Capital Gains Tax will hit low income earners most - Economists, tax experts

by Lalin Fernandopulle

Economists and tax experts said the reintroduction of the Capital Gains Tax and reversing the direct to indirect tax ratio from 20:80 to 40:60 by 2020 would adversely affect investors and low income masses as a greater proportion of their income would be taxed and the situation would aggravate when income levels drop.

Former Central Bank Deputy Governor, W.A. Wijewardena said the government should have introduced a tax on every transaction carried out instead of a capital gains tax which discourages investors. The transaction tax will not affect investors.

“I endorse the views of the Share Brokers Association that the Capital Gains Tax in not conducive to attract investors and drive capital market growth,” Wijewardena said.

He said the Capital Gains Tax should have been reintroduced when the market was doing well in 2010 when the All Share Price Index recorded growth and not now when there is a downturn in the market.

Given the current economic scenario in the country, the reintroduction of the Capital Gains Tax is not conducive for investors.

Tax expert and partner, Gajma and Company, N.R. Gajendran said this is not a conducive tax for low income earners who wwould be the most affected segment.

No doubt the tax to GDP ratio which is currently 10.7 percent, the lowest in the world, has to be raised to around 13.5 percent in the short term and then to around 18 percent to finance development programs.

The government raised the Value Added Tax (VAT) from 11 to 15 percent to enhance revenue while not taxing essential commodities. The Nation Building Tax (NBT) remains at two percent.

“The move to raise revenue while not burdening the masses is a uphill task for the government,” Gajendran said.

Tax experts said if the government wants to achieve a tax to GDP ratio of 18 percent, inefficiency, corruption and malpractices in the revenue collection offices should be reduced. The competency of revenue officers must be enhanced to achieve the targets.

“Key Performance Indicators (KPIs) and the introduction of Revenue Administration Management Information System (RAMIS) linking 26 institutions will help boost efficiency in revenue administration,” Gajendran said.

It is not clear as to how the government will implement the Capital Gains Tax. It is a tax on profit of people and corporates.

Chairman, Colombo Stock Exchange (CSE), Vajira Kulatilaka said the imposition of Capital Gains Tax has been a concern of the capital market for some time. In the past, before national Budgets were presented there were rumours that the Capital Gains Tax would be imposed. However, it was never introduced. So the market panicked when the Government said the Capital Gains Tax would be imposed on shares.

However, nothing was mentioned about the applicable rates and holding periods. As such, the reaction was based more on panic than a reaction after actual evaluation.

“Capital gains computations in an active market is extremely difficult and investors can adopt tax minimisation strategies. Collection of this tax is also difficult. Hence, the Government may not get the anticipated revenue through the tax,” Kulatilaka said.

He said the Capital Gains Tax will hinder trading in the capital market. The Sri Lankan capital market is at a stage, where liquidity is low. Hence, the tax would lower liquidity further. This will also adversely impact foreign inflow of capital as most probably foreigners will also be subject to the tax. Some foreigners may have to pay the tax in Sri Lanka and their own country thus subjecting themselves to double taxation.

Overall, there was a method to tax the listed market through the Share Transaction Levy and it was functioning smoothly. Collectability was assured as the CSE collected the levy and transferred it to the Inland Revenue Department. The Capital Gains Tax on listed securities will have an adverse impact on attracting capital and it will also diminish the liquidity of the market.

“We still don’t know the exact rate and the applicable period for the tax. It is also important to know the rates applicable to different sectors. It is too premature to comment on the medium to long term impact on various investors. But I can surmise that all sectors in the short term, will panic,” he said.

“The CSE functions in a global environment and is negatively or positively affected by global political, economic and social factors. Today, most of these factors are negative, adversely affecting our market. However, we can be happy that the Sri Lankan market is somewhat resilient, vis-a-vis similar markets in the world,” Kulatilake said.

“What we need today is more attractive stocks with high liquidity to enter the market through IPOs so that investors will be attracted to it. Simultaneously, we will have to market the country and the capital market globally. Good IPOs will act as a catalyst for this purpose.

Criticising the special statement by Prime Minister Ranil Wickremesinghe in Parliament regarding the new taxation including imposing the Capital Gains Tax and raising VAT, Opposition MP Prof. G.L. Peiris called on all Sri Lanka Freedom Party parliamentarians to vote against the new proposals, which are expected to be placed before the House in the next few weeks.

“Wickremesinghe adds burdens on the public by increasing VAT and reintroducing the Capital Gains Tax. The Joint Opposition will never vote for such proposals and hopes SLFPers who care for the country to follow us for the county’s sake,” Peiris said.

Earlier this month the Prime Minister in a seven-page statement slammed the previous government of former President Mahinda Rajapaksa for concealing debt accumulated by State-Owned Enterprises and other public companies, which had to be added to the consolidated fund by the Wickremesinghe-Sirisena administration.

The Prime Minister also outlined how the Government allowed a forensic audit by the International Monetary Fund (IMF) ahead of a possible program between the two entities to increase fiscal consolidation.

A new tax system likely to be implemented in 2017, is also under discussion between the Government and the IMF.

Wickremesinghe said VAT would be increased from 11% to 15%, while capital gains would be taxed for the first time since 1987 under the new measures. However, VAT increases would not be imposed on electricity bills and essential goods, he said.

The new tax rates were decided on at a special Cabinet meeting where VAT exemptions to telecommunications, private education and the health sector among others was ruled out to simplify the system.

Wickremesinghe told Parliament that the Government owed Rs. 9.5 trillion ($65.6 billion) or 74.9% of GDP, as he revised some of the main Budget numbers presented in November. He said the former Government headed by Rajapaksa had not included the Rs. 1.04 trillion in borrowings by State enterprises in the national debt, which was estimated at Rs. 8.48 trillion at the end of last year.