A streamlined mechanism to facilitate Withholding Tax (WHT) refunds and exemptions is essential, according to experts.
President Anura Kumara Dissanayake recently announced that Sri Lanka had reached an agreement with the International Monetary Fund (IMF) to increase the WHT on deposits from 5% to 10%.
The measure aims to broaden the tax base, enhance compliance, and improve tax administration. Exemptions will be provided for individuals in lower income brackets and senior citizens.
Depositors earning less than Rs. 150,000 per month can obtain an exemption certificate from the Inland Revenue Department (IRD). Similarly, individuals in income tax brackets below 10% will have the ability to reclaim the additional taxes.
Rs. 66 b IRD revenue from WHT at 5%
Speaking to The Sunday Morning, an IRD spokesperson stated that the tax revenue generated by the department in 2024 from WHT on interest (5%) amounted to Rs. 66 billion.
While various proposals and statements have been made regarding the 10% increase, exemptions for lower-income brackets, and specific mechanisms to facilitate the refund process, these mechanisms have yet to be implemented and the IRD is currently awaiting the necessary amendments.
“The different proposals available for a mechanism will be considered and one will be selected. At the moment, there are several proposals and any decision in this regard requires further approval,” the spokesperson added.
An assessment of the number of people affected and reports on the number of refund claims by senior citizens are yet to be received by the IRD. However, the IRD encourages senior citizens to apply for refunds and be made more aware of the process, as per the circular issued for senior citizens.
Further, The Sunday Morning learns that while the Revenue Administration Management Information System (RAMIS) is used for verifying information, no specific digital system has been introduced yet for the purpose of facilitating tax refunds, exemptions etc.
Circular for senior citizens
In 2023, the IRD announced the launch of a programme to refund the Advance Income Tax (AIT) deducted at 5% on interest income by banks or financial institutions to support the financial well-being of the country’s senior citizens.
The IRD circular titled ‘Senior Citizens’ Quarterly Income Tax Refunds for Advance Income Tax (AIT/WHT) Deducted on Interest,’ released on 25 September 2023, outlines the procedure for refund payments to senior citizens.
The requirements to claim a refund under this mechanism include the following: the applicant must be a resident individual and a Sri Lankan citizen who is 60 years old or above, with an annual income not exceeding Rs. 1,200,000.
The maximum refund claim is Rs. 25,000 per quarter and Rs. 60,000 per year. Additionally, the applicant must not have any outstanding payable amounts for the relevant year of assessment.
This mechanism requires obtaining a Taxpayer Identification Number (TIN). A duly completed Registration Form for Senior Citizen Refunds (Form No. KFN/IT/WHT/71-E) must be filled out and submitted to the nearest IRD Regional Office or Metropolitan Office corresponding to the senior citizen’s permanent address.
Refund payments are transferred directly to the bank account of the respective senior citizen. Furthermore, the information provided must match the details recorded in the RAMIS of the IRD.
However, it is understood that many senior citizens are unaware of the mechanism for reclaiming WHT, which requires the submission of several documents to prove the deduction.
To support the process of WHT, the Government plans to introduce a specific mechanism to facilitate exemptions and refunds, including a system to refund WHT for retirees who are not subject to income tax. Additionally, a dedicated unit is to be established within the IRD to provide guidance and assistance to the public.
Attempts made by The Sunday Morning to reach the Ministry of Finance as well as Cabinet Spokesperson Dr. Nalinda Jayatissa regarding the mechanisms to be implemented proved unsuccessful.
Refund system requires overhaul
Speaking to The Sunday Morning, Verité Research Lead Economist Raj Prabu Rajakulendran noted that WHT refunds, such as the tax refund system in general, needed an overhaul.
He noted that implementing a proper mechanism should concern timing and faster claiming of refunds, adding that systems should be designed in a way that refunds could be processed promptly, as delays created liquidity problems for both individuals and companies.
“The system should be one that facilitates online procedures or convenient procedures. It should also accommodate senior citizens and people who lack tax files, such as when their income is below the income tax threshold or those without TIN numbers. The refund system should primarily address these two issues. There are even certain countries that exempt senior citizens entirely so that they do not have to pay this tax at all,” he said.
Rajakulendran added that while awaiting the implementation of such a system, it was crucial to have a mechanism in place to ensure that refunds could be received quickly.
