“Imputed rental income”
View(s):This week I had the opportunity to communicate with a friend of mine living in the UK. During our conversation, I remembered to ask him about his property tax payment. I knew that there were property taxes in the UK and other European countries.
He answered: “Here, it is called Council Tax. We live in Kent – an expensive area in London so that our Council Tax is also higher than that in most of the other areas of England. Our home is a semi-detached, 3-bed room average house and only two people live here – my wife and myself. We pay 2,676 pounds per year as the Council Tax.”
I converted his property tax into Sri Lankan rupees; at the current GBP-LKR exchange rate, it is more than one million rupees.
An iconic apartment complex. Residents of apartments could be subject to the new tax.
Need more taxes
As public protests are becoming quite common in Colombo, the week was also marked by a few of them – one by unemployed graduates seeking government employment, another by government employees seeking salary hikes and another by government pensioners seeking pension hikes. So, some protests are before entering the government, other after entering the government and, another even after leaving the government.
There is no question that the unemployed graduates should have jobs. However, whether such jobs are from the government, or the private sector is a different question. The government employees who launched a strike demand for an increase in their salaries. In this case too, it is fair enough to ask for higher salaries from the government because the previous governments have made a promise to do so. Besides, cost of living has doubled during the past two years. The same issue applies to the government pensioners who launched another protest demanding the government to increase their pensions.
We have not heard the demands of the millions of “voiceless people” in the country; they all have demands from the government. However, to meet all these demands, the government should also have a higher tax revenue. After the increase in tax rates and widening the tax base, last year the government was able to collect 9.8 per cent of GDP as tax revenue in 2023. It was a remarkable improvement from its 7.3 per cent in 2022.
But it is not enough, because
Sri Lanka is still one of the few countries in the world with the lowest government revenue to GDP. As per the IMF Country Report issued a few days ago, the average government revenue (taxes and other) in emerging market and middle-income economies during 2019-2022 was 26 per cent of GDP, whereas in Sri Lanka it was just 9.3 per cent.
Property tax
As a result, the government has been still borrowing from domestic sources other than money printing; during the first quarter of 2024, domestic debt has increased by about Rs. 1,500 billion. The IMF has estimated that the government’s tax revenue must increase from 9.8 per cent of GDP in 2023 to 12.4 per cent in 2024 and to 13.9 per cent in 2025.
One of the controversial tax proposals of the IMF is the Imputed Rental Income Tax, which is due to be implemented from next year onwards. It is a property tax on owner-occupied or vacant houses calculated as a percentage of “imputed rental income” if the house was rented out. It does not include actual rental incomes of property owners, which is taxed elsewhere under income tax schedules.
Property tax was a shocking news to many. Neither was it a politically correct initiative when there are elections round the corner. Nevertheless, for anyone who knows a little bit of ‘direct tax systems’ in the world, I am sure there is nothing to be surprised about.
However, most of the
Sri Lankans are not used to paying direct taxes and the governments were not prepared to collect direct taxes. Suddenly, everything has changed, and the new taxes come as knockout punches to the people who have been already battered with a series of such blows over the past two years.
Cap on luxuries
Let me brief about property taxes in the world. It is a common direct tax implemented across most of the countries such as US, UK, EU countries, Japan, Australia, New Zealand, Singapore, South Korea and Malaysia as well as most of the developing countries including India. Usually, it has also been a local government tax.
In general, the annual property tax rate in these countries varies between 0.1 per cent to 1.0 per cent of the annual gross value or the imputed rental value of the houses. In some countries, the upper limit of the tax rate can be seen much higher, like in Singapore or Japan.
The location of the property and, sometimes, the number of occupants in the property are also important factors to determine the applicable tax rate. If properties are being valued and data being stored digitally, the property tax is an efficient one with no room for corruption and tax evasion.
It is also a progressive tax because properties with higher rental values are subject to higher tax rates. If you have a big luxury house with higher rental value, it will be taxed at a higher rate. If you have a habit of buying many houses to keep your wealth, then it is also discouraged by the proper tax system.
With a property tax, a country’s wealth can be diverted more towards productive investments, averting “wasteful spending” by some wealthy individuals to build luxury houses. Formation of “housing bubbles” is also controlled by property taxes. Accordingly, property taxes are good fiscal instruments to promote social equity and avoid possible housing market crashes.
But, need a system
As the IMF identified, digitalisation is a key factor underlying efficient implementation of the property tax system as well. IMF recommends establishing a database on property valuation, operationalising digital Sales Price and Rents Register (SPRR) and improving data-sharing among relevant government agencies.
Simply the issue is that the government does not have a digitalised system to trace not only the property values of people, but also their income and wealth. It has made the implementation of an efficient and effective tax system more difficult.
A similar tax had already been introduced by the Inland Revenue Act No. 10 of 2006. However, the IMF has noted that this tax generated hardly any tax revenue because of its broader exemptions, downgraded property values, and the use of outdated systems.
In cases where digitalisation progressed in some places, sharing such information among different government agencies remained blocked by their own regulations as well as by constitutional constraints. As per IMF, tax reforms along with the introduction of a digitalised tax administration are critical for raising government’s tax revenue. As per the estimates, the property tax is expected to generate 0.2 per cent of GDP to the government’s revenue in 2025, and 0.4 per cent in 2026.
Seventeenth time to IMF
The Annual Report 2023 of the Treasury has made an interesting remark citing that the Sri Lankan authorities had been discussing with the IMF the same reforms even 50 years ago and provided two references to IMF documents confirming it (page 36). The irony is that such reforms were limited only to the discussions and documentations, neglecting their actual implementation.
During the same period,
Sri Lanka’s Southeast Asian neighbouring countries continued with undertaking reforms: They “adopted sound macroeconomic policies, integrated with the global economy and built competitiveness, invested in education, and attracted global capital and know-how, allowing rapid economic take-off and improvement of the quality of life of their populations” (Treasury’s Annual Report 2023:P36).
Sri Lanka is still trying to implement such reforms that were planned to be implemented 50 years ago, leaving the country well behind its peers. The economy that did not progress remained vulnerable to any disturbances, compelling it to resort to IMF assistance repeatedly – 17 times now.
I have no dispute over the fact that Sri Lanka must stop going to IMF for the 18th time. The question is, but how to stop it. We will soon focus on this issue as well.
(The writer is Emeritus Professor of Economics
at the University of Colombo and can be reached at
sirimal@econ.cmb.ac.lk
and follow on
Twitter @SirimalAshoka).
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