Sri Lanka will be going into 2025 with a new Government in place and higher targets in hand under the International Monetary Fund (IMF) programme, since the 2025 Budget is expected to achieve a 2.3% primary surplus – one of the main targets for achieving debt sustainability.
Thus far, the new Government has spoken of the tax relief it will provide to the people through the Pay-As-You-Earn (PAYE) Tax and the removal of Value-Added Tax (VAT) on certain essential items as mentioned in its economic policy statement. However, it has remained silent on the countermeasures to recover the loss of revenue from such relief measures, as the country is expected to have a revenue of 15.1% of Gross Domestic Product (GDP) in 2025.
According to a Finance Ministry statement clarifying revenue and expenditure measures, the forthcoming budget anticipates revenue at 15.1% of GDP – approximately Rs. 3.9 trillion – while expenditures are projected at nearly 20% of GDP – around Rs. 5.2 trillion – striking a balance between recurrent and capital investments.
In countries like Sri Lanka, which do not have abundant natural resources such as oil or minerals, tax revenue is the key contributor to Government revenue. Historically, tax revenue contributes around 80% of Sri Lanka’s Government revenue.
The Finance Ministry said that there was a misconception that exports, tourism, and other external inflows accrued to the Government revenue, noting that this was not the case. Instead, those revenues are collected by private enterprises while the Government only receives the corporate tax component of the profit of these enterprises.
Dividends and levies from State enterprises contribute to Government non-tax revenue; however, historically this has been a net drain on Sri Lanka’s fiscal balances due to losses incurred by State enterprises.
Fines, fees, and rents contribute only a very small component of Sri Lanka’s Government revenue; taxes comprise the largest contribution.
Therefore, the IMF recommends prioritising revenue increases over expenditure cuts, although both strategies could help address the primary deficit. The focus will also be on improving the efficiency of capital investments to yield better returns from public spending.
Revenue enhancements are expected through broadening the tax base and improving compliance, while expenditure will prioritise effective capital investments that provide high returns.
Second generation of reforms needed
Speaking at the farewell ceremony for Treasury Deputy Secretary Priyantha Rathnayake on Tuesday (5), Treasury Secretary Mahinda Siriwardana said that the second generation of reforms to unlock economic growth, which included trade reforms, investment reforms, and measures to improve the ease of doing business, needed to be implemented now.
He said that trade and investment reforms were critical to ensure the required non-debt-creating inflows to support long-term external debt sustainability.
Siriwardana said that unless the required reforms were crystalised, fiscal discipline became entrenched, and structural imbalances were eliminated, Sri Lanka’s economic progress could be seriously hampered given the lack of sufficient economic safety buffers.
He added that in order to arrive at a sustainable solution, it was also necessary for Sri Lanka to get the maximum out of the new social contract that was being created by the new administration.
“The ongoing transformation is expected to change various decades-long economic, social, and political practices and traditions in the country,” he said.
He noted that the effective management of the economy based on contemporary domestic and international developments, along with a professional approach, were critically important to preserve the hard-won gains in ensuring economic stability while improving governance.
He added that this would put Sri Lanka strongly on a path to economic recovery in order to achieve a higher, sustainable, green, and job-rich growth to address poverty and inequality, as well as ensure much-needed social protection and social justice, along with political stability.
“What is undeniable is the fact that Sri Lanka can no longer carry on in a ‘business-as-usual’ manner,” he said, adding that as a country, Sri Lanka had to be able to adapt to a changing environment.
Siriwardana further stated that Sri Lanka must adopt a path of fiscal and macroeconomic discipline going forward. He noted that one of the highest priorities of the new administration was the elimination of governance weaknesses and corruption vulnerabilities as well as the recovery of stolen assets.
He said that it was essential that the country did not return to its past practices of living beyond its means, adding that if Sri Lanka were to maintain discipline and work hard, due rewards would undoubtedly materialise.
“We must learn from the past and learn from the practices of other countries that have succeeded in similar contexts,” he said.
Changes likely to PAYE Tax top rate, corporate tax rate
Speaking to The Sunday Morning, KPMG Sri Lanka Tax and Regulatory Division Principal Suresh Perera said that the Government was currently exploring different models with regard to PAYE Tax, looking at increasing the threshold from Rs. 100,000 to Rs. 150,000 or Rs. 200,000, although nothing had been finalised yet.
He said that there was a potential for the top rate of 36% in the PAYE Tax to increase further, with potential changes in the middle-income category. “They might increase the rates at the top and try to recover the losses from the relief given to the lower end,” he added.
Moreover, Perera said that there could be rate changes in other taxes such as the corporate income tax.
He noted that in expanding the tax net, there were taxpayers within the existing law who should be paying taxes but were not in the net, who should be included. He added that with improvement in tax administration, new tax bases may be created in future.
Govt. in talks to remove imputed rental income tax
Speaking to The Sunday Morning, an official involved in the talks with the IMF on behalf of the Sri Lankan Government said that the removal of the proposed imputed rental income tax was at the top of the agenda in the ongoing discussions with the IMF.
The official said that the country was discussing with the IMF various proposals to compensate for the revenue loss from raising the threshold of the PAYE Tax and the removal of VAT on certain essential items.
Speaking during his first media interview after taking office, President Anura Kumara Dissanayake said that he intended to bring the PAYE Tax adjustments and VAT reduction through the upcoming budget next year. He also said that they intended to review the ‘Aswesuma’ programme, which would lead to certain families falling out of the programme. Currently, 1.7 million families are receiving ‘Aswesuma’ benefits.
Dissanayake also added that the fourth tranche from the IMF was anticipated by the end of January or early February next year following the completion of the third review.
