His Excellency the President presented the Budget for 2011 as Minister of Finance.

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3 Preamble His Excellency the President presented the Budget for 2011 as Minister of Finance. The Budget proposals were a distinct departure from previous annual budgets in that they focused on the basic relevant tax regime. Several nuisance levies that had lead to onerous requirements on the same taxed entity have been removed. There is now an emerging tax structure that is likely to bring into reality the long awaited promise that the Sri Lankan economy will emerge as vibrant and will provide opportunities to the members of the younger generation to excel as equals with the best around the world. 22 November 2010

4 Table of Contents Income Tax Economic Service Charge Value Added Tax Nation Building Tax Customs Duty Excise Duty Miscellaneous Taxes & Regulations

5 Income Tax Determination of Business Profits - Deductions Proposals provide for the following costs to be claimed when determining the tax profits from business. Changes are to come into force from 1 st April Nature of Claim Proposal Comment Depreciation allowance Plant & Machinery 33 1/3 % 12 ½ % The accelerated depreciation rates would grant tax payers cash flow benefits. The new rates of tax apply to assets acquired after 1 st April Depreciation allowance New building constructed for commercial use 10 % 6 2/3 % The new rate is to apply to buildings constructed after 1 st April 2011.

6 Nature of claim Proposal Comment Research expenditure Allow a double deduction for research conducted within Sri Lanka through an institution established for research purposes. Research expenditure falling within the definition of Section 25 (1) (i) is an allowable expense in determining the profit or income. Proposal seeks to intensify corporate that improve processes. Listing Expenses Deductible subject to a limit of 1% of the value of IPO. No deduction as considered to be capital in nature. Proposal seeks to develop the capital market. Unabsorbed VAT input credit as at 31/12/2010 on revenue expenditure 1/4 deductible No relief Seeks to grant relief to VAT unrecoverable. on capital expenditure Considered part of the capital asset cost and entitled to capital allowance. No relief It is most likely that adjustment would be made over the useful life of the asset.

7 Corporate Taxation Determination of Business Profits Revisions to Disallowable Expenses Expense Proposal Comment Advertising Expenses It is proposed to restrict disallowance on advertising to 25% Currently, 50% of advertising expenditure is disallowed except in relation to advertising outside Sri Lanka and incurred solely in relation to; Export trade or, The provision of services for payment in foreign currency, for which a deduction was granted in full. Proposal is to harmonize tax base to net profits and it is presumed that the current exclusions would continue. Foreign Travel Expenses Foreign travel expenses are to be allowed in full subject to same being incurred in the production of income. However, aggregate expenditure on foreign travel and foreign training being restricted to 2% of the previous year s statutory income from trade or business. Foreign travel expenses were deductible if it was incurred solely in connection with; Promotion of the export trade Provision of any services for payment in foreign currency Promotion of tourism It is not clear whether the cost would be deductible if a business suffers a trade loss in the previous years.

8 Expense Proposal Comment Foreign Training Foreign training expenses are to be allowed in full subject to the aggregate expenditure on foreign travel and foreign training being restricted to 2% of the previous year s statutory income from trade or business. Currently foreign training expenditure is deductible if; Directly relevant to the duties performed by such employee before the commencement of such training Essential for upgrading the skills or performance of such employee, in such trade or business and Necessary for improving the efficiency and performance of such trade or business. In the event of a business loss in the previous year, treatment of deductibility of costs is to be clarified. Management Fees Ceiling on deductibility of management fees paid to be limited to higher of Rs. 2 Mn or 1% of the turnover whichever is less, or Amount determined by CGIR as reasonable. Currently, ceiling prevails at the higher of Rs. 1 Mn or 1% of the turnover whichever is less or Amount determined by CGIR as reasonable. Relief has been provided but may not be sufficient to cover cost currently being charged on companies.

