Mini Budget 2016 and its modifications:

How to implement VAT without raising C-o-L

by P. Guruge

Prime Minister Ranil Wickremesinghe made a statement in Parliament on March 3, 2016, explaining certain changes to Budget-2016 which have been already approved. He has given a number of reasons to justify such changes. The purpose of this article is to examine briefly the impact of these changes to the people.

Income taxation - 2016-17

Many changes proposed in the original budget will not be implemented from April 1, 2016 (i.e. (Year of Assessment YA 2016-17)

The calculation of taxable income for the YA 2016-17 is done under the Inland Revenue Act, as applicable to the YA 2015-16.

Main income tax rates applicable for the YA 2016-17, to individuals, companies and other entities will also be the same as those applicable to the YA 2015-16, except for one change.

The proposed change is in relation to the miscellaneous tax rates given in certain provisions of and in the 5th Schedule to the Inland Revenue Act. As per the original budget proposals, all such miscellaneous rates (i.e. 8%, 10% and 12%) were to be made 15%.

But, now all such rates will be converted to 17.5%, for the YA 2016-17 in keeping with the Prime Minister’s statement.

However, there are some ambiguities, which need clarifications -

The higher rate applicable to liquor, tobacco, lotteries, betting and gaming activities, which is 40% now, needs a change in consideration of the 25% ‘surcharge’ proposed in the original Budget for 2016. What will be the WHT rates applicable to the income received as provided for in the Inland Revenue Act, which are as follows -

Current rate
Interest on deposits
(Section 133, 134 and 135) - 2.5%
Interest on compensation
(Section 36) - 10.0%
Interest on special deposits
(Section 37) - 10.0%
Dividends (Section 65) - 10.0%
Govt rewards, fine shares, winnings
from lotteries,
betting and gambling
(Section 151) - 10.0%
Management Fees
(Section 160) - 5.0%
Annuity or Royalty
(Section 160) - 10.0%
Sale of gems -
(Section 161A) - 2.5%
Payment to persons outside
Sri Lanka (Section 95) - 20.0%
Non-citizen entertainers or
artistes - 15.0%

Two important WHTs which were generating considerable revenue were abolished in 2011, by the ‘Rajapaksa-Jayasundara’ combination in relation to commercial rent and other specified fees under Section 151 and 155, may be re-introduced from April 1, 2016.

Revenue implications - additional revenue may not be available in 2016.

According to the original Budget – 2016 the estimated revenue from income tax was only Rs. 233 billion.

However, in 2015, income tax collection was anticipated to be around Rs. 250 billion with the addition of the Super Gains Tax (SGT). Since the same provisions are to be applied for the YA 2016-17 too, the Inland Revenue Department (IRD) can expect the same amount of revenue this year as well. However, there will not be SGT in 2016 and therefore, it may be less than Rs. 250 billion.

Due to the changes in the miscellaneous rates, additional revenue may be expected. However, it is doubtful whether this increase in revenue will be realised this year due to the income tax payment system under the Self-Assessment Scheme.Any chargeable person can pay an amount equal to one-fourth of the previous year’s tax payable for the current year for each self assessment payment and pay any balance by September 30 of the following year.

As a result, those concerned may legally wait till September 30, 2017, to pay the additional tax due on the change in the tax rates! Therefore, the IRD will miss this additional revenue in 2016. To collect any additional income tax, in 2016, it may be necessary to think about some other measures.

Nation Building Tax (NBT)

The original budget proposal was to increase the NBT rate to 4% from January 1, 2016. This has now been abandoned. The NBT rate will remain at 2%.

However, there was a proposal in the original Budget to bring the following exempt items to the liable category and tax them at 4%.

Electricity, telecommunication and lubricants

This amendment will stand subject to the rate change and the above three items will be liable to the NBT and the additional revenue will have to be shared with the Provincial Councils.

There was a proposal to bring down the Rs. 25 million exemption threshold given to certain activities, to Rs. 3 million. We hope that this amendment will also be effective although not specifically mentioned in the new proposals, which will bring in more additional revenue.The NBT has distorted the market prices due to its cascading effect as in the case of a Turnover Tax. It is better to abolish the NBT and make a simple tax system.

Value Added Tax (VAT)

A considerable increase in revenue may be expected from the change in the VAT rate. The 11% applicable up to the enactment of amended provisions of the VAT Act will not be converted in to two rates as proposed in the original Budget-2016. The new rate will be 15% (single positive rate). However, the method of implementation of this new rate is not clear.

The relevant authorities may use the provisions of Section 2(4) of the VAT Act and immediately, effect this rate change by an order under that Section, without waiting for the approval of the relevant amendment in Parliament.

Else, it may be delayed by another two or three months. The IRD expected to be collected was around Rs. 206 billion as VAT for 2015 under the 11% regime.