Aso addressing the increased rates and their implications for tax compliance, he said: “Since increasing the WHT is not an additional tax, ideally, there should not be any economic cost. Overall, there is an economic net benefit as it creates an incentive for people to file income taxes. With more income being withheld, there is a greater incentive to file income taxes, which generates a necessary discourse about how and why taxes should be filed.”
He noted that the implementation of the WHT brought this conversation to light, as people were now more aware of the need to file income taxes. This conversation itself is a net benefit, resulting in an overall positive impact.
Additionally, Rajakulendran highlighted how this system helped tax compliance, with studies having shown that in developing countries, taxing at the source such as through WHT was one of the most effective ways to increase tax compliance.
“While most developed nations already have a strong culture of tax compliance and filing, Sri Lanka, as a developing country, needs to create incentives for tax filing. Therefore, having taxes deducted at the source is beneficial for improving compliance,” he stated.
In Sri Lanka, there are several types of Withholding Taxes. Advance Personal Income Tax (APIT) refers to taxes deducted by employers directly from employees’ salaries. Meanwhile, AIT is withheld at the source by the payer from the recipient’s income generated through investments, such as interest, dividends, royalties, etc.
Moreover, WHT on specified fees involves taxes retained at the source by the payer on payments from the individual recipient for certain identified service categories. Deduction of WHT, AIT, and APIT were made mandatory by the IRD with effect from 1 January 2023.
Various mechanisms available
Speaking to The Sunday Morning, KPMG Sri Lanka Tax and Regulatory Division Principal Suresh R.I. Perera noted that the current issue regarding WHT was that certain groups were subjected to this tax, despite not being liable.
He stated that when amounts were withheld, the withholding party was under a blanket obligation to withhold from every payment they made. Due to this, individuals who are not liable to pay taxes are also subjected to the withholding mechanism when they receive payment.
“Generally, with a withholding mechanism in place, under the old Inland Revenue Act, there was a direction mechanism. The direction mechanism involved obtaining a direction from the IRD Commissioner General, proving that the individual is not liable for taxes. Once approved, a written direction was issued, instructing the relevant parties not to withhold taxes.
“Under the previous Inland Revenue Act, there was also another mechanism that allowed individuals to make a self-declaration to the bank. Based on this declaration, the bank refrained from deducting WHT if the taxable income was below the liable threshold,” Perera explained.
Additionally, he noted that when the 2018 Inland Revenue Act was introduced, while the withholding mechanism was included, the direction mechanism was not.
Addressing ways to remedy this issue, Perera suggested that a regulation could be issued under the Inland Revenue Act itself to re-establish the direction mechanism and/or a self-declaration mechanism to address the inconvenience caused to individuals who are below the taxable threshold but are still subjected to WHT.
He further noted that filing a return and requesting a refund, in cases where taxes were deducted despite an individual not being liable, was another option. However, he pointed out that this was not a very successful mechanism, as it was rather challenging for taxpayers to get their refunds through this procedure.
“In my opinion, the refund mechanism is not viable, as it can create a lot of hassle for the taxpayer. Either the self-declaration or the direction mechanism, or rather, a hybrid of both would be viable options,” Perera said.
Increased WHT, increased tax compliance
Commenting on the increase in rates, Perera noted that the increase to 10% would apply not only to bank interest but also to specified fees.
According to Section 85 of the Inland Revenue Act, certain individuals, such as doctors and engineers, are recognised as independent service providers, and at present 5% is withheld from their specified fees or services under Section 85(a) of the act.
It is likely that this withholding rate for specified fees and services provided by identified individuals will also increase from 5% to 10%.
WHT is a collection mechanism through which income tax is collected and there are two methods by which the IRD collects income tax. One is the self-assessment basis, where taxpayers are required to pay taxes in four installments, while the other method involves deducting part or the full amount of tax liabilities at the source.
The introduction, increase, or decrease of WHT therefore does not affect the taxpayer’s overall tax liability, as it remains the same, with no economic impact on the taxpayer.
Addressing the implications of the increase, Perera noted that when the withholding rate increased, the amount payable under the self-assessment basis changed accordingly.
However, in practice, particularly with banks or specified fees when 5% is withheld, some taxpayers fail to pay the remaining balance to the department, constituting tax evasion. By increasing the withholding rate, the IRD will be able to ensure better tax collection, which is the expected outcome.