The Government has officially withdrawn the proposed amendment that would have lowered the annual turnover threshold for mandatory Value-Added Tax (VAT) registration from Rs. 60 million to Rs. 36 million. However, experts have varying views about the decision and its fiscal, economic, and policy-related implications in the short and long term.
The total estimated tax revenue in the 2026 Budget is Rs. 4,910 billion, which includes revenue from income tax at Rs. 1,210 billion, taxes on goods and services at Rs. 3,056 billion, and taxes on external trade at Rs. 644 billion.
As per the latest data, the Inland Revenue Department (IRD) has achieved 52% of its annual income tax target so far, which is Rs. 2,401 billion. Rs. 1,255 billion has been collected to date, representing a 117% progress compared to the previous year. In May this year, the IRD also surpassed the milestone of collecting over Rs. 1 trillion in tax revenue.
Support for SMEs
In Sri Lanka, a large percentage of Government revenue comes from taxes.
Deputy Minister of Economic Development U.D. Nishantha Jayaweera said that the Government’s decision to retain the VAT registration threshold at Rs. 60 million had been taken in view of prevailing economic conditions, especially the challenges faced by Small and Medium-sized Enterprises (SMEs), which were still in the process of recovering.
Speaking to The Sunday Morning Business, the Deputy Minister said that the decision reflected the current state of the economy and the need to avoid placing additional pressure on businesses that were rebuilding.
“The economy was affected by several factors, including foreign exchange issues, Cyclone Ditwah, and the difficulties faced by SMEs. Many of these businesses are recovering only now. Taking all of that into consideration, the decision was made to retain the VAT registration threshold,” he said.
He noted that retaining the mandatory VAT registration threshold at Rs. 60 million would provide relief to SMEs, adding that businesses still had the option of registering voluntarily if it suited their operations.
“Support has been extended towards SMEs by not changing the threshold. In many cases, manufacturers supply their products to businesses that are already VAT-registered, and such buyers request VAT invoices.
“If a business chooses to register for VAT, the VAT paid on raw materials and other input services can be claimed as input tax. In addition, businesses that are expanding usually need to issue VAT invoices. Even though the mandatory threshold remains at Rs. 60 million, there is no obstacle preventing anyone from registering voluntarily if they wish to do so. What was stopped was reducing the mandatory threshold from Rs. 60 million to Rs. 36 million.”
Addressing concerns about the possible impact on Government revenue, Jayaweera said that retaining the threshold would not affect revenue targets, noting that tax collections had continued to improve without tax rates being increased.
“We have not necessarily increased tax rates this year. Even under the existing rates, the tax base has expanded significantly. If you compare the number of registered taxpayers today with the number at the end of 2024, there has been a considerable increase.”
Thus, he noted that the Government revenue had also increased alongside the expanding tax base, without changes to the tax rate or the VAT threshold being lowered.
Fiscal implications
When asked about the fiscal implications of this decision, tax expert and KPMG Sri Lanka Principal – Head of Tax and Regulatory Suresh Perera observed that fiscally, this was a deliberate sacrifice of immediate revenue for short-term economic stability, which meant that the Government was forgoing a primary tool for broadening the tax base.
He added that the planned revision had been expected to bring a significant number of businesses within the turnover range of Rs. 60 million to Rs. 36 million under the VAT net. He further noted that by shelving the measure, the Government was accepting a short-term revenue shortfall and slowing down the pace of fiscal consolidation targeted under the International Monetary Fund (IMF) programme, relying instead on improved compliance from existing taxpayers.
“Several interconnected factors influenced this reversal, I believe. The Government cited recent external shocks (such as cyclone impacts and Middle East tensions) that have severely strained small businesses. Imposing new registration burdens now could push them into bankruptcy. Also, for a business turning over Rs. 36–60 million, the cost of mandatory Point of Sale (POS) machines (~Rs. 200,000), accounting software, and hiring tax consultants is disproportionately high relative to their profit margins, making compliance difficult.”
Perera also noted inadequate administrative capacity, noting that the IRD was not equipped to suddenly audit and support 10,000 new, largely unorganised taxpayers. He added that the parliamentary Committee on Public Finance (COPF) had explicitly flagged this lack of readiness.
Furthermore, he noted that as a new Government navigating a fragile recovery, imposing a new tax burden on the politically vocal small business sector would have created significant social and political backlash.
Meanwhile, the Government has noted that voluntary registrations had already surged (VAT returns filed have increased from approximately 18,000 to over 35,000), stating that improving enforcement among current registrants is more effective than bringing new businesses into the tax net.
Asked about the implications of this decision on businesses already paying taxes, Perera said that it would have a negative impact and create an uneven playing field.
He explained that businesses already in the net (turning over Rs. 60 million) could not compete on price with SMEs in the Rs. 36–60 million bracket, which remained outside the system and could undercut prices without charging VAT. However, as this is a situation that has existed for some time, he noted that it was a settled issue to some extent.
Furthermore, Perera explained that larger businesses that purchased inputs from such exempt SMEs could not claim input VAT credits, raising their overall operational costs and reducing competitiveness.
Short-term and long-term impacts
Commenting on the impact on tax revenue, Perera said that it would be lower than projected and that the Government would miss the projected revenue injection from the new cohort. However, he added that the IRD could partially offset this by intensifying audits and enforcement among existing VAT registrants and through the collection of more revenue from income tax due to new measures that had been introduced to strengthen tax administration.
Moreover, he said that the Government had delayed rather than abandoned tax base broadening targets, noting that only the numerical broadening had been stalled. However, he pointed out that the Government was pivoting to ‘deepening’ the existing base by compelling current registrants to declare their true turnover rather than ‘widening’ it aggressively.
