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ECONOMYNEXT – Sri Lanka’s excessive protectionist taxes with import duties and para-tariffs on capital goods are a barrier to foreign direct investments in the island rather than income tax, a former head of the island’s investment promotion office said.
Sri Lanka has been trying to phase out tax holidays and concessions given for Board of Investment approved firms, especially under the Strategic Development Project Act where discretionary concessions are believed to be fostering corruption.
But the excessive import protection and para tariffs on capital are not found in other countries with open or export-oriented economies. East Asian nations in particular are subject to stringent free trade requirements under the ASEAN.
Sri Lanka is taxing building materials in particular at high rates, including, steel, tiles, aluminum and also cement to some degree to give ‘rents’ or excessively fat profits to politically powerful ‘domestic industry’ businessmen, critics say.
Go, No Go Decision not on income tax
“When you look at investment criteria the go ‘go no go decision’ is not made because of tax holiday or accelerated depreciation. Thilan Wijesinghe, a one-time chairman of the Board of Investment, and now head of TWCorp, a consultancy, said at a Economic Freedom forum organized by Advocata, a Colombo-based think tank.
“It is because of para-tariffs and upfront taxes.
“On manufacturing, before you earned one dollar of revenue, (upfront taxes) was at 14 percent. On real estate it was 20 percent.”
Calculations done some time ago when income tax was at 28 percent, and there was also dividend withholding tax, there was negative hit on the Internal Rate of Return of 7 to 10 percent due to the taxes based on taxes prevailing at the time.
As a result, people were seeking relief under a Strategic Development Project Act (SDP), which however did not have transparent criteria and pre-set concessions.
“When you factor in these taxes on a real estate project, it had a 7 to 10 percent negative impact on project IRR.
Over time the powers of the Board of Investment to give exempt taxes under the Schedule B of its law was taken out and the SDP was the only avenue to get it.
The new para tariffs altered the environment from time to time.
“Investors did not have the sanctity of future taxes impacting the business, after they signed the BOI agreement,” Wijesinghe said.
“So, whilst the BOI was weakened, the SDP Act virtually allowed the exemption of every tax in the country.
But it was a non-transparent process of granting investment incentives, whereas the BOI law clearly spelt out the qualification criteria, for you to qualify for an investment, he said.
“There was actually only one criteria in the SDP act, that is a minimum investment of so much, and for you to prove some nebulous concept of whether this was a strategic investment or not.”
Wijesinghe said that 100 percent of investment over 100 million that commenced after 2009 have been under the SDP Act’s mandate.
“Of the 25 or so SDP projects approved or implemented in this time period, not even one project is export oriented, or in manufacturing.”
There were however services export firms in services such as in IT/BPO and port terminal.
An overwhelming 75 percent of SDP projects to date are in the non-tradable sector and in real estate, and that 20 percent are in export services.
But without the exemptions of upfront taxes, even these investments would not have come.
Port Terminals and the HCL software project and only two foreign companies that started construction after January 2015 have invested over 100 million dollars in Sri Lanka’s Hambantota port and West Container Terminal, he said.
“This is what probably made the investors chase after the SDP,” Wijesinghe said.
“I believe without the SDP none of these investments would have come.”
Studies have found that not just a factory is expensive to build due to building material duties and para-tarifs but ordinary people cannot also build a small house.
Most Sri Lankans cannot afford a house amid state-protected building material oligopolies: study
While the SDP gives 20-year tax holidays the BoI gave shorter holidays.
Most BOI firms now paying normal taxes?
According BOI data 80 percent of the 1,700, BOI companies were now paying normal taxes according to the tax laws.
He had at the time disagreed with some long-term tax holidays that were given particularly for the South Asia Gateway Terminals project by the Treasury, which he saw in the budget.
Tax incentives requires a balance, he said.
In the 5 year to March 2001, 750 projects were implemented (not approved) Wijesinghe said. A big part of the larger volumes of FDI came through Public Private Partnerships. All over the world PPPs now form a large part of the FDI indicating the need for a PPP agency, he said.
A unit that was set up under him was disbanded after the Gotabaya Rajapaksa administration came to power and some of the staff were now working for him at TWCorp, exporting PPP knowledge to countries like Bangladesh and Nepal.
In addition to taxes, Sri Lanka also has monetary instability, due to following unworkable anchor conflicting central banking regimes, analysts say leading to frequent trips to the International Monetary Fund.
Most East Asian nations have either full or greater monetary stability, giving a stable environment for businesses to operate as well as lower tax rates, which seem to go hand in hand (corporate tax of 20-pct or lower and value added tax of 15 percent or lower), according to some analysts. (Colombo/Jan18/2024)
