Tirani Kulathunge 00:12 Hello, everyone. Welcome back to another Advocata Studio conversation. Today, we are going to dive into one of the most discussed economic developments in Sri Lanka, tax amendments, VAT reforms, and what it actually means for businesses, entrepreneurs, investors, and even consumers. At Advocata, we have been consistently arguing that Sri Lanka needs a tax structure that improves tax revenue, tax collection, and more to make it more broader, simpler, more transparent, and less distortionary. The less distortionary, one that is again improves tax collection without discouraging entrepreneurship, investment, or even formalisation. To this today, we are joined with mr. Suresh Preya, the tax principal of KPMG Sri Lanka. Thank you so much for joining, mr. Suresh. So, with the big picture, people panicked when this gazet came out, but if we simplify everything, let's say, what is this reform actually trying to do, and baseline is it also the government trying to say that too few people are paying taxes and we can't survive like this anymore? What are your thoughts? Speaker 1 01:34 Okay, when you see when you say the gazette, I'm not sure what you are meaning by the gaset because there are so many things right now happening. There's a what I call a media shake-up happening in relation to the taxation, right? So there are a couple of things we witnessed in passing of the Social Security Contribution Act, so it's law in Sri Lanka. The and then basically the 29th of April, VAT bill was published in the Gazette, so it has to take its path for it for it to become the law, and then we also witnessed a Supreme Court's the Inland Revenue Bill was challenged before the Supreme Court, and Supreme Court had given the determination, and that was that is also out. So that's yeah, so. that inland revenue bill should now go through the parliament, the second debate, committee stage amendments, etc. and become law. So we do find all three taxes in Sri Lanka, all three main taxes in Sri Lanka, being changed. So I think that is sometimes for a tax consultant, it's a lovely topic. Maybe for the ordinary people, it's a bit of a so it's a Tirani Kulathunge 02:45 difficult topic. Yeah. So let's digest it. Let's start with the VAT, right, and how that will affect SMEs. I think one of the questions that were brought up is they they they are pointing it as a controversy, saying that the threshold reduction from 60 million to 36 million. Now, let's say if if someone is running a kotsu shop or a small cafe doing 40 to 50 million a year, suddenly needs VAT filing, accounting systems, POS machines, and the whole thing. Are we formalising business here? Or, I mean, one of the comments that were brought up is that are we punishing businesses that are trying to grow? Speaker 1 03:25 Okay, let me put it this way: Say, once upon a time, you can remember in Sri Lanka the VAT threshold was only 12 million a year, and then in 2019 it was suddenly increased to 300 million a year, from 12 million to 300 million a year. So now the government has realised the repercussions, and they are trying to bring down the VAT threshold. See, for VAT operate in a particular jurisdiction in a country, all the activities, most of the activities should be in the VAT net. Then only that this input output mechanism works, then only actually tax could be calculated and collected on the value addition, right? So, to me, bringing down the VAT threshold from 60 million to 36 million, I have no quarrel with that whatsoever because, as I said, it was 12 million once upon a time. Tirani Kulathunge 04:19 Yes. Speaker 1 04:20 So bringing it down theoretically, correct. Yes, basically. Once upon a time, who were paying VAT, they came out, and now again they are they are coming in. So that is what is happening, right? But it's not just the VAT. There is social security contribution levy. That is also the threshold. Threshold 60 million is coming down to 36 million. So on the first of July, two things are happening: VAT threshold is coming down, social security contribution threshold coming down. So because of that, the category of suppliers who are between 60 million to 36 million. Are the new entrants? So there's a new set of people, new set of traders who are coming into the SSCL and the VAT net, which means they are going to increase the prices. So I do expect there could be slight increase of goods and services, the prices in the marketplace. Tirani Kulathunge 05:20 But there's this thing that was also been discussed, saying that okay, now the now VAT is 20.5% right? But now has VAT absorbed SSCL and is SSCL gone already? One of the comments about water. So Speaker 1 05:35 so that now that's a different aspect of it, right? Now when you say VAT has gone up to 20.5, we have to keep in mind that is a different kind of a VAT. So in Sri Lanka there are two types of VAT: normal VAT, which is 18% continues, and the