The International Monetary Fund (IMF) proposed an Imputed Rental Income Tax (IRIT), an approach to generate revenue by taxing the notional income of owner-occupied and vacant residential properties. The IMF estimated that this tax could contribute between 0.4% and 0.6% of the country’s Gross Domestic Product (GDP), equivalent to approximately $ 324-486 million annually.
However, the new Government has decided to adopt a different route, introducing a mix of other taxes instead and getting rid of the proposed IRIT. The decision has raised questions about whether the IRIT could have been a more effective and equitable move to address the country’s fiscal challenges.
What was the Imputed Rental Income Tax?
The proposed IRIT aimed to tax the imputed rental income, which is the notional income that a homeowner could earn if they rented out their property. The IMF’s May 2024 Technical Assistance Report outlined that the tax would primarily target higher-value residential properties, offering a progressive structure with two main models as follows:
- 30% tax on imputed rental income exceeding Rs. 400,000, potentially generating 0.5% of GDP
- 50% tax on income above Rs. 800,000, targeting the wealthiest 30% of property owners
According to the IMF, about 80% of residential properties would not meet the taxable threshold, meaning the tax would primarily affect wealthier property owners. The IRIT was designed to be a more straightforward and administratively feasible method to boost revenue while maintaining equity in the tax system.
New taxes introduced by the Govt.
Instead of adopting the IRIT, the Government introduced several smaller taxes in the recent Budget, under the Inland Revenue (Amendment) Act.
These include:
- 15% tax on foreign currency income for freelancers: Applies to individuals earning in foreign exchange and remitting funds through Sri Lankan banks
- 15% tax on digital service exports: Targets companies and individuals providing digital services to overseas clients
- Advance income tax on savings interest: Increased from 5% to 10%, impacting interest earned on savings and fixed deposits
- 45% tax on profits from betting and gaming: Aimed at increasing revenue from the betting and gaming sector
- 45% tax on alcohol and tobacco profits: Applied to the manufacture, import, and sale of alcohol and tobacco products, excluding exports
- Revised personal income tax rates: New tax brackets introduced, with rates ranging from 6% to 36% based on income levels
Will these have the same potential as IRIT?
These taxes are expected to expand the tax base, but their combined revenue potential may not match the IRIT’s projected gains, according to economic experts. The IMF report suggested that the IRIT could achieve these revenue targets with fewer administrative challenges and a more progressive approach.
Speaking to The Sunday Morning Business, University of Colombo (UOC) Department of Economics Professor Priyanga Dunusinghe stated that the Government should have proceeded with the proposed IRIT.
“The Government should have implemented the property tax alongside other taxes such as those on IT services and exports as well as withholding taxes. However, the advance income tax on interest should have remained at 5% instead of being increased to 10%,” he said.
Outlining several reasons for supporting the property tax, he pointed out Sri Lanka’s high income inequality as a primary reason.
“Even during the economic crisis, the top 20% of earners did well. Their earnings increased significantly, partly due to interest rates reaching 30%. Additionally, their asset values, including business stocks, saw sharp increases within a short period. They benefited disproportionately during tough economic times,” he added.
Another key point is the issue of tax avoidance. “There are groups that have avoided paying taxes while accumulating sizeable wealth in the country. They used various means to evade taxes and build their wealth. Implementing a property tax would be an effective way to bring these individuals into the tax net,” Prof. Dunusinghe said.
He also addressed the issue of illegal income sources, noting that a significant share of the population earned through illegal means, whether through bribes, corruption, or underworld activities.
“These earnings are not captured by the current tax system. Over the last two decades, Government officials, politicians, and certain businessmen have accumulated wealth that cannot be justified by legal income sources. A property tax could help address this issue.”
He further stated that a property tax would help improve the Government’s ability to track wealth and income sources. “One major problem with income tax collection is identifying and locating income sources. Combining property tax with income tax would enrich the Inland Revenue Department’s (IRD) database. This would provide a clear picture of household assets and income sources, making it easier to collect taxes in the medium to long term.”
He noted that other countries, including India and developed nations, had successfully implemented similar taxes. The IMF proposed the property tax twice, once in 2017 and thereafter under the current IMF programme, but these plans were dropped on both occasions.
