Top experts say:

Capital Gains Tax deters FDI

by Lalin Fernandopulle

Tax experts said the country is grappling with the challenge as to what is the ideal combination of taxes to promote businesses and trade endeavours and for it to be a preferred destination for Foreign Direct Investments (FDIs).

N.R. Gajendran

Vajira Kulathilake

Ravi Abeysuriya

Tax Consultant and Partner, Gajma and Company, N.R. Gajendran said the policy statement of Prime Minister Ranil Wickremesinghe provided an overall direction as to how taxation should be directed as we approach 2020. The salutatory thought was articulated by the Premier that the ratio of direct tax to indirect tax should move up to 40:60 compared to the current 20:80.

This is in line with the traditional and accepted thought in fiscal policy where income tax which is considered a progressive form of tax, should generate a greater proportion of revenue compared to indirect tax.

The indirect tax being a consumption tax has a greater adverse impact on the poorer segment of society. This clearly shows that the government’s policy is not to impose greater hardship on the less-privileged people as its objective is to generate a greater proportion of revenue from the affluent segment. The policy of the government is that the tax to GDP ratio which is at an abysmal level of 11.7 percent in 2015 to progress to 18 percent by 2020. The dual fiscal aim is to achieve 18 percent tax to GDP ratio and the direct to indirect ratio to be 4:6 by 2020. This will be the first step for fiscal consolidation, Gajendran said.

In achieving these objectives, there has been aberrations in the fiscal policy making and inconsistencies and uncertainties have emerged for many reasons such as to achieve the objectives in 2020, ensure the less-privileged segmental is not burdened which is vital to avoid social unrest and manage debt and the exchange rate which is a major challenge faced by the government, he said.

Debt is being rolled over so that the country moves away from the high cost of debt finance to a manageable level of debt servicing cost. In this regard, the country will have to face the demands of multilateral agencies which are prepared to fund at a lower cost. Debt management is vital because the interest cost for 2016 has been projected at half a trillion rupees which in absolute and relative terms has become the significant expenditure for the government.

The current state of taxes is receiving mixed reactions as the State has to face a conflicting and contradictory fiscal and monetary state of affairs, Gajendran said.

With regard to the Capital Gains Tax (CGT), he said CGT is a progressive form of tax.

It is a tax on the realised gain on a capital transaction and a part of direct tax. One would pay only if a capital gain is realised. If there is a capital loss in line with the normal principles it should be allowed against the capital gains. This is in line with the principle of capacity to pay. The capital market is not doing well currently even without the CGT.

On RAMIS (Revenue Administration Management Information System), Gajendran said it is an ambitious program using technology for revenue administration. It is not the first time such as program was tried. Many attempts to modernise and revamp the system has come a cropper.

RAMIS is not a panacea for all ills. It will link 26 government institutions. If RAMIS is implemented the way it is spoken of then it will yield good results such as minimising tax evasion, scaling down corruption and improving efficiency.

President, Colombo Stock Brokers Association and CEO/Director, Candor Group of Companies Ravi Abeysuriya said the CGT was completely abolished from August 26, 1992 to promote share trading. The market has advanced a lot and one can argue for a case to introduce the CGT. But this is not the time for it, due a number of reasons.

Sri Lanka is faced with the necessity to attract FDIs for development and economic growth. International investors care a lot about a country’s international standing in terms of credit worthiness and market-friendly policies.

Now the credit has been downgraded which will undoubtedly negatively affect our ability to attract FDIs and portfolio investments. The increase in the CG tax will be viewed negatively by investors because it will reduce their returns.

This could result in a decline in share prices. A strong share market enhances the international standing and investor attraction. Hence, in the aftermath of a credit downgrade, introducing a CG tax will further affect the country’s international investment standing and this is counter-productive to the Government’s vision to attract international investments for development.

The purpose of the CG tax is to increase government revenue and thereby reduce the Budget deficit, particularly in the very short-term, to put the fiscal house in order. But we are in an environment, both domestically and globally, where share markets have declined (CSE about 20% down).

The short-to-medium term outlook is not very positive either. So, effectively the government will not be able to collect CG taxes, if there are no capital gains.

The CG tax could result in further net foreign outflows which will lead to worsening of the foreign reserves and thereby putting more downward pressure on the rupee. So, you are actually exacerbating the existing forex and currency problems.

The CG tax, particularly in a weak or declining market, has the potential to discourage trading activity, thereby, reducing the liquidity in the share market. That will also increase the bid-ask spreads and transactions costs to market players.

The Government has earned Rs.38 billion over the past 10 years through the 0.3% Share Transaction Levy (STL) without any effort whatsoever from Inland Revenue officials to collect revenue.

Further, over Rs.1.5 billion was earned in 2015, a year when share trading activities were comparatively very low. Capital losses will have to be offset against capital gains, resulting in further revenue losses to the government. This might not in fact give the government the increased revenue they desire.

The bottom line is that this is not the proper time to introduce the CG tax. It can be considered when the capital markets are vibrant and rising. In fact, this will be counterproductive to the need to preserve a good international standing and attract foreign investors.

The government should and can reduce the budget deficit in many other ways that will be less detrimental in terms of macro-financial implications. The Government has to be smart about it.

Tax experts said a capital gains tax on quoted share dealings will result in a drop in daily turnover, exit of local and foreign investors from the market, lower volumes of turnover tax based on Bourse turnover, drastic drops in indices, the absence of bonus and rights issues, a drop in market capitalisation, holding back of expansion drives due to lack of fresh capital, delistings from the market and inability to create more private sector jobs, flow of foreign institutional funds to overseas markets with no capital gains tax and lower transaction costs and net foreign outflows from the market burdening the rupee further.

Instead heavy fines for all illegal offences at airports and sea ports and also for acts such as human and drug trafficking and motor traffic offences. It will force the public to desist from carrying out such acts.

Chairman, Colombo Stock Exchange, Vajira Kulatilaka said the CGT will impede trading in the Capital Market which is in a stage where liquidity is low. Hence Capital Gains would lower the liquidity further.

This will also adversely impact foreign inflow of capital as most probably foreigners will also be subject to Capital Gains Tax. Some foreigners may pay Capital Gains in Sri Lanka as well as in 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 on listed securities will have an adverse impact on attracting capital and it will also diminish the market liquidity.