9 Expense Proposal Comment Tax borne by Employer Nation Building Tax Tax on the employment income borne by the employer on behalf of the employee is to be disallowed NBT cost is to be allowed in full. Current tax law does not specifically disallow same hence it is claimed as a cost of employment. Deductibility is restricted on 1/3 rd of NBT. It seems that the indirect income tax borne by the employer is being considered as a prescribed levy This removes the current disallowance on cost.

10 Income Tax Exemptions - Tax Holiday for New Investments It has been proposed to grant a five year tax holiday to any company which carries on a new undertaking, with a minimum investment of not less than US$ 5,000 and not more than US$ 10 million or its equivalent in rupees in such activities as are specified by the Minister from time to time by order published in the gazette having regard to the development of the national economy. Prior approval is to be obtained from the CGIR. Exemption - Foreign Exchange Earnings Proposal It is proposed to extend the current exemption applicable to profits earned in foreign currency on any service provided to a person or partnership outside Sri Lanka. The said exemption would not apply to commission, discounts or similar type of receipts earned in foreign currency for activities carried out in Sri Lanka. Currently the said profits are exempt in terms of section 13 (dddd) up to 31 st March Exemption - Foreign Exchange Earnings from Supplies to Headquarters of foreign buyers in Sri Lanka Proposal It is proposed to exempt foreign exchange earnings from supply of textiles, leather products, footwear and bags to foreign buyers who establish their headquarters in Sri Lanka for management, finance, supply chain and billing.

11 Exemption - Industry Exemptions Fishing & Agricultural Seeds It is proposed to exempt following sectors for a period of five years commencing from the year of assessment 2011/12. Fishing Cultivation and primary processing of agricultural seeds or planting material Fishing tax at lower rate of income tax - 15% Cultivation and primary processing exempt up to the year of assessment 2010/11 There is ambiguity as to the activity covered by the exemption. ie whether to cultivation and primary processing in one combined activity or and two separate activities being, cultivation and primary processing. Unit Trust/ Mutual Funds It is proposed to exempt profits from investment in listed debentures and equity. The profits and income arising on sale of listed debentures and equity is currently exempt from income tax. Dividend income remains exclude from tax. Interest income on listed debentures is taxable. The proposal seeks to exempt debenture interest from tax.

12 Income Tax Industrial Exemptions It is proposed to exempt following institutions from income tax from all sources of income with effect from 1 st April Institution No. of years Sri Lankan Air Lines Ltd 10 Mihin Lanka (Pvt) Ltd 10 Ceylon Electricity Board 5 National Water Supply and Drainage Board 5 Ceylon Petroleum Corporation 5 Sri Lanka Ports Authority 5 These institutions are currently liable to income tax. These institutions will be required to pay a dividend of 25% on annual gross profits to the Government

13 Income Tax Business Profits Amendments to prevailing exemptions Administrative Clarifications Section 17- Areas of exemption to be specified. Sections 24C and 24 D Exemption limited to profits from specified business. Sections 21 & 21A cut off date extended from March 31, 2009 to March 31, 2010 to comply with the qualifying criteria.

14 Co- operative Societies Proposal It is proposed to extend the income tax exemption to co-operative societies registered under the provincial council statutes. Co operative societies registered under the co- operative societies Act No.5 of 1972 are exempt from income tax, thereby implying that those registered under the provincial council statutes are not exempt.

15 Income Tax Qualifying Payment Relief Individual Qualifying Payments relief available to individual are being rescinded as follows. Recipient Of Payment Approved Charities Government and other specified institutions Proposed Comments Claims to approve charity established for the provision of institutional care for sick and needy. Claimable Claimable Claimable Expenditure incurred by any person included in the development plan of the Government of Sri Lanka Life and Medical insurance premia Claimable Claimable Premia paid for a special health insurance schemes which cover incurable sickness etc Claimable Claimable It is presumed that prevailing upper limits remains applicable Donation to specified institutions To be withdrawn Claimable Production of Films To be withdrawn Claimable Expenditure incurred in repayment of a housing loan or capital of any approved housing loan. To be withdrawn Claimable