“The IMF’s goal was to shift from an 80% reliance on indirect taxes to a 40-60% ratio between direct and indirect taxes. The property tax could have been a step towards this goal by targeting wealthier individuals who often avoid paying their fair share of taxes,” he observed.
According to Prof. Dunusinghe, the current tax policy is not conducive to economic growth or poverty reduction. “We need to reduce the tax burden on essential goods, education, and healthcare. Introducing more direct taxes, like the property tax, could help lower these costs and improve economic conditions.”
On revenue potential, he stated that the IMF had calculated that the property tax could generate 0.5% of GDP in its first year, potentially increasing to 1.2% in subsequent years. However, establishing the property tax would require property valuation, a property registry, and other groundwork. Starting in urban areas like the Western Province could help gradually expand the system, he added.
Further noting an additional economic benefit of the property tax, Prof. Dunusinghe said: “In Colombo, many properties are underutilised or left vacant. A property tax would incentivise owners to use their properties productively, contributing to economic activities. Instead of holding properties merely for capital gains, the tax would push property owners to utilise their assets effectively.”
Recommendations for tax reform
Meanwhile, speaking to The Sunday Morning Business, Advocata Institute Chairman Murtaza Jafferjee stated that the previous Government had introduced an IRIT in order to generate revenue for the Central Government. He added that typically, property taxes accrued to Local Governments, for example, the annual assessment paid to municipalities.
“However, these taxes are exceptionally low in Sri Lanka. In contrast, residential property tax rates in the US range from 0.75% to 1% of property value, whereas an apartment in Colombo is taxed at a mere 0.05%. While US property taxes often fund schools, the disparity in rates remains stark. That said, the IRIT is projected to generate only 0.15% of GDP, making its elimination relatively inconsequential if viable alternatives are pursued,” he said.
His recommendations, in order of priority, are as follows:
- End all tax holidays and concessions immediately: These constitute tax expenditures and have little justification. Moreover, they create corruption risks if not phased out since those who benefit from them will resolve to rent-seeking behaviour to ensure that they continue. They also distort the competitive landscape by advancing those who enjoy these benefits.
- Reconsider the 15% tax on offshore service exports: Other exports are taxed at 30%; there is no compelling reason to grant preferential treatment to this sector. This sector should also be taxed at 30%.
- Lower the excessively high Value-Added Tax (VAT) threshold: At Rs. 60 million, it is double the IMF’s highest recommended threshold of $ 100,000. This results in lost revenue and distorts competition. Many businesses either remain below the threshold or structure themselves to evade VAT, exacerbating unfair advantages, especially in high-value service industries, where Rs. 60 million is a substantial amount relative to firms dealing in goods with lower value addition.
“These reforms would enhance tax efficiency, improve fairness, and reduce revenue leakages,” Jafferjee added.
A missed opportunity?
In response to inquiries about why the Government did not consider the IRIT as a revenue-generating measure, Deputy Minister of Finance and Planning Harshana Suriyapperuma explained that the administration’s approach to revenue generation was guided by specific priorities outlined in the national Budget.
Speaking to The Sunday Morning Business, the Deputy Minister stated that revenue strategies were crafted to align with the nation’s investment needs, debt repayment obligations, and the goal of transitioning towards a production-based economy.
“The Government’s approach to revenue is very clearly indicated in the Budget, which is the basis, because we need to ensure the amount of revenue that needs to be generated in order to facilitate expenses, in order to ensure investments are made, and in order to ensure that debts are repaid. We are preparing our nation for the production economy journey that we have embarked upon,” he stated.
Suriyapperuma noted that the Budget outlined the Government’s focus areas based on current economic requirements and national priorities.
“The objective of the Government is not to burden people and citizens with increasing taxes, but to instead provide necessary relief and prepare for economic growth,” he added.
While the IRIT presented a potential avenue for generating steady revenue and promoting equity within the tax system, the Government’s decision to pursue alternative taxes may align fiscal strategy and budgetary priorities. However, as experts highlight, the existing tax policy may not sufficiently address income inequality or prevent tax avoidance by wealthier individuals.