Introduction

As Sri Lanka embarks on a critical phase of economic recovery, the government has unveiled a set of tax reforms aimed at enhancing fiscal sustainability and alleviating economic burdens. Affirming the country’s path to economic recovery, President Anura Kumara Dissanayake announced these tax reforms during his address on 18 December 2024. He also highlighted the significant progress made in restructuring USD 12.55 billion in debt, including USD 1.7 billion of defaulted debt, with a stated goal of increasing foreign reserves to USD 15.1 billion.

These reforms are anchored in the second review of the Extended Fund Facility provided by the International Monetary Fund (IMF). In its Executive Board Assessment, the IMF has emphasized the need for additional revenue measures to achieve fiscal sustainability.

With a focus on increasing government revenue while balancing the needs of vulnerable populations, the reforms promise to reshape the nation's fiscal framework.

Below is a detailed breakdown of the proposed reforms:

Reform of Personal Income Tax

To reduce the financial strain on middle-income earners, the tax-free threshold for personal income tax has been increased from LKR 100,000 to LKR 150,000 per month. Additionally, the first tax slab, currently taxed at 6%, will now apply to income up to LKR 1 million per annum, up from the previous limit of LKR 600,000 per annum. These adjustments aim to provide relief to middle-class taxpayers and stimulate disposable income.

Withholding Tax Rate

The withholding tax rate will increase from 5% to 10% starting 1 April 2025. Recognizing the potential impact on retirees and individuals who rely heavily on fixed deposit income, the Inland Revenue Department will establish a special unit to assist taxpayers, whose income is below the tax-free threshold, in clarifying their obligations and assisting with exemptions where applicable. This measure seeks to balance revenue generation with sensitivity to vulnerable populations.

Corporate Income Tax on Export of Services

Under the current tax framework, export of services utilized outside Sri Lanka are exempt from corporate income tax. From 1 April 2025, this exemption will be removed, and these services will be taxed at a reduced rate of 15% (compared to the standard corporate tax rate of 30%). This change will primarily affect industries such as IT, BPO, and other knowledge-based services providers, which have benefited from this exemption. While the reduced rate is a concession, the move is expected to increase the overall tax liability for these sectors.

Continued Retention of SVAT (Simplified VAT)

The SVAT system, designed to ease cash flow for businesses engaged in zero-rated or VAT-exempt transactions, has faced criticism for hampering government efforts to generate revenue. As such, the previous government had proposed to abolish the SVAT scheme from 2025.

However, concerns were raised by industry groups that its removal would impose a significant cash flow burden due to delays by the various Government agencies in processing VAT refunds. The SVAT scheme was originally introduced to address these challenges. In his speech, the President announced that, with the approval of the IMF, the scheme will be retained.

VAT Reforms

To address food insecurity and malnutrition, particularly among children, milk and dairy products will be exempt from VAT. In addition, the government plans to impose an 18% VAT on digital services based on consumer jurisdiction. This reform aligns Sri Lanka with regional trends in digital taxation and is expected to generate significant revenue while modernizing the tax framework.

Income Tax on Betting, Gaming, Tobacco, and Liquor Industries

The income tax rate for businesses in the betting and gaming sector, as well as for manufacturers, importers, and traders of liquor and tobacco, will increase from 40% to 45%, effective 1 April 2025. This measure aims to generate additional revenue from industries considered to have higher social and economic costs.

Reopening the Vehicle Market

The government’s phased approach to reopening the vehicle market began on 14 December 2024 with the importation of passenger transport buses and vehicles. The second phase, allowing the importation of private vehicles, will commence in February 2025. This decision follows recommendations from the Central Bank of Sri Lanka to mitigate potential pressures on foreign reserves. A gradual implementation strategy seeks to balance economic recovery with fiscal prudence.

Stamp Duty Revisions

Effective 1 January 2025, the stamp duty on leases has doubled from 1% to 2%. This adjustment is expected to contribute to increased government revenue while standardizing tax obligations in the leasing sector.

Implications and Challenges

The proposed tax reforms reflect the government’s commitment to achieving fiscal sustainability and driving economic recovery. By restructuring tax brackets, increasing rates for high-revenue sectors, and addressing inefficiencies in the current tax system, these measures aim to boost revenue while alleviating the burden on vulnerable groups.

However, successful implementation will require planning, robust administrative mechanisms, and transparent communication with stakeholders. Monitoring the impact of these reforms on economic activity, household income, and business operations will be crucial to ensuring their effectiveness.

Conclusion

The tax reforms for 2025 mark a pivotal moment in Sri Lanka’s economic recovery journey. While they present opportunities to enhance revenue and modernize the tax system, their success will hinge on the government’s ability to execute them effectively and address potential challenges proactively. As the nation navigates this transformative period, the proposed measures offer a roadmap to fiscal stability and long-term growth.