16 Income Tax Qualifying Payment Relief Corporate Qualifying Payments relief available to corporate are being rescinded as follows. Recipient Of Payment Proposed Comments Approved Charities Government and other specified institutions Restricted to payments made to approve charity established for the provision of institutional care for sick and needy. Claimable Claimable Claimable It is presumed that prevailing upper limits remains applicable Expenditure incurred by any person included in the development plan of the Government of Sri Lanka Claimable Claimable Expenditure incurred in a certain specified industrial undertaking Claimable Claimable Donation to specified institutions To be withdrawn Claimable Production of Films Expenditure incurred in construction of a cinema To be withdrawn To be withdrawn Claimable Claimable Expenditure incurred in upgrading of a cinema Undertaking for construction or sale of houses for low income families To be withdrawn To be withdrawn Claimable Claimable

17 Income Tax Withholding Tax Interest income to individuals on deposits with Banks and Financial Institutions In keeping with the increase in tax free allowance and tax slabs, the following changes to withholding of tax on interest is proposed.. Proposed Rs. % Rs. % Up to 500,000 Nil Up to 300,000 Nil 500,000-1,500, ,000-1,000, ,500,000 and above 8 1,000,000 and above 10 Rate of final tax applicable to individuals It was intimated that the final tax rate applicable to individuals would be revised as follows: Proposed 8% 10%

18 Income Tax Withholding Tax Exemption granted on interest payable to non-resident persons Payment of interest income which is exempt from income tax in terms of the Inland Revenue Act is to be exempted from Withholding Tax. Section 95 of the Act requires a deduction of withholding tax on any interest which is payable to a non-resident even though such is exempt from tax in the hands of the recipient. Interest could be remitted free of tax only with the approval of the CGIR. Comment This exemption would reduce the administrative burden of obtaining a direction.

19 Income Tax Withholding Tax on Specified Fees Proposal It has been proposed to abolish withholding on specified fees effective Withholding of 5% on specified fee is applicable to payments made for services rendered in the course of any business, profession or vocation or other activities of an independent character or on the purchase of articles via a tender or quotation procedure. Construction fees were liable to tax at 1%. Comment This proposal seeks to simplify the tax system by removing the burden on the tax payer of administering a Withholding Tax.

20 Income Tax Withholding Tax on Government Securities / Corporate debt securities Proposal It has been proposed to impose withholding tax on corporate debt securities. Comment Currently withholding Tax is similar, hence it is unclear as to what the proposal seeks to introduce.

21 Income Tax Corporate Tax Rates of tax Proposals intimated the following changes to rates of tax which are to come into force for 1 April Nature of Profit Proposal Profits and income from sale and Manufacture or import of liquor or tobacco products 40% 35% Standard rate of tax 28% 35% Quoted companies 28% 33 1/3% Public corporations and Government owned 28% 30% business undertakings Profits on the receipt of any fund setup or funds received by a Non Governmental Organisation 28% 30% - Banks and other financial institutions, including off shore banking activities - Finance companies - Leasing - Insurance and - Other specialized banking services 28% 35% Off-shore banking - 20% Venture capital companies 12% 20% Petroleum exploration 12% 15% Entertainer or artist 12% 15% Taxable income not exceeding Rs. 5Mn 12% 15% (Not applicable to any company in a group) Profits from Export, tourism, construction 12% 15% Profits representing sales of any product having a domestic value addition of 65% and Sri Lankan Maximum 10% 35%/15% brand name Clubs and association 10% 20% Undertaking for operation and maintenance of 10% 35% facilities for storage Local software development or supply of labour 10% 35% Agricultural undertakings after section 16 10% Exempt exemption period SME s 10% 15% Partnership Tax 8% 10%

22 Income Tax Deemed Dividend Tax Reduction in requirement to distribute dividends It has been proposed to reduce the distribution requirement to 10% of distributable profits. Currently a corporate is required to distribute 25% of distributable profits to avoid payment of the deemed dividend tax. Comment It was intimated that the intent of the proposal is to encourage investments by corporate.

