECD’s global minimum tax framework, which proposes a 15% minimum tax on large multinational companies.

Other South Asian nations are also moving in this direction. Bangladesh introduced VAT on digital services provided by non-resident companies in 2021 and began collecting taxes from companies like Facebook and Google by 2022. Nepal introduced similar digital service tax policies, and by 2023, major international platforms were registered with their tax authorities. The momentum in the region reflects a growing consensus that the digital economy cannot remain outside traditional tax systems.

Southeast Asia provides further useful models. Singapore introduced GST on cross-border digital services in January 2020. However, what sets Singapore apart is its balanced approach. While introducing digital taxes, it also heavily supports its local digital sector through tax exemptions, co-funding schemes, startup accelerators, and grants via Enterprise Singapore and the Infocomm Media Development Authority (IMDA). This dual approach ensures taxation does not come at the expense of innovation or competitiveness.

Australia, too, opted for consumption-based taxes, requiring foreign digital platforms to collect Goods and Services Tax (GST) on sales to Australian consumers. This model, focused on indirect taxation, avoids targeting specific companies while ensuring broad tax collection. It has proven relatively non-disruptive and easy to administer.

In the European Union, countries like France, Italy, and Spain imposed a Digital Services Tax (DST) of 3% on revenues earned from user data and targeted digital advertising. However, these taxes drew sharp criticism from the United States and triggered bilateral trade tensions. Most EU countries now await the global OECD framework to replace their DSTs with a more harmonised system. This example demonstrates the geopolitical risks of digital taxation, especially when it disproportionately affects foreign companies from powerful economies.

Thoughtful policy design

For Sri Lanka, avoiding such risks requires thoughtful policy design. Any new digital tax must be transparent, non-discriminatory, and aligned with global standards. The government should prioritise building capacity within the Inland Revenue Department to handle complex digital transactions and support small businesses in adapting to new compliance rules. Technology-based tax collection tools, simplified online registration for VAT, and educational campaigns for digital entrepreneurs will be critical in easing the transition.

In addition, the Government should consider offsetting new taxes with targeted incentives for local tech firms and startups. For example, tax holidays for early-stage digital companies, R&D tax credits, and public-private partnership funds for digital transformation would help maintain growth momentum. A startup earning less than LKR 10 million in revenue should not face the same compliance pressure as a multinational earning billions. Differentiation and proportionality must be part of the policy framework.

To build long-term resilience, Sri Lanka should also actively participate in global tax discussions, including the OECD/G20 Inclusive Framework on BEPS. By aligning with international standards, Sri Lanka can ensure that its tax policies are future-proof, fair, and attractive to responsible foreign investors. Regional collaboration with India, Bangladesh, and Southeast Asian neighbours can also enable best-practice sharing and coordinated approaches to digital taxation, especially for cross-border transactions.

Ultimately, digital taxation in Sri Lanka is not merely a fiscal issue.it is a question of national strategy. A well-crafted tax framework can boost government revenue, formalise the digital sector, and create a fairer marketplace. But to truly unlock the potential of the digital economy, taxation must be part of a broader digital policy that includes education reform, connectivity infrastructure, investment promotion, and innovation support. With the right balance of regulation and encouragement, Sri Lanka can turn its digital tax policy into a tool for inclusive growth, resilience, and long-term prosperity.

(The writer is a seasoned, vibrant and result-oriented professional with 30+ years of rich experience covering digital, ICT solutions, marketing, innovation, development, integration and market development in global prestigious organisations.)