Taxes: “Grand art of levying so as not to oppress”
View(s):The Prime Minister made a special statement in the Parliament on March 8 to specify certain amendments to the budget proposals 2016, to clear the mist prevailing in the arena of taxation. This seems to reconcile the tax changes to be implemented and are in line with the tax policies stipulated in the Prime Minister’s Economic Policy Statement on November 5, 2015. There is a thrust towards the collection of more direct taxes towards the journey of achieving 60:40 per cent indirect to direct tax ratio by 2020 and also to heal the low ‘Tax to GDP ratio’ by boosting overall tax revenue.
File pic of a vegetable market. Will the new taxes impact on prices ?
The corporate and non-corporate income tax proposals presented in the November 20 Budget would be on hold for a period of one year and status quo will remain subject to the changes announced. However, all these announcements including the previous variation are pending legislation.
Corporate Income Tax
As per the present Inland Revenue Act, there is a 5-band income tax rate that would be applicable on corporates depending on the nature of the business activity. The standard rate of 28 per cent is applicable on most of the companies whereas the concessionary rate of 12 per cent applies on selected industries such as agriculture, exports, tourism, healthcare, small and medium enterprises (SMEs), construction, etc. Few sectors including education, warehouse, poultry, Unit trusts enjoy the low rate of 10 per cent. Trustees, Executors, Receivers are taxed at 24 per cent. Companies engaged in Liquor and Tobacco contribute to the state coffers at the rate of 40 per cent.
The currently applicable spread of the income tax rates reflects the policy of ‘Re-pricing’ (one of the 4 R’s of taxation) i.e incentivise and discourage certain business sectors by using high/concessionary rates. The 2016 Budget Proposals was focused at projecting Sri Lanka as a ‘low income tax jurisdiction’ in terms of both corporate and individual income tax.
The proposal was to apply a 15 per cent standard corporate tax rate on all corporates except subjecting few selected industries (liquor, tobacco, betting and gaming, trading, banks and financial institutions) to a higher rate of 30 per cent. The 15 per cent standard corporate tax rate proposed was way below both the global average corporate tax rate of 23.64 per cent as well as the Asian average 22.49 per cent.
Suresh Perera
However pursuant to the PM’s statement, Sri Lanka would apply a 3-band income tax rate on its companies depending on the nature of the business activities. The currently applicable standard corporate tax of 28 per cent and the higher rate of 40 per cent would continue to be applicable as legislated in the current Inland Revenue Act (IRA) sans any change. The companies enjoying concessionary and the low rate of 12 per cent and 10 per cent, respectively would be called upon to contribute to the state coffers at the rate of 17.5 per cent once the IRA is amended. The fate of income tax rate applicable on trustees, executors, receivers is yet to be seen.
The strategy of attracting foreign investors by projecting Sri Lanka as a low income tax jurisdiction with a standard corporate and individual tax rate of 15 per cent is a challenging task in the context of Sri Lanka’s low ‘tax to GDP ratio’.
The effect of the PM’s proposal is to hold over the said strategy of the low income tax regime and to collect more corporate and individual income taxes in aggregate. However, the additional corporate taxes that may result in is at the expense of the corporates that were enjoying concessionary and low tax rates such as exports, health care, agriculture, SMEs, tourism, construction, etc. Perhaps this is an unintended result that failed to capture the attention of the policy maker.
These preferential categories would experience additional rate hike of 5.5 per cent and 7.5 per cent on top of the currently applicable rate of 12 per cent and 10 per cent. There is neither a corporate tax rate increase nor a decrease for companies currently paying income tax at the rate of 28 per cent and 40 per cent. However, overall corporate income tax (direct tax) collection in absolute terms should rise compared with the previous years provided that the number of corporates and their profit levels do not dip in the future.
This move, reverses the Rs. 6 billion loss of corporate income tax collection budgeted for the downward revision of corporate tax rate in Budget 2016 proposals to project country as a ‘low income tax regime’.
Tax on individuals
Under the present IRA, the computation of the income tax liability of the white and blue collar worker, professionals in practice or self-employed earners have subtle differences. The budget proposed a three time hike of the personal income tax free allowance for the white and blue collar workers and a five time hike for the professionals in practice and self-employed earners with a flat 15 per cent tax rate in lieu of the progressive tax rates for additional income above the tax free allowance.
As per the new announcement the above budget proposals will not go through and the currently applicable progressive income tax rates, tax free allowance and the tax deductions would continue. All individuals enjoy Rs. 500,000 personal tax free allowance. White and blue collar employees are permitted an additional Rs 250,000 as a qualifying payment deduction taking up the total tax free earnings to Rs 750,000.
The decision to maintain the statusquo would also eliminate the budgeted Rs. 4 billion loss in the budget proposals.
This ensures the personal income taxation in the country would not be converted to a “regressive” system as pointed out by some critics earlier. For those who are not savvy with the technical term, investopedia (online dictionary) defines ‘regressive tax’ as “a tax that takes a larger percentage from low-income people than from high-income people. A regressive tax is generally a tax that is applied uniformly. This means that it hits lower-income individuals harder”. The policy to maintain the statusquo with regard to the personal income taxation is in harmony with the ‘canon of equity’ in taxation i.e broader shoulders should bear more weight.
Nation Building Tax
The PM pointed out that Nation Building Tax (NBT) is a tax on turnover and that the proposed rate increase in the budget of 2 to 4 per cent could affect all sectors of the economy. This is because a tax on turnover is cursed with the evil cascading effect.
In order to collect indirect taxes, the comparison is between an incremental cascading 2 per cent on turnover under the aegis of NBT as opposed to incremental 4 per cent on value addition (difference between the VAT rate of 15 per cent and 11 per cent). The Government has done well by opting not to increase the rate of NBT but to increase VAT for the collection of indirect taxes. VAT is the global indirect tax collection tool opted by over 160 countries for gathering indirect taxes.
