The insatiable desire of political parties in power to entertain their voter base – which secured their election, helped them get their grip on power, and will most likely help them in another election – along with an extravagant style of governance while lacking concrete revenue sources, has led to Sri Lankans developing an aversion to one word, or rather, one concept: taxes. However, more taxes are looming ahead.
The Sri Lankan Government has already implemented a series of taxes as part of its ongoing Extended Fund Facility (EFF) arrangement with the International Monetary Fund (IMF). However, the IMF has recommended additional taxes to be introduced, along with specified timelines for their implementation.
What awaits Sri Lanka in January 2025 are the Wealth Tax, Wealth Transfer Tax, Gift Tax, and Inheritance Tax.
The Staff Report published by the IMF in March 2023 on Sri Lanka clearly stipulates the revamping of the property tax system and introducing a Wealth Transfer Tax. In particular, Sri Lanka has to introduce a nationwide real property tax and adjust the system of transfers between the Central and Provincial Governments. It also proposes to introduce a Gift and Inheritance Tax with a tax-free allowance and minimal exemptions.
SL not in a position to negotiate
Speaking to The Sunday Morning Business, KPMG Sri Lanka Tax and Regulatory Principal and Head Suresh Perera expressed doubts about the Government’s ability to negotiate the proposed taxes with the IMF. His scepticism stems from the country’s tax collection performance, which remains unsatisfactory despite implementing the tax reforms recommended by the fund earlier this year.
According to the 2022 Annual Report of the Ministry of Finance, tax revenue for the first quarter of 2023 experienced a significant surge, reaching Rs. 578 billion. This marked a substantial increase from the Rs. 370 billion collected during the same period in 2022.
However, despite this growth, the tax revenue collection for Q1 2023 fell short of the target agreed upon with the IMF, which had been set at Rs. 650 billion. The actual collection was 11% below this target.
Even by the end of the first half of 2023, Sri Lanka had not achieved its tax revenue goal of Rs. 1,300 billion, as outlined by the IMF. Central Bank of Sri Lanka (CBSL) data revealed that the Government had managed to achieve only 92% of this target.
According to the CBSL, the country’s total revenue for the first six months of 2023 amounted to Rs. 1,317.05 billion, marking a 43% increase Year-on-Year (YoY). Out of this total, Rs. 1,198.85 billion came from tax revenue. However, Sri Lanka recorded a primary surplus of Rs. 30.72 billion for H1 2023, whereas the IMF had projected a deficit of Rs. 113 billion for the same period.
“It is doubtful whether the Government can say ‘no’ to these new taxes that are supposed to come into effect from January 2025. The current tax collection is not at a satisfactory level, therefore there will be immense pressure on the Government to implement the tax reforms strictly. Had tax collection been satisfactory, the Government would have been able to secure a position to negotiate from,” Perera explained.
Wealth Tax
According to Investopedia, a wealth tax applies to the net fair market value of all or some of a variety of asset types held by a taxpayer, including cash, bank deposits, shares, fixed assets, personal cars, real property, pension plans, money funds, owner-occupied housing, and trusts.
According to Perera, wealth tax is extremely difficult to implement, with the collection process being tedious.
“Different countries have different formulas for the implementation of their wealth tax. In the past, many countries had implemented wealth tax, but most gave up halfway and only a very few countries implement it at present,” he stated.
Pointing to India as an example, he noted that India’s Wealth Tax Act, introduced in May 1957, had imposed Wealth Tax on individuals, Hindu undivided families, and corporations based on their net worth as of the valuation date.
However, in the Union Budget (2016-2017), then Finance Minister Arun Jaitley repealed the Wealth Tax, following recommendations from the Chelliah Committee. The Wealth Tax was seen as burdensome for both taxpayers and tax authorities due to difficulties in assessing assets such as jewellery and luxury cars, leading to undervaluation of productive assets.
Over a dozen European countries once implemented wealth taxes, including Austria, Denmark, Finland, France, Germany, Iceland, Ireland, Italy, the Netherlands, Luxembourg, and Sweden. However, the majority of these countries, with the exception of Norway, Spain, and Switzerland, have since repealed their wealth taxes.
A wealth tax poses significant administrative challenges, often incentivises tax evasion, and can potentially lead affluent individuals to relocate from countries where it is enforced. These considerations, along with ongoing debates regarding equitable implementation, may account for the limited number of countries globally that levy such a tax on their citizens.
Hence, the parameters, ability of the Government to administer it, and the implementation of the Wealth Tax in Sri Lanka remains questionable. However, both the IMF and the Ministry of Finance confirmed that the preparatory work to implement these tax reforms will commence this year, supported by IMF technical assistance.
Wealth Transfer Tax, Gift Tax and Inheritance Tax
There are two primary categories of taxes imposed on wealth: those that are levied irregularly or periodically on an individual’s wealth (known as net wealth taxes), and those imposed on the transfer of wealth (referred to as transfer taxes).
Net wealth taxes are typically calculated based on the net value of the taxpayer’s taxable assets, which is the value of assets minus any associated liabilities. These taxes can be assessed either sporadically, often referred to as ‘capital levies,’ or on a regular, recurring basis.
Transfer taxes, on the other hand, are typically assessed on the net value of the taxable assets being transferred and can be categorised into two basic types: those imposed on the transferor or their estate (more commonly found in common law countries), and those imposed on the recipient.
Taxes imposed on the transferor can be categorised into those applied to transfers during an individual’s lifetime, known as gift tax, and those applied to transfers upon an individual’s death, referred to as estate tax. These taxes may be assessed separately or combined into a single integrated tax.
Recipient-based taxes, on the other hand, can include taxes on transfers during an individual’s lifetime (gift tax), taxes on transfers at the time of an individual’s death (inheritance tax), and integrated taxes that cover both scenarios (accessions tax).
Perera noted: “Inheritance tax rates are usually quite high. Countries like Japan and the UK implement this tax. Sri Lanka was earlier implementing an Estate Tax.”
A majority of European nations have implemented estate, inheritance, or gift taxes within their tax regimes. This tax framework is prevalent across several countries, including Belgium, Bulgaria, Croatia, the Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Lithuania, Luxembourg, the Netherlands, Poland, Portugal, Slovenia, Spain, Switzerland, Turkey, and the UK.
Estate taxes are imposed on the entirety of a deceased individual’s property and are settled from the deceased person’s estate. On the other hand, inheritance taxes exclusively target the value of assets being transferred and are the financial responsibility of the heirs. Additionally, gift taxes are applicable when property is transferred by a living individual to another.
Typically, a country chooses to impose either estate or inheritance tax, but not both.
The Ministry of Finance informed The Sunday Morning Business that a feasibility study had to be undertaken by the Government together with the IMF to determine the parameters upon which the aforementioned taxes would be introduced.
With the ministry remaining firm on introducing the tax by the stipulated time period, whether these new taxes will be a success or whether the Government will have to end them due to administrative issues remains to be seen.