normal goods and services 18% continues. It has not changed. But VAT on financial services, which stood at 18% is going up to 20.5% but that is because the SSCL on financial services, which was at 2.5, is being abolished. That is being aggregated to the 18% rate. So it's basically consolidation that takes place, and it is I would say it's a welcome move because earlier people, the institutions, the financial banks, etc. had to file a VAT return as well as a SSEL return. So now, administratively, it's going to be easy for both the institutions as well as the Inland Renewal Department. So I, because of that, there should not be any increase of the prices of the financial services, also there is no legal basis for that. Of course, from the income tax point, there could be a small impact to the institution because it's worked on financial services is not tax deductible when you are calculating the income tax. SSCL was deductible, 2.5 was deductible, but now all 20.5 cannot be deductible. So because of that, there could be an impact with regard to the income tax liability, a little bit slightly. Tirani Kulathunge 07:14 When you say little bit slightly, what does that mean? Speaker 1 07:18 Okay, so basically, what there was a deduction of the 2.5, so that 2.5 deduction disappears, and that gets added to the 18% VAT, and that becomes 20.5. That part is not tax deductible for income tax. So income tax is the direct tax. Strictly speaking, the institution should not be passing on that to the consumer. So if they have. a it will have an impact with regard to their profit margin, little bit, little bit, little Tirani Kulathunge 07:49 bit. Okay, okay. So again, one of the another criticisms is that now Sri Lanka has you know has a tradition, let's say, on layering taxes upon taxes, and then with SSL, especially every stage in the supply chain, say get taxed from manufacturer, distributor, even the retailer, right? And the logic is that what people are asking is that the consumer pays all of it. Is that right? And then bringing to the point again, is SSCL actually a bad tax economically? Yep, you're correct. Speaker 1 08:27 SSCL is a bad tax. It should not be in the Sri Lankan tax net. Tirani Kulathunge 08:32 Right. Speaker 1 08:32 In 1998, we abandoned what was called turnover tax at that time, and we embraced GST, goods and services tax, which is another name for VAT. Tirani Kulathunge 08:43 Yes. Speaker 1 08:44 In other words, taxing the turnover concept we abandoned in 1998, and we we embrace the concept of taxing the value addition, which is the correct thing to do. Tirani Kulathunge 08:55 Yes. Speaker 1 08:55 But thereafter, this turnover tax appeared in another name. In 2009, it was called NBT Nation Building Tax, abolished in 2019. After a short period, again it appeared with another name. Now we are calling it SSCF. So what do we have in Sri Lanka? We have the VAT and the turnover tax, both a hybrid system. That's wrong, theoretically. That's Tirani Kulathunge 09:21 wrong. Okay. Okay. Understood. So now let's turn on to the digital VAT stuff. So now this is the interesting part because even Advocata uses a lot of imported digital services, and now Sri Lankans they are supposed to pay taxes on things like Netflix, Spotify, Zoom, Google services-basically, the modern economy, you could say, right? But at the same time, there's this segment in the economy, like startups, that heavily use rely on these tools, right? How do you tax the digital economy? Let's say without. Making innovations more expensive, and there's also this case where the the digital tax right now with the digital VAT is at its most effective structure, or is there anything else that we can add in the bill? Speaker 1 10:16 Okay, so let's put this way: when you say VAT, VAT liabilities on supply of goods, selling goods or selling services, or importation of goods. Importation of services was not in the Sri Lankan VAT net. So then there was an amendment that was introduced to the charging section to introduce this concept of digital VAT. So we have been struggling to get this right. Amendment came, and then it was challenged in the Supreme Court. Gassett came, implementation date was fixed, implementation date was postponed, postponed again. So now, basically, what we see is in this new VAT bill again, there is a section. Use couple of sections have been introduced. A methodology has been introduced, and we are also expecting another gaze to come. So implementation date is first of July as of now, right? So now we have to understand exactly what this digital VAT is and what is this methodology. When you look at worldwide, when you look at the recommended methodology by the OECD, there are mainly three methods. One is called vendor registration, simplified vendor registration. So that means a non-resident is providing a service via electronic platform to a Sri Lankan consumer. Tirani Kulathunge 11:38 Okay, Speaker 