Financial Times

Corporate brief
Is ESC the right solution?
Innovative revisions have been the feature of the recent tax legislation. These were also the first laws of the present government elected to power in April with high public expectations.

Taxation plays an influential role in investment, employment and the general well being of the people. The Economic Service Charge (ESC), a proposal of the Budget 2004, was among the many tax laws passed in parliament in September. Based on the minimum tax concept, ESC is a tax (ranging from 0.25 to 1%) on turnover on all businesses exceeding a turnover of Rs 50 million. ESC paid is recoverable against income tax payable within a period of two years with no provision for refunds thereafter.

As pointed out by the revenue authorities no business can continue to be operated at a loss, but for many who are incurring genuine losses ESC would be an additional burden that may drive them to further despair. This is not what we want during an economic downturn.

As the Commissioner of Inland Revenue (large tax payer unit) described it, government hospitals and schools among other various infrastructure facilities are used by all businesses directly or indirectly and hence a minimum tax is payable to the society in return.

The concept of minimum tax is not entirely uncommon but one based on turnover is rare. Past practices in the developed world do not provide encouraging evidence that taxes of this nature have achieved the original goal. Instead they have added substantial complexity to an already overburdened tax structure. Alternative Minimum Tax (AMT), an unusual levy, was first introduced in USA in 1975 following concerns that a large number of high income tax payers were not paying income taxes. The 1986 tax reform act provided a better mechanism to counter artificial tax shelters leading to tax losses which led to loss of state revenue.

AMT however is not a tax based on turnover but on income worked out on a different basis with actual liability being the greater of the two under the two systems.

Minimum Alternative Tax (MAT) was introduced in India in 1996, but this too is not turnover based. Additionally, MAT is applicable only to profit making companies. Indians have been wise to exempt certain infrastructure projects and exports from MAT due to their national economic importance.

We often hear the tax authorities going public on the deficiencies of the system and large scale evasion. Sadly these defects have not been rectified and it is the compliant who are mostly taxed. Given the global trends of a wider role for the private sector and the pruning down of state sector employment, governments must provide the right business environment to generate profits and create employment.

ESC legislation presumes that all businesses and sectors are equal in capacity in earning profits and hence the levy is no major issue. BOI companies who of course enjoy many concessions have been given preferential treatment.

One example of a crucial sector is the plantations - a low margin, high turnover business operating amidst threats of periodic wage demands. Owing to continuing high capital investments and brought forward tax losses (tea/rubber as raw material commodities are subject to global conditions and may not yield profits evenly) most of the plantation companies will not be liable to Income Tax and will not have the liberty to set off the ESC liability against tax payable. While this situation justifies the minimum tax concept it may have a negative impact on the economy on the longer term.

Sri Lanka is a highly import dependent economy relying heavily on exports, foreign investments and other foreign exchange earnings such as tourism and worker remittances to pay for imports. This situation demands a cautionary approach by policy makers on taxing the export businesses competing in the global market.

Today Colombo tea auction prices are booming and providing comfort to the depleting foreign reserves. Oil rich Middle Eastern countries, major consumers of our tea, may spur further demand. Iran has just privatized the tea imports. These opportunities should not be missed by weakening the important plantation sector which has now graduated to a quality conscious food product supplier.

Back to Business