23 Income Tax Charitable Institutions Withdrawal of tax exemption on business profits. Exemption available to specified business profits of charitable institutions are to be withdrawn. Under current provisions profits of business carried by a charitable institution is exempt from tax if such profits are solely applied to a charitable purpose of the institution and, (a) (b) either the business is carried on in the course of the actual carrying out of a primary purpose of that institution of the work connection with the business is mainly performed by the beneficiaries of the institution, or such institution receives grants from the Government of Sri Lanka and is approved by the Ministry for the purpose of this paragraph, and the business is of casual nature. Defining Charitable Purpose. It is proposed that charitable purpose which determines whether an institute is a charitable institute or not would be amended to incorporate the following, - excluding educational activities carried out by any institute established under the Companies Act or for business purposes. And, - adding activities carried out by institutions engaged in activities of environmental protection and eco friendliness. Accordingly a charitable purpose would read as being, a purpose for the benefit of the public or any section of the public in or outside Sri Lanka, of any of the following categories (a) (b) (c) (d) (f) the relief of poverty. the advancement of education or knowledge, excluding educational activities carried out by any institute established under the Companies Act or for business purposes. the advancement of religion or the maintenance of religious rites and practices or the administration of a place of public worship. any other purpose beneficial or of interest to mankind, not falling within any of the preceding categories. adding activities carried out by institutions engaged in activities of environmental protection and eco friendliness.

24 Investment Fund Account Proposal It has been proposed to require for the persons engaged in the business of banking and financial services to maintain an investment fund account at the Central Bank effective from 1st April A synopsis of the operation of Investment Fund Account can be summarized as follows; Criterion Proposal Mandatory Period 3 years Time of investment At the end of each year of assessment Minimum amount to be invested 8% of the profits calculated for VAT on Financial Services; and 5% of the adjusted profits calculated for income tax purposes before tax Allowable purposes for fund utilization For the investor to grant long term loans at a lower rate of interest. Taxation on Income from investment Interest on investments will be exempt from income tax. Comment The purpose of introducing investment fund account is to transfer all tax savings arising from the current budget proposals. The Central Bank and the Department of Inland Revenue will be issuing specific regulations requiring banks to adopt low interest rates and longer term maturity for lending of these funds.

25 Administrative Provisions Administrative Provisions Time bar for raising of assessments. It has been proposed to determine the time bar period for raising of assessments from the statutory date of filling of income tax returns. Under the current provisions the time period within which an assessment could be raised commences from the end of the said year of assessment. Comment The proposed changes would grant an Assessor a further 8 months to raise an assessment. Accordingly an assessment could now be made within a period of 2 years and 8 months from the end of the said year of assessment. Recovery action against Company officials. It has been proposed to incorporate provisions to enable the recovery of taxes from specified company officials where it is established that such officers are directly responsible for default of income tax. Current provisions enable recovery action only against the tax payer or on person who hold monies/assets to his credit / on behalf. Comment The proposal seeks to strengthen compliance with tax laws by holding decision makers of corporate accountable for the compliance with tax laws.

26 Income Tax Administrative Provisions Establishment of an Appeal Commission. It has been proposed to establish an appeal commission constituting legal, technical and operational experts, which is to function in terms of a specified law. The Commission will hear determinations made by the Commissioner General of Inland Revenue and will also cover appeals on taxes in dispute under other statutes. The commission is required to determine appeals within 90 days. Function of the Board of Review is to be discontinued. In terms of the current law a tax payer dissatisfied with a determination made by the Commissioner General is required to appeal to the Board of Review. The Board of Review is required to determine appeal within two years from the commencement of hearing. Comment The proposal seeks to afford tax payers an independent and fair hearing. It also seeks to address issues experienced in the delays seen in calling up cases for hearing and the competencies of the board members to hear same. Whilst the proposal is welcome, legislation would have to consider cases currently being heard and whether the time period specified for determination of appeals is sufficient. Collection of tax pending decision of tax court. It has been proposed that any appeal made consequent to the determination of an appeal by the Independent Appeal Commission would require payment of the disputed tax in full. The said proceeds would be held pending the final determination of the court. Currently the statute does not mandate the payment of tax. The Appeal court has the right to make an interim determination for the recovery of tax. Comment The proposed revision would require tax payer to settle taxes in dispute prior to the court determination.

