EARNING THE TRUST OF TAXPAYERS

Q: Taxpayers are being asked to pay substantially higher taxes as part of the government’s push to increase state revenue. What would you say to taxpayers who feel they’re paying more but don’t see their tax rupees being spent wisely? 

A: There are two perspectives to consider: corporate taxpayers and individual taxpayers.

From a corporate perspective, many businesses in sectors such as exports, tourism and certain strategic industries benefited for years from tax exemptions and concessionary tax rates. While the tax burden today is undoubtedly higher than in the past, most corporates recognise the country’s need to rebuild its public finances and the role taxation plays in supporting national development. 

Sri Lanka has historically provided free education and healthcare, which almost everyone has benefitted from in some way. What frustrates corporate taxpayers is not necessarily how tax revenue is used but the lack of certainty and consistency in tax administration. 

Taxpayers are more willing to contribute when the system is fair, predictable and consistently applied

Shehani Paranavitane

Concerns arise when tax assessments appear arbitrary or authorities exert undue pressure on taxpayers to settle outstanding matters or tax payments. There is also a perception that compliant taxpayers face greater scrutiny while parts of the informal economy remain outside the tax net. Taxpayers are more willing to contribute when the system is fair, predictable and consisten­tly applied.

For individuals, the situation can feel more acute. 

Personal income tax rates have increased in recent years amid a higher cost of living. Individuals who rely largely on private healthcare, education and other services may question what they receive in return for their tax contributions.

Policymakers could consider targeted relief measures that acknowledge the contribution of compliant taxpayers. Deductions or relief for qualifying expenses such as interest on housing loans, healthcare costs or education related expenditure could improve perceptions of fairness, and streng­then confidence in the tax system. 

Q: We have seen repeated amendments to income tax, VAT and other tax legislation. Is Sri Lanka changing its tax system too frequently for businesses and individuals to plan with any sense of certainty, in your opinion?

A: While there have been numerous amendments to tax legislation in recent years, I do not believe that the main challenge is the frequency of legislative change itself. 

The principles underlying income tax, VAT and other taxes have largely remained unchanged. Furthermore, where a taxpayer has been guaranteed a tax holiday, I have not seen those benefits prematurely revoked through legislative changes. 

Most amendments have centred on removing open ended exemptions and concessionary tax rates, broadening the tax base and increasing rates to support revenue collection. In a country undergoing fiscal consolidation, such policy changes are not entirely unexpected.

The greater concern is the lack of certainty in how tax laws are interpreted and administered. Businesses can plan for changes in tax rates. What is harder to plan is the reinterpretation of provisions that have existed for decades despite no change in the law. Predictability and consistency in tax administration are as important as certainty in tax policy.

One example is the value added tax on financial services assessments raised on holding companies. Historically, VAT on financial services was introduced to tax financial institutions and related activities; it wasn’t generally understood to apply to holding company structures. 

Yet, many holding companies have been subjected to assessments based on a new interpretation of longstanding provisions. Whether or not one agrees with that interpretation, the concern is the uncertainty it creates. Holding companies facilitate capital accumulation and investment, and revisiting long established tax positions without corresponding legislative changes may prompt businesses to reconsider how and where they structure their operations.

What frustrates corporate taxpayers is not necessarily how tax revenue is used but the lack of certainty and consistency in tax administration

The insurance sector provides another example with assessments raised despite no change to legislation that had been in ope­ration for decades. The dispute centred on how the profits of a life insurance business should be calculated, particularly whether management expenses attributable to the business could be deducted from the investment income of the life insurance fund. 

Such situations can have a greater impact on investor confidence than changes in tax rates. Businesses are generally prepared to comply with the law but need confidence that the rules will be applied consistently and in line with the original policy intent.

Tax laws will and should evolve to meet the needs of the country and its economy. However, stronger alignment between poli­cymakers and tax administrators is needed to ensure that legislative intent is reflected in its application. 

Businesses and individuals require certainty about what the law says, and how it will be interpreted and enforced. This is criti­cal for long-term planning, investment and economic growth.

Q: Do you believe the present personal income tax regime strikes the right balance between revenue needs and retaining skilled professionals in the country?

A: The current personal income tax regime has undoubtedly helped the government restore revenue at a critical time. How­ever, from the perspective of attracting and retaining skilled professionals, I believe there is still room to achieve a better balance.

A maximum marginal tax rate of 36 percent is significant, particularly as it was introduced during a period of high inflation and a sharp increase in the cost of living. The combined impact of higher taxes, rising housing costs and increased living expenses has placed considerable pressure on middle and upper income professionals. As a result, we have seen a notable outflow of skilled talent in recent years.

An important consideration for professionals is the ability to build long-term stability for themselves and their families. Home ownership in particular is a strong anchor. When individuals are able to purchase property and establish roots in a country, they have a greater incentive to remain, invest and build their future there. 

Which is why I have consistently advocated for targeted personal tax deductions, particularly for housing loan interest. Such measures can make home ownership more accessible while encouraging a long-term commitment to the country. 

The tax system should not be viewed solely as a means of collecting revenue. It can also be used to enhance individuals’ quality of life through targeted deductions, which in turn could reduce the outflow of professionals from the country. This could also serve as a tool to encouraging more professionals to enter the tax net. 

Q: Would you agree that the new laws focus excessively on compliance by voluntary taxpayers while those who are guilty of tax evasion continue to get away?

A: A number of amendments have recently been introduced to the Inland Revenue Act and the Value Added Tax Act, strengthening the powers available to the Inland Reve­nue Department (IRD) to improve revenue collection and compliance. 

Many provisions target those who remain outside the tax net or fail to comply with their fundamental tax obligations. Stronger penalties have been introduced for taxpayers who fail to register with the Commissioner General of Inland Revenue, file tax returns, furnish required returns or annual statements, or comply with statutory noti­ces issued by the IRD. Continued noncompliance may result in criminal prosecution and fines or imprisonment, or both. 

These provisions are clearly directed at improving compliance and bringing noncompliant taxpayers into the tax system. However, there are also amendments such as the recent changes to Section 163 of the Inland Revenue Act that provide the IRD with a faster mechanism for recovering taxes deemed to be outstanding. 

Under this provision, where tax remains unpaid, the Commissioner General of Inland Revenue may initiate recovery proceedings through a magistrate’s court. The concern is not necessarily the legislation itself but its application. We are currently seeing significant efforts by the IRD to recover historical tax arrears with taxpayers being asked to produce appeals relating to assessments issued decades ago.

Some assessments appearing in the IRD system are more than 30 years old. Failure to provide these records has resulted in bank accounts being seized, and taxpayers spending time, money and effort resolving the matter. 

While Section 163 may have been introduced with the legitimate objective of enhancing revenue collection, the risk is that over time, they may become tools that primarily increase pressure on existing taxpayers rather than expanding the overall revenue base. 

A successful tax system must have strong powers to combat evasion. However, it is equally important that tax administration does not disproportionality burden existing taxpayers in its efforts to collect revenue and meet revenue targets.

Shehani Paranavitane is the Partner – Tax of EY Sri Lanka.