“Overall, this is a classic short-term buffer versus long-term trade-off. In the short-term, it is favourable. Economically, it acts as a fiscal stimulus. It preserves SME cash flow, prevents immediate layoffs, and avoids a sudden spike in consumer prices (as businesses will not pass on VAT). Politically, it buys the Government goodwill and social stability during a delicate recovery phase.”
However, Perera noted that it would be unfavourable in the long-term. This is because it weakens Sri Lanka’s structural revenue position fiscally. He further explained that with a narrow tax base, the Government would remain overly reliant on a few large corporates and indirect taxes, which was regressive and inefficient.
“It misses the opportunity to formalise the shadow economy. SMEs staying outside the system today will be harder to bring in later. Ultimately, this decision delays (but does not cancel) the inevitable need for fiscal consolidation, meaning tougher measures may be required in the future.”
Thus, according to Perera, this is a pragmatic but costly pause, which while favourable for survival and SME welfare today, is likely to be unfavorable in building a resilient, self-sufficient tax system tomorrow. He explained that the Government was betting that economic growth from sustained SME activity would eventually generate enough natural revenue to offset the foregone VAT, a high-risk but socially compassionate gamble.
Voluntary VAT registration as a double-edged sword
The VAT law also provides for any person below the liable threshold of Rs. 60 million to register voluntarily. Perera added that this would enable them to claim input VAT credit and lower the operational cost directly.
“One must understand that voluntary VAT registration is a double-edged sword. The advantages include that it cuts costs via Input Tax Credit (ITC), boosts credibility with large clients, and legalises business cash flow. Disadvantages include imposing strict periodical filing obligations and upfront system investments.
“The decision boils down to a simple maths equation: are your suppliers charging you VAT on a large scale? If yes, voluntary registration is a hidden profit-recovery tool. If your suppliers are mostly unregistered individuals or small vendors (who do not charge VAT), you will have little input tax to claim, making registration an unnecessary burden,” he added.
Fiscal transparency and evidence-based policymaking
Commenting on fiscal transparency and evidence behind this policy decision, Verité Research Lead Economist Raj Prabu Rajakulendran noted that the main issue was not only whether the VAT registration threshold should remain at Rs. 60 million or be reduced to Rs. 36 million. Rather, he said that the larger concern was fiscal transparency and evidence-based policymaking.
The reduction of the VAT/SSCL threshold was announced in the 2026 Budget as a measure to broaden the tax base. Since VAT is one of Sri Lanka’s key revenue sources, he added that not implementing a budgeted revenue measure created a fiscal cost.
He stated that the Government should therefore explain what analysis supported this decision and what compensatory revenue measures would be employed to meet the revenue target.
“This is especially important because, even if the pre-2019 VAT threshold is adjusted for inflation, it would still be significantly below the current Rs. 60 million threshold.”
Rajakulendran added that there were alternative revenue options available. For example, he noted that correcting cigarette taxes could generate around Rs. 17.3 billion annually, while further reforms could raise this to around Rs. 30 billion. Another option that could be considered is increasing the Withholding Tax to 15%.
“The point is that any compensatory measures should be clearly presented and transparently debated. While there may be valid concerns about the compliance burden on smaller businesses, the answer need not be to abandon tax-base broadening. The Government could have reduced the threshold while improving VAT administration, especially by making refunds faster and more predictable,” he said.
Easing pressure on businesses
Meanwhile, University of Peradeniya (UOP) Department of Economics and Statistics Professor Ananda Jayawickreme welcomed the Government’s decision not to lower the VAT registration threshold, describing it as a positive step that would ease pressure on businesses and the wider economy.
“Taxation is only one part of the economy. At present, the economy is still facing fiscal challenges and a number of internal and external shocks. SMEs, in particular, do not have well-established business frameworks. Most of them rely on day-to-day operations and prevailing market conditions,” he said.
Prof. Jayawickreme explained that lowering the VAT registration threshold would have brought more SMEs into the tax net, increasing their costs and ultimately affecting consumers through higher prices. As prices increase, demand declines. When demand falls, these businesses face more difficulty protecting their markets, and exporters may also become less competitive in international markets.
According to him, this move is beneficial for the economy as it prevents unnecessary distortions and avoids placing additional pressure on economic activity.
Prof. Jayawickreme also noted that the Government’s revenue performance at present suggested that there was no immediate need to widen the VAT net by lowering the threshold. He noted that Government revenue had increased substantially during the first few months of this year, noting that a large share of this additional revenue had come from vehicle-related taxes, taxes on professional services, and other existing taxes.
Commenting on tax reforms needed in general, he suggested that instead of expanding the VAT base, the Government should review other areas of the tax system, including reducing tax rates and improving tax administration.
“The Government should reconsider several other aspects of the tax system. It should reduce the general VAT rate to keep prices lower. Personal income tax should also be reviewed. At the same time, tax laws need to be implemented more effectively. Many high-income earners do not pay the taxes they should, because they underreport income or avoid taxes altogether. The authorities are mainly collecting taxes from those whose incomes are already reported, while those who evade taxes continue to escape the system,” he said.
Prof. Jayawickreme also noted weaknesses in tax enforcement among certain professions and businesses, adding that improving compliance would be more effective than imposing additional burdens on registered taxpayers. He further noted that high taxes were being passed on to consumers despite the traditional view that income taxes should not be shifted.
Thus, he highlighted that taxation should support economic activity rather than weaken it. “The Government needs to redefine the tax system. Taxes, whether they are income taxes or other forms of taxation, should not distort the market too much. Through the decision not to lower the VAT registration threshold, people will retain some purchasing power, businesses will have a better environment to operate, and economic activity will be less affected.”