Govt. in the dark as FDI tax incentives become obsolete

KPMG Sri Lanka Principal and Head of Tax and Regulatory Suresh Perera – Pic by Upul Abayasekara

• KPMG Sri Lanka Head of Tax and Regulatory Suresh Perera warns policymakers “in the dark” on sweeping changes to global investment rules
• Tax incentives/holidays granted under existing BOI, Port City Colombo and other investment regimes already being neutralised
• Urges Finance Ministry to lead urgent redesign of incentive framework, warning Inland Revenue Department has neither mandate nor policy role
• Calls for renegotiation of existing tax holidays before investors shift to regional competitors
• Questions why Govt. has yet to endorse BEPS Pillar Two, saying it is unclear whether delay reflects policy or lack of understanding

Sri Lanka risks losing ground in the race for foreign direct investment (FDI) because its tax incentive regime is no longer fit for purpose under the Organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) Pillar Two global minimum tax framework, KPMG Sri Lanka Principal and Head of Tax and Regulatory Suresh Perera warned last week.

Delivering the keynote address at the CA Sri Lanka 5th Annual Economic and Tax Symposium on ‘Positioning Sri Lanka as a Global Investment Hub,’ Perera said the debate on attracting FDI in Sri Lanka had largely ignored the most significant change in international corporate taxation in decades.

“We can’t speak about attracting FDI without speaking about what is happening in the international or global tax arena,” he said, adding that while globalisation, digitalisation, and transfer pricing dominate discussions, “no one is talking about” the implications of BEPS Pillar Two for Sri Lanka’s investment strategy. 

Perera said the OECD reforms have altered the effectiveness of profit-based tax incentives. For multinational groups within the scope of the rules, tax holidays and concessionary tax rates no longer reduce their global tax burden because any tax forgone by Sri Lanka can be recovered by another implementing jurisdiction through the global minimum tax mechanism.

“The benefit that is meant for the investor cannot be enjoyed by the investor. That is being enjoyed by the Government of another country,” he said. “So, there is no point giving tax holidays for these big multinational companies.” 

He also argued that many incentives granted under existing Board of Investment (BOI), Port City Colombo, and other investment regimes had already been neutralised for multinational groups subject to the OECD rules.

“In the past, we have given these tax holidays to many companies. Going forward, with these rules coming, those tax holidays given in the past also become neutralised,” Perera said. 

Perera argued that Sri Lanka’s current incentive architecture remains geared towards smaller investors rather than the multinational enterprises the Government is seeking to attract.

“What we have as tax holidays is only for the small-time investors. We don’t have anything for the high-end investors,” he said. 

He warned that Sri Lanka has yet to recognise the scale of the policy shift taking place internationally.

“Right now, it’s not happening in Sri Lanka. Nobody has thought about BEPS because I think all of us are in the dark with regard to the change that is taking place internationally. Right now we haven’t even thought about it, but when you look at regional countries–Singapore, Malaysia, Vietnam and Indonesia–all of them have done these things. So, we need to basically get ourselves going. Nothing is too late, but we should start now,” he said. 

Perera said the immediate priority should be for the Finance Ministry to determine how much revenue Sri Lanka is currently foregoing under the OECD framework by identifying multinational groups that fall within the scope of the global minimum tax rules, quantifying the top-up taxes being collected elsewhere, and reviewing existing investment agreements.

“There is no point in looking at the Inland Revenue Department (IRD). That is not their job. Their mandate is administering the tax statutes. Who is in charge of our fiscal policy? The Finance Ministry. It has to appoint relevant committees, do the surveys, gather the data, do the calculations, and then we know how much we are bleeding. Then there is a series of activities that we need to do,” he said. 

Perera suggested the Government should design new investment incentives centred on Qualified Refundable Tax Credits and substance-based incentives linked to genuine economic activity, while simultaneously renegotiating existing tax holiday agreements.

“Even if you are going to renegotiate tax holidays, we need to have things to offer for them to give up the tax holidays and bring them to the table. If we don’t do this now, there is a possibility that existing investors may be compelled to relocate,” Perera warned. 

“When it comes to attracting new FDIs, we need to have the relevant tools and relevant incentives,” he added. 

Perera also questioned why Sri Lanka has yet to formally endorse BEPS Pillar Two despite the far-reaching consequences for investment policy.

“For whatever reason, the Sri Lankan Government today has not endorsed Pillar Two. I don’t know whether it is because we don’t appreciate, understand, or whether it’s a Government policy.”

Successive governments have relied heavily on tax holidays to attract foreign investment through the BOI and, more recently, Port City Colombo. However, economists have increasingly argued that macroeconomic stability, regulatory certainty, and policy consistency carry greater weight in investment decisions than generous tax concessions, particularly following the introduction of the OECD’s global minimum tax regime.