All hikes of tax rates are bitter for the taxpayer however an exercise of better discretion could reduce the bitterness.
NBT was introduced in 2009 as a temporary measure only for two years in budget 2009. Sri Lanka at present levies indirect tax not only on value addition but on turnover, making a hybrid tax system. NBT should be eliminated in the tax reform process of Sri Lanka in the medium term with the gradual stabilisation of the tax system.
As per the November budget and confirmed in the PM’s statement, NBT has been extended to hitherto exempt electricity, lubricants and telecommunication services.
Telecom industry
Telecommunication industry has been imposed with VAT in addition to the NBT. The reintroduction of these two indirect taxes warrants tracing the history of the industry. At the beginning of 2011, by way of Telecommunication Levy Act No 21 of 2011, ‘Telecommunication Levy’ was introduced as composite tax to substitute VAT and NBT that were applicable on the industry prior to 2011. Perhaps, what prompted the policy makers of the day for the switch was that there were disputes between telecommunication companies and tax authorities in relation to the application of VAT on distribution of telecom cards via distributors and dealers.
A study of VAT on distribution of telecom card sales in foreign VAT jurisdiction reveal that the VAT statutes contain specific technical VAT rules as to the manner of application of VAT on telecom card sales whereas there is a lacuna in the Sri Lankan VAT statute addressing the industry. The policymaker of the day instead of including telecom industry specific rules to the VAT Act to address the issue, opted to eliminate telecom services from the VAT base and introduced a simple, composite levy, currently at the rate of 25 per cent while exempting both VAT and NBT in 2011. Hence the re-introduction of VAT and NBT on top of the telecommunication levy is placing the industry players in double jeopardy, whilst inclusion of the telecom services within the VAT base is the right move from overall tax policy perspective. However, the double jeopardy should be avoided by freeing the telecommunication industry from the telecommunication levy. It goes without saying telecom specific VAT rules must be embedded in the VAT statute in order to avoid a repetition of the past.
Value Added Tax
Commendable is the fact that the Government took cognisance of the complexity both the taxpayers and the administrators would have been exposed to with multiple rates and that too one for goods (at 8 per cent) and one for services (12.5 per cent) by introducing the single rate of 15 per cent. The country that is hailed as a role model among the GST/VAT jurisdictions, New Zealand is also using a rate of 15 per cent. The World Bank’s Systematic Country Diagnostic Report (at paragraph 86) points out that a decline in VAT collection is the main driver of ‘tax to GDP’ reduction in recent years.
Contrary to the popular belief, for a person VAT exempt status is not the preferred status as it prevents the person from claiming input VAT paid to his suppliers. Coming out of the VAT exempt status and being liable for VAT, enables person to recoup all the VAT paid to the suppliers. This, reduces the cost of sales which in turn enables to reduce the price to the end customer though the VAT should be charged on the customers. Hence, the removal of exemption leads to an increase in price by the quantum of VAT rate is a misnomer. All consumers must be aware of this when entangled with price bargaining with the traders. There seems to be a move to reduce the multitude of exemptions which is the bane of the Sri Lankan VAT system as reflected in the removal of existing VAT exemption on private education and private healthcare.
In order to provide relief it was proposed by the PM to keep essentials goods out of the VAT on wholesale and retail trade. However, even at present some of essential goods are free from VAT due to being subject to Special Commodity Levy.
Capital Gains Tax
Perhaps the high watermark of the PM’s statement which has caught the attention of many is the re-introduction of Capital Gains Tax (CGT). The reason of the policymakers for the decision may be traced to the recent revelation in the World Bank Systematic Country Diagnostic Report that there is great disparity with regard to the spread of capital among the citizens in Sri Lanka. Twenty per cent of the population is in possession of 80 per cent of the capital of the country. This fact, coupled with the requirement to gather more direct taxes to the Government coffers both to rectify the very low tax to GDP ratio and anomaly seen in the direct and indirect tax ratio may have compelled the Government to resort to the move.
An amendment to the late 1950’s to Income Tax Ordinance 1932 introduced the CGT to the Sri Lankan web of taxes. Since the inception, the CGT witnessed many changes. From the Y/A 2002/2003 by virtue of the Amending Act No 10 of 2002, levying income tax on capital gains as a source of income was abolished. Sri Lanka has not been levying a tax on capital appreciation from 2002/2003. Tax on Capital Gains provides a common source of tax revenue to many Governments globally. In the Asian region, though Singapore does not levy tax on capital gains, countries such as India, Bangladesh, Pakistan, Cambodia, Afghanistan, Malaysia, Taiwan, and Thailand charge tax on capital gains.
The famous 4 R’s of Taxation sets out the reasons for levying tax, and the 4 R’s are ‘Revenue’ for the State, Re-distribution of wealth (one of the significant purposes of taxation), ‘Re- pricing’ (to incentivise and discourage certain industries) and ‘Representation’ (accountability of the representatives).
Reintroduction of the concept into the Sri Lankan web of taxes should be carried out with great caution, being alert to various dimensions. The policymakers must appreciate that levying a tax is an art, like ‘the bee extracting honey without harming the flower’.
King Fredrick the Great (in 1712) said “No government can exist without taxation. This money must necessarily be levied on the people, and the grand art consists of levying so as not to oppress.”
In conclusion, taxpayers deserve more certainty with regard to the tax system and a long term vision taking into consideration Sri Lanka’s social environment. Policymakers should unleash the Sri Lanka’s economic growth potential while short and medium term measures are being implemented to heal the immediate wounds. Tax reforms is an unending journey. Sri Lanka’s tax policy and tax administration requires more care and attention.