According to Finance Ministry data, Sri Lanka is expecting $ 1,363 million from the IMF, the World Bank, and the Asian Development Bank (ADB) in 2025, out of which $ 400 million is expected from the World Bank and $ 300 million from the ADB.
Vote on account to clarify path to IMF
Speaking to the media on Wednesday (6), Senior Consultant to the President on Economic Affairs and Finance Prof. Anil Jayantha Fernando said that the Government would prepare the vote on account, including all primary expenses such as salary payments and maintenance of ministries and departments for the first four months of 2025 following the General Elections.
He added that the IMF could not decide on the third review merely by looking at the vote on account alone, as there should be a budget for the fund to make its projections until June 2025.
“The vote on account will have our primary expenses. The budget will be presented to Parliament in January 2025 and approved in the last week of February or the first week of March next year,” he said.
He added that the Government would introduce budget proposals that would be in equilibrium with the vote on account, adding that the IMF would be able to see whether there were any conflicts between the vote on account and what had been agreed upon.
Prof. Fernando added that the Government expected to reach the Staff-Level Agreement (SLA) on the third review in December, as the review would commence on 12 November and continue until about 28 November.
‘Immediate tax admin changes unlikely’
Speaking to The Sunday Morning, Verité Research Lead Economist Anushan Kapilan said that even for the IMF staff-level approval of the third review, the Government would have to produce budget proposals for the IMF to see whether they aligned with the programme.
“The IMF would anyway have more information on what will be included in the budget even before it is released to the public,” he said.
He said that the only problem observed thus far in the upcoming budget was that the Government had promised tax reductions on the PAYE Tax and VAT, while only talking of improving tax administration to compensate for the revenue loss.
Kapilan said that while it was acknowledged that there was much to improve in tax administration, which would lead to a higher tax collection, it was unlikely that those changes could be implemented immediately in order to start collecting taxes.
In its statement on revenue and expenditure, the Finance Ministry said that tax administration and tax compliance enhancement measures played a very important role in revenue enhancement, although they typically took a long time to yield returns. This is because such measures require administrative, technological, and process-related reforms which take time to implement and show results.
According to the Finance Ministry, in Sri Lanka’s case, tax administration measures are implemented in parallel to tax rate increases, but the short-term increase in revenue is derived almost entirely from the increase in tax rates.
“I hope the Government will wait and see how things are and then make the decision, instead of immediately reducing taxes,” Kapilan added.
Moreover, addressing the possibility of relying on vehicle import taxes to compensate for revenue loss, Kapilan said that although vehicle imports would raise tax collection, it would still be limited to a maximum of Rs. 150 billion, only compensating for the loss from the proposed adjustment to the PAYE Tax.
‘Not sensible to seek revenue via tax admin upgrade’
According to a recent study by Verité Research, the tax burden at the lower income levels, particularly for those earning below Rs. 250,000 per month, measured as a percentage of income paid in taxes, is lighter than in other South Asian countries in terms of personal income tax.
For example, individuals earning Rs. 150,000 in Sri Lanka pay just 2% of their income as taxes, while the rest of South Asia, on average, pays 4%. However, beyond this income level, the tax burden rises steeply.
For incomes exceeding Rs. 250,000 per month, Sri Lanka’s tax burden increases more rapidly than its regional peers, making it one of the highest in South Asia. At an income level of Rs. 500,000, Sri Lanka’s tax burden is much higher at 21%, compared to the South Asian average of 15%.
However, according to Verité Research, it is still below the tax burden of Pakistan (22%) and Nepal (23%). Ultimately, Sri Lanka’s personal income tax system places the country in a distinct position within South Asia.
On one hand, it offers substantial relief to low-income earners with its high tax-free threshold. On the other hand, it imposes a steep tax burden on high-income earners, far more quickly than its neighbours.
Kapilan noted that according to the findings of the study, it was not sensible to raise the threshold of PAYE Tax from Rs. 100,000 to Rs. 200,000 because Sri Lanka’s problem was that its tax base was too low.
The Finance Ministry noted that Sri Lanka’s tax-free threshold is set at Rs. 100,000 per month, which results in only the top 20% of income earners being subject to income tax, which was clearly established in the Supreme Court judgment on the amendments to the Inland Revenue Act in 2024.
It said that the fact that Sri Lanka’s income structure was skewed in this manner was also supported by the fact that the total number of active credit cards in the country was under two million, less than 10% of the total population.
“As soon as income earners enter the tax threshold, the effective tax rate is very low, at a 6% marginal rate. Therefore, a person earning Rs. 125,000 per month would only pay a tax of Rs. 1,500 per month, or 12% of their total income,” the Finance Ministry statement read.
Further, Kapilan said that there were questions that arose from relying on the collectable defaulted taxes to revenue collection agencies such as the Inland Revenue Department (IRD) and Customs to compensate for revenue losses, such as how the Government would collect these taxes now when it had been difficult for the same tax administration in the past.
Out of the balance taxes in arrears outside the appeals process of Rs. 18 billion as of end-2023, the IRD had already collected Rs. 104 billion in the first six months of 2024.
No substitute for tangible tax policy measures
It is also important to note that the IMF does not consider revenue gains from improvements to tax administration and compliance as a tangible short-term revenue measure.
The IMF may include incremental revenue gains from tangible administrative measures (such as the 0.3% GDP gain expected from VAT administration improvement in 2025); however, these do not substitute for tangible tax policy measures, particularly when considering primary budget balance inputs for the Debt Sustainability Analysis (DSA) framework.
More importantly, the realities of Sri Lanka’s Treasury cash flow pressures are such that mandatory payments on interest, salaries, and essential welfare dominate Government expenditure.
“It is simply not feasible to hope for revenue gains from ‘addressing leakages’ to provide the revenue flows to meet these payment obligations. Realistic and specific revenue measures are necessary in this case,” the Finance Ministry said.