1 11:39 not a business, a consumer, right? If that if the liability of that value value of supply liability is above 36 million, that that foreign vendor must register with the Inland Revenue Department, collect the taxes from the consumers, and pay it to the Inland Revenue Department and file the return tax. So Netflix, one Tirani Kulathunge 12:03 of the examples. Oh. Speaker 1 12:06 Yeah. So I can't talk about the. Okay. I'll remove. I'll remove branding. Exactly. So that that's one, right? So, but at the same time, when you look at the other countries, now if I give you example, let's see. Basically, a software engineer in Bangladesh, another in a particular platform. Let's see. Basically, all these service providers are registered. So, we, the consumers in Sri Lanka, we go to that particular platform. We identify the service providers that are registered and obtain services from those service providers. So now, if those service providers are exceeding the registration threshold, they have the legal obligation to register with the Inland Revenue Department and carry out the process, collect the VAT, pay, file the return. But now, if they don't do that thing voluntarily, there's nothing much in London department in Sri Lanka can do. You can't you can't go after those foreign parties. So basically, because of that, there's another methodology that is being successfully used, recommended by the OECD. That's called the platform liability. In other words, the platform itself is considered the deem supplier. So this platform has the obligation to register with the tax authority, pay VAT on behalf of the suppliers who are operating on that platform, administratively easy. More taxes will be collected. So now in the Sri Lankan scenario, what do we see? This is with regard to consumers again. I'm not talking about businesses. Now, we are totally relying on the voluntary registration of those service providers who are operating on those platforms, and there's nothing much if they are not going to register voluntarily. Tirani Kulathunge 13:56 Okay, people can just yeah free. Correct. So, in other words, Speaker 1 13:58 basically we we will be saying that okay, we do have digital vet in Sri Lanka, but I don't expect much revenue to come. Other than the big players, big service providers, because of their reputation, they don't want to damage that. They may register, but other than that, the small small service providers will not be registering, right? So because of that, the revenue that we are expecting is minimal, right? So I think Sri Lanka should go for the platform registration to supplement the vendor registration. So I think this is a fundamental mistake that we are doing right now, not not going for the platform registration. Okay. Now, what are we Tirani Kulathunge 14:39 going right now? Speaker 1 14:41 We are going only for simple vendor registration. Tirani Kulathunge 14:43 Okay. Okay. We are Speaker 1 14:44 we are depending on the voluntary nature of the software engineers in Bangladesh to everywhere else. Right here. So it's it's so that's another one. Now, now this is with the consumers that I've been speaking, not only consumers the. Services provided by non-residents, digital services to Sri Lankans include to the Sri Lankan businesses also, ones who are registered for VAT. Tirani Kulathunge 15:10 Okay. Speaker 1 15:10 So the OECD recommended methodology for that is reverse charge mechanism. So you look at the European Union, etc. It's a reverse charge mechanism. So what is reverse charge mechanism? They are the the liability of the foreign service provider shifted. The burden is shifted on the Sri Lankan resident consumer. Sri Lankan resident consumer must calculate the VAT and pay to the Sri Lankan Indra Department. So there is a documentation process that happens. So normally, what happens is there is a cancellation set off of the self-assessed input VAT invoice against the output VAT takes place. So you get IRD gets so normally a small amount. But at the same time, wherever the non non-resident digital service provider is providing the services to VAT exempt institutions, let's say the banks, financial institutions, largely exempt from VAT. In such a scenario, there is revenue that comes to the Inland Revenue Department. So now, what we have done is we are not imposing digital VAT on the businesses. That means the ones that are registered. So what we are doing is instead of using the RCM, the reverse charge mechanism, we are using this methodological. I call it for is B 2b carve out. B 2b carve out means it's not B 2b. It's basically people who are registered to a VAT carve out. That means we are keeping them out of the VAT net, VAT act altogether. Digital VAT is not applicable when the transaction is between a foreign supplier and a Sri Lankan VAT registered person, mainly the businesses. Is there with some Tirani Kulathunge 16:50 intention just