A FAIR FRAMEWORK IS A SINE QUA NON

Q: Sri Lanka’s tax revenue has risen sharply in recent years. Has the country reached a point where the emphasis should shift from raising more taxes to making the existing system work better and fairer by taxpayers?

A: The country has successfully comple­ted the revenue mobilisation phase of its post-crisis recovery, and is now reaching the point where the emphasis should increasingly shift towards improving tax administration, compliance and fairness.

The country’s tax to GDP ratio has reco­vered significantly from crisis era levels and government revenue performance has exceeded several IMF programme targets. 

Much of this improvement has been driven by VAT increases, broader tax bases and stronger collection efforts. The challenge now is ensuring that the burden is distributed more equitably and the system encourages voluntary compliance rather than relying primarily on higher rates.

And the next stage of reform should focus on expanding the tax base, reducing informality, improving taxpayer services, modernising Revenue Administration Management Information System (RAMIS), accelerating refunds and dispute resolution, and using data analytics to identify noncompliance. 

The challenge now is ensuring that the burden is distributed more equitably

Charmaine Tillekeratne

A well administered system that taxpayers trust is ultimately more sustainable than repeatedly increasing rates on the same compliant taxpayers.

Q: The clock now runs longer for VAT offences (to as many as 12 years) and penalties have been increased by an average 40 times, according to some reports. How do you view this scenario?

A: The extension of the limitation period to 12 years and the substantial increase in penalties reflect a clear policy decision to strengthen tax enforcement, and deter deli­berate tax evasion.

Given the scale of value added tax fraud risks and fraudulent refund claims internationally, the rationale for providing the Inland Revenue Department (IRD) with a longer enforcement window is understandable. 

However, the effectiveness of these me­asures will depend heavily on how they are applied. Strong penalties are justified where there is fraud, concealment or wilful evasion. 

Businesses will nevertheless expect assu­rance that genuine mistakes, interpretation differences or system related compliance failures are not treated in the same way as deliberate misconduct.

From a business perspective, these amendments significantly increase compliance risk. Companies should strengthen documentation, maintain VAT records for longer periods, review refund claims carefully and ensure internal controls are robust. 

The message is clear: VAT compliance is no longer a routine administrative exercise but a board level governance issue.

Q: When international investors compare Sri Lanka with competing destinations in the region, where does the tax system help us? And where does it put Sri Lanka at a disadvantage?

A: The country’s tax system has several strengths that investors value. 

It has an established treaty network, OECD aligned transfer pricing rules, an Advance Pricing Agreement (APA) framework, targeted investment incentives, and competitive lower rate arrangements for qualifying exports and cross border servi­ces.  

Enhanced capital allowances could be claimed as a double deduction, which could end up with a tax loss – this will give more years to claim such a loss and could be considered as something similar to a tax holi­day 

These features provide a relatively sophisticated tax architecture compared to many emerging markets. 

The challenge is not usually the architecture but the execution. 

Investors place a premium on certainty, predictability and administrative efficiency. Frequent legislative changes, slow dispute resolution processes, delays in refunds and perceptions of regulatory uncertainty can increase investment risk. 

In addition, Sri Lanka’s standard corporate tax rate of 30 percent is higher than that of several competing jurisdictions in Asia.

In short, Sri Lanka offers a technically credible tax framework but its competitiveness would improve significantly through greater stability, administrative efficiency and policy consistency.

Q: What would you say to critics of the tax regime who argue that taxpayers are bearing the brunt of administrative inefficiencies and gaps in implementing the tax laws?

A: The criticism has some merit. 

When assessments are delayed, and interpretations vary among offices and appeals take years to conclude, or refunds remain outstanding for extended periods, taxpayers effectively bear costs that arise from administrative inefficiencies rather than noncompliance. 

That said, the conversation should not be framed as ‘taxpayers versus the administration.’ A modern tax system requires accountability on both sides. Taxpayers must comply with their obligations while the administration must provide clarity, consis­tency, timely guidance and efficient service.

A well administered system that taxpayers trust is ultimately more sustainable than repeatedly increasing rates on the same compliant taxpayers

The positive development is that tax policy reform is increasingly being matched by tax administration reform. 

Strengthening RAMIS, adopting data analytics, moving towards prefilled returns, improving taxpayer services and modernising audit processes are all important steps. 

The ultimate objective should be a tax authority that is not only effective in collecting revenue but also predictable, transpa­rent and service oriented.

Q: With VAT at 18 percent, how is the current tax structure affecting the restaurant and hospitality sector – both in terms of consumer demand and the cost of doing business?

A: The hospitality and restaurant sector fa­ces pressure from both the demand and cost side. Dining out is discretionary spending, making it highly sensitive to price increases. 

An 18 percent VAT environment inevitably influences consumer behaviour, particularly among middle income households whose budgets remain under pressure following the economic crisis. 

At the same time, businesses face rising operating costs including labour, utilities, food inputs and financing expenses. 

Although registered businesses can claim VAT credits, cash flow constraints remain a challenge, particularly for smaller operators. Therefore, many businesses face a difficult balancing act between maintaining affordability for customers and protecting profitability. 

The sector has demonstrated resilience especially with the recovery of tourism but margins remain under pressure. For many operators, the challenge is no longer gene­rating revenue but maintaining sustainable profitability in a higher cost environment.

Charmaine Tillekeratne is the Partner, Head of Tax of Deloitte Sri Lanka & Maldives.