On the same basis, without considering increased consumption of taxable goods in 2016, at the new rate of 15% there may be nearly a 36% increase (around Rs. 74 billion) in the total VAT revenue, in 2016, if the rate change is effected without delay.

However, already three months have passed and if the new rate of 15% is implemented from April, 2016, there may be around 27% increase of revenue in 2016 (around Rs. 55 billion)

Removal of exemptions. Although, the exemptions have become a ‘cancer’ in our VAT system, the Prime Minister has decided to remove only three specific items as given below from the marathon exemption list of the VAT Act.

Telecom services

I wish to draw the attention of the relevant authorities to certain problems in this respect. During the Rajapaksa regime, VAT on telecom services was removed and that was also added to the currently charged ‘telecom levy’. Now, the telecom levy is charged at 10% and 25%. A ‘cess’ is also charged in addition to this levy. The total charge is little more than 15%, currently. Now, another 2% will be charged as NBT. If 15% VAT is also imposed, the total charge will be around 33%.

With the downward trend currently experienced by the telecom sector, it may not be possible to charge such a big amount as taxes and levies. Consumers may not be willing to pay 33% to the government out of money they spent on a telephone call.

Educational services (private sector)

The main problem in this sector is the identification of educational services. Even now, the exemption is available only to the provision of educational services (ie. tuition fees).

But currently, many educational institutions do not comply with the regulations. The classification should be educational services or not and it is immaterial whether it is the private sector or public sector.

Many non-educational services are provided by the public sector institutions without paying VAT. The public sector may be exempted only on pure educational services. Another problem is to identify the public sector educational establishments very clearly.

If proper criteria and guidelines were not in place many influential parties involved in this sector which are not public institutions may avoid the VAT payments on the liable services provided by them.

Health care services (private sector)

In this area there are two exemptions available now. Institutions providing health care services. Relevant professionals providing such services.

I hope both these categories will be liable to VAT under the proposed regime. It may not be difficult to identify public sector institutions and the relevant professional services provided in the public sector. It will be important to cover all health care services including Ayurvedic and other non-western medical services as well.The revenue potential of all these three sectors will depend on their input tax claims. During the exemption period they had to absorb such input VAT as a cost. But when they become liable they can claim credit on such VAT paid by them in providing the relevant services. Therefore, the revenue estimate cannot be made by just applying 15% to the gross collection.

Wholesale/retail

The Prime Minister had stated that certain specified items will be made liable to VAT in this sector. Many people have misunderstood this statement and await the publication of VAT liable items under the proposed regime!. However, it has to be done very carefully, since the previous experience of ‘Rajapaksa-Jayasundara’ system of wholesale/retail VAT became not only an utter failure but it was irrational and illegal.

The wholesale/retail sector consists of three categories - manufacturer selling goods manufactured by him; importer selling goods imported by him; local buying and selling of goods.

Of these three categories, the present VAT regime already tax (a) and (b). Therefore, only local buying and selling of goods should be considered. However, most of such traders belong to the small and medium scale and may not be liable to be registered for VAT.

Any system of VAT to cover this category should be very simple and a good tax handle. Due to the non-taxation of buying and selling under VAT (they are already liable to NBT at half the normal NBT rate) many manufacturers and importers adopt a system of supplying their goods to ‘connected persons’ for sale, at a very high discount and avoid VAT on such transactions.

Although, the Assessors of Inland Revenue can challenge such arrangements it normally does not happen. If we can avoid this manipulation instead of taxing entire ‘buying and selling sector’, it may generate some additional revenue.

It can be done very easily by removing the exclusion already available to such persons, under the VAT Act.

If you are going to decide on separate exemptions for wholesale/retail, it may create practical problems. Until such time the entire Exemption Schedule is revisited, it may be prudent to apply the same exemptions to all the activities including buying and selling of goods.

Capital Gains Tax

There are various taxes on capital and Sri Lanka has tested almost all capital taxes and finally given up all capital taxes. Although, we have some problem in our ‘tax mix’, the solution may not be the re-introduction of some capital taxes. After all, how many ‘super rich’ Sri Lankans are in Sri Lanka?

If you take the share market for example, it is said that there are about 20 very high net worth investors. Even in other sectors there may be around 50 to 100 in each sector who are super rich people (such as Casino Kings).

Impact on consumer prices

Any revenue from indirect taxes is finally paid by consumers. If the consumer can absorb the tax and enjoy consumption of relevant goods and services, then such tax may be considered reasonable. In relation to VAT and NBT, there was a large number of exemptions granted in the relevant statutes. When you consume such exempt goods/services, the relevant tax will not be charged. When the above exemptions are considered, the increase in the VAT rate may not have any considerable impact on the cost of living of the masses in Sri Lanka.

The writer is a Senior Tax and Investment Consultant