to with the car out, like you know, are we trying to protect these? Is there a thought like that? Speaker 1 16:57 Well, let me put it this way: in Sri Lanka, we are short of tax, so wherever we can collect taxes, sorry, just to Tirani Kulathunge 17:07 jump on again, are we short on tax number of taxes or tax revenue? Speaker 1 17:12 Tax revenue. Tirani Kulathunge 17:13 Yes. Speaker 1 17:13 Sri Lanka's tax to GDP is very low. That is why IMF said we should go for digital VAT. Tirani Kulathunge 17:18 Yes. Speaker 1 17:18 So now what are we doing? So this is these are bases that we could we should collect taxes for the Sri Lankan government. Now we are letting these things go out, and we are bringing the SSEL threshold down. We are collecting that required revenue for the government from the wrong base, wrong target, using the wrong tax. As I said, SSCL should not be in the Sri Lankan VAT net, Sri Lankan tax net at all. Let alone reducing it from 60 million to 36 million. That gap we can collect from another base. Now this is what we are talking about: the reverse charge mechanism instead of the B 2b Tirani Kulathunge 18:04 covered. Yeah, interesting. Now there's this also requirement saying that the the government wants more peer systems and invoicing now that it's a compulsory thing or is it a selective that okay the right now there's a pilot Speaker 1 18:21 programme going on, but I think the vision is noble. What the government is trying to do is to adopt digitalization to the tax process. So we have been attempting to do this thing maybe number of years. So we are progressive to that. There are plus points, minus points. That are they are success stories as well as the failures. But somehow we do have a vision, and we are going towards that. I hope. I think all of us should hope and basically pray that it will it should be successful. This is what we find in the developed countries. Tirani Kulathunge 18:57 Asuna, there's this question now. Okay, India and Estonia they have used this digitization and by far have improved compliance. Now, within your pluses and minuses, do you think our compliance will improve also with this digitization process? Yeah, so Speaker 1 19:11 there are so so many so many measures that the government has taken. The Inlander Department has introduced with regard to how do I say from the manual systems to various digitization things, in different degrees, we do see that they are working, and there are certain ones okay we do find not working also. But overall, I think we are going in the right direction. We should keep focusing on that. Tirani Kulathunge 19:38 Super. Now coming into CGT or capital gains tax. Now say now Sri Lanka obviously we want it wants investments, but at the same time, now there are people are saying that okay we increase capital gains tax, constantly you know change all these tax rules and basically creates uncertainty again. There's this part where they have brought up saying that countries like Vietnam compete aggressively for investors through predictability. Again, of course, are we making Sri Lanka harder to invest, or are we making it easier? Any thoughts on that? Speaker 1 20:17 Okay, so since you are asking about the capital gains tax. I think the latest change that we do find is once the Inland Revenue Act amendment is introduced, in case of individuals, what is at 10% now will be going up to 15% But that that does not have an impact with regard to the FDI. Tirani Kulathunge 20:35 Okay. Speaker 1 20:36 So it's like this. Basically, in 1819, capital gains tax was introduced. There was a particular revenue figure that was targeted, but the collection was very poor, negligible. But then the message goes out to the investors: Sri Lanka has capital gains tax, a red flag. But at the same time, the way we are implementing it, while we are telling the world we do have capital gains tax and frightening the investors, because capital gains tax prevents capital formation. All right, we have not collected anything significant. Also, so either we should get the mechanism correct. Collect significant taxes, some taxes, or abolish it. One of the two. Okay. So now this Tirani Kulathunge 21:31 mechanism, I think we have spoken previously. Would you like to explain what kind of mechanism that would correct? So even capital Speaker 1 21:37 gains tax also. There are different ways in which you can collect what we have done is again is I think is a easiest way of doing it. We have a flat tax, 10% 15% When it comes to companies, 30% What we have is a flat tax. But you can design the capital gains tax in different methodologies. You can have progressive rates depending on the period of holding, etc. depending on the asset type. So, what we have done is we have just done the most simple thing that we can do, and then say, "Hey, we have capital gains tax. Tirani Kulathunge 22:14 Right. Speaker 1 22:15 And we are not collecting anything. Also, we are not collecting anything significant. But compared to 1819, now it's a little bit more, but then still, it's. I think it could be more. Tirani Kulathunge 22:26 Okay, so I mean, in terms of mechanism again, what do you think is the right mechanism right now for us when it comes to CGT itself? Speaker 1 22:33 I would say basically, take a look at India, go for progressive system, not a flat system. So progressive system means basically depending on the holding period, depending on the value, you have different rates. You start at let's say 5% 10% like that. Okay, 15% like that. You have like the way the in in case of individual income tax progressive system that we have slab systems. So that kind of a thing I think would be more appropriate. Administratively, it's a little bit difficult, but at the same time, I have a feeling it'll work. Tirani Kulathunge 23:10 Okay. Then again, now since you also mentioned that CHT won't necessarily affect FDI, just the raw messaging. But are we actually using the right tools to get FDI in the country right now. Speaker 1 23:24 Okay, this is the main thing. So, if you look at in Sri Lanka, look at the seminars, the webinars, the TV shows, so many things that are happening about the about this concept of FDI, foreign direct investment. How do we attract the foreign direct investments? You will read articles. So many things happen. Tirani Kulathunge 23:42 Yes, Speaker 1 23:43 but see, Sri Lanka still has not understood the fundamental thing from the taxation perspective. When you give FDI's come because of many factors. It's not just the tax, right? There are so many other factors. You need to have the political stability. You need to have the infrastructure. You need to have the right labour policies, etc. So many things. From the tax angle, what are we doing? We are still giving tax holidays and then holding out and say, hey, we are giving tax holidays. Come to Sri Lanka. Tax holidays because of the internationally the international changes that are taking place in the arena of taxation, concepts have changed. Tax holidays are not, how do I say, appetisers attractive to big investors. Tirani Kulathunge 24:37 Right. Okay. And Speaker 1 24:38 what I see is basically when we study other countries, regional, the other countries in the region, everywhere in the world, in 2002, 2003, they started changing their systems, adapting their systems, expecting what this new change that is taking place called the base erosion BEPS pilot. Global minimum tax thing. They they anticipated. They started changing their laws into 2023. Now they are being implemented. So they are basically somehow insulated themselves, or they have responses to with regard to this new environment that is being created. But in Sri Lanka, we have not still. We are not. We are not even considered. We are not even speaking. That's I said at the beginning. You go for FDI seminar, FDI webinar, etc. Tell me whether the speaker is speaking about the pillar two impact. How how we should get our tax policies correct, panellists, audience. Nobody speaks about the most important aspect with regard to the FDI attraction policy. Tirani Kulathunge 25:53 Right. Speaker 1 25:53 So we are all in the dark. So we need to get ourselves educated, appoint relevant committees, come up with right policies, come up with the relevant laws, rules, regulations. Tirani Kulathunge 26:08 Don't the tax department bring all of this up? Speaker 1 26:10 No. Let me let me be fair by the Inland Renown Department. What is the job of the Inland Revenue Department? Not to make tax policies. Their job is to administer the taxes that are there. Tirani Kulathunge 26:18 Okay. Speaker 1 26:19 Policy formulation is the job of the finance ministry. Tirani Kulathunge 26:22 Right. So Speaker 1 26:24 there are advisers. There are people basically have to come up with the policies. Tirani Kulathunge 26:30 Noted. Understood. So let's say there's this part of informality that I wanted to bring up. Let's say now, okay, Sri Lanka itself has a lot of informality. Let alone a lot of Sri Lankan businesses already operate informally. Let's say now, okay, if compliance becomes too difficult, won't businesses just stay underground? I mean, you mentioned this again before as well, and let's say beyond enforcement, isn't trust a huge part of taxation too? Because people pay taxes more willingly when they actually trust the state. Denmark is an example. What are your thoughts? Speaker 1 27:15 Okay, it's like this. I understand what you're saying. The concept of the voluntary compliance. You trust. You trust the system, then you pay. Tirani Kulathunge 27:24 You get the expected return. You could say Speaker 1 27:26 correct. Yes, so you do have that aspect also. But at the same time, to me, I will not rely on those things in a developing country like Sri Lanka, where systems are not That great, so I would say introduced less complex implementation mechanisms. For instance, I would prefer withholding tax spreading in the in all sorts of taxes because that is an easy way of collection of the taxes. So you are not depending on the voluntary nature, the taxpayers' trust, etc. Tirani Kulathunge 28:09 Okay. Those Speaker 1 28:10 are those are good advanced concepts. Okay. But in a in the society that we are living in, if we try to rely on those concepts, we will we will not get anything. So basically, I'll give you an example. I think once upon a time, this is exactly what happened in 2019. Also, we went and reduced the taxes, increased the threshold, thinking that the people will people will automatically trust everything and start making the payments. No, it doesn't happen in our countries like that. We should not have draconian laws, but we should have simplified ways of collection of taxes. Digitization is a good one. That's I said that we are in the right path. So basically, it's tax evasion becomes difficult, and at the same time, say mechanisms like withholding taxes also it's easy. For instance, let's say you have you have bank deposit, and you have to keep paying interest. Now it's a headache for you. At the end of the year, go to the bank, tell what my amount of interest. Now how much? How do I calculate? How do I basically file the return and pay? That headache would go off if automatically the relevant part of the interest is deducted, withheld, and the institution is remitting to the inlet and department. So, so I Tirani Kulathunge 29:32 prefer that too. Much less of it. Exactly true. Everybody for all Speaker 1 29:35 of us, cities. We have so many things in life that we have to attend to. Not going to a tax consultant's office, sitting and collecting and getting the bank statements from the from the banks and all that. Basically, I mean, not everyone Tirani Kulathunge 29:49 has access to tax consultants also. So exactly, Speaker 1 29:52 exactly. Tirani Kulathunge 29:53 Okay. So just another question on the other side of compliance. Now we see that. I have. What is the biggest mistake Sri Lanka continues to do? And let's say what is something that we are doing right, right now. Speaker 1 35:09 So when you say mistakes, there are so many. But let me try to see this. See, if you start from the beginning, let's say 1940s, 1950s, there about Sri Lankan tax system is evolving like the road system in Colombo. When you want to go from one place to another place, what do we do? We put a road there. Tirani Kulathunge 35:31 Okay. So there is no Speaker 1 35:32 scientific manner in which the way the roads are structured in Sri Lanka. So that is how the Sri Lankan tax system is also developing. When you are short of cash, we bring a new tax. When we want to, when you are short of cash, we increase the revenue, increase the rate, take out the exemptions, introduce the exemptions. So there is no scientific way in which tax system is being administered. So this is why I was advocating this concept of the tax policy unit, now it has been now it has been established. But we want to see the results coming from that, and they have to be active and doing the contribution. There's a bit of Tirani Kulathunge 36:12 a active, you know, the slowness in your wearing. So it's not Speaker 1 36:16 it's not enough that establishment. You have to put the right people, and you have to ask results from the members. For instance, digital vent. Why this only vendor registration? Why we are not bringing the platform platform registration here? Those questions should come from the from the TPU tax policy unit. They should have the knowledge. You see, but that is the way forward. So somehow, one thing good about this government is government is listing, right? So basically, that's correct. Yes. So if you look at the, if you look at the three bills when they came out, so so many people pointed out so many things minus points in relation to that, and whenever we have pointed out, the government has withdrawn those. For instance, take the case of the Inland Revenue Act. There were so many things, and though there was there at one point there were five petitions that were filed against the bill when it came. But when it when it was being taken up to the Supreme Court, from the Attorney General, they pointed out most of those ones that were being challenged. Government, the cabinet had decided to withdraw. So the government is listening. So I think it's a positive thing from that aspect. Tirani Kulathunge 37:33 Okay. All right. So now we have discussed the biggest mistakes and also the good that we have tried to progress into. And thank you, mr. Suresh, for joining for this conversation. And for our listeners, if you want to listen to more in-depth insights from more tax experts or more experts relating to other topics, please subscribe to our channel. Thank you so much for listening. Transcribed by https://otter.ai