27 Income Tax Other Administrative Provisions Maintenance of Accounts At present a person carrying on different businesses is chargeable to tax at different rates or exempt is required to prepare, separate statements of accounts for the purpose identifying attributable to each such source. It was proposed to expand this requirement to recover different business carried on by the same person. Accordingly, now a person having two distinctive businesses would be required to maintain separate accounts even though taxable at the same rate. Authorised Representative The Members of AAT (Association of Accounting Technicians) to be considered a authorized representatives Penal provisions to Auditors/ Tax practitioners Penal provisions are to be introduced to prosecute auditors and tax practitioners who deliberately misuse statutory provisions of any Act or regulation. The proposal is directed at misinterpretation of any provision We have to await the statutory application of this proposal to see, what constitute misinterpretation. Method of Refund payment At present refunds are issued directly to the tax payer. The proposal to credit the bank account to the tax payer directly seeks to avoid fraudulent claims. Ambiguities or omissions Where necessary, translation errors will be rectified in both Sinhala and English versions of Inland Revenue Act No.10 of Employment Income If the employment income is the only source, the PAYE tax will be the final tax and no files needs to be maintained for the employees. Existing files of such employees would also be closed.

28 Closure of existing personal tax files In the case of existing files of individuals, where final tax has been deducted at source in respect of all relevant sources of income files need not be maintained further and will be cancelled. Accordingly Section 106 which requires every person to file a return will be amended to exclude such employees. Write off of Taxes SME Income tax, ESC, NSL, GST and obsolete taxes that whether charged or in default due to conflict, environment and financial constraints and turnover is below Rs. 100 Million will be written off provided there is due compliance in the future. Remission afforded to NGO The scope of the remission procedure is to be expanded to meet contemporary social needs. Partnership Tax The non refundable partnership tax of 10% at present does not provide for relief of the PAYE tax which is levied on salaries that form part of the divisible profit of each partner. An amendment is needed to rectify this.

29 Income tax Personal Tax Exemptions Income source Proposed Employment income - Contributions from Provident Funds Exempt Taxed at concessionary rates Rental value of any official bungalow provided by the Government Exempt Exempt Motor vehicles Motor vehicle allowance Exempt Exempt to a maximum of Rs. 50,000 p.m. Taxed depending on engine capacity to a maximum of Rs. 15,000 p.m. Taxed at standard rates Interest income to senior citizens Exempt threshold increased to Rs. 500,000 Exemption threshold was Rs. 200,000 Emoluments earned by noncitizen individual participating in international events Exempt Liable at standard rates

30 Income Tax Personal Tax Withdrawal of Exemption Proposal announced intimated the withdrawal of exemption currently applicable to employment income. Nature of Income Proposed Comment Emoluments of public sector employees Income to be chargeable to tax Exempt Emoluments of public sector employees are to be made chargeable to tax at Share award / option scheme To be made chargeable to tax Exempt, if the share scheme is considered to be reasonable by the CGIR standard rates. The incentive which was introduced in 2007 is to be withdrawn.

31 Income tax Personal Tax Tax Free Allowance - Standard Proposal Tax free allowance has been increased to Rs. 500,000 per annum and has been extended to non-residents who are citizens of Sri Lanka. In terms of the current law, the tax free allowance is Rs. 300,000 and was applicable only to residents of Sri Lanka. Tax Free Allowance - PAYE It was proposed to grant employees falling within the PAYE scheme a tax free allowance of Rs. 600,000. This is to apply both government and private sector employees Currently the tax law does not provides for a specific tax free allowance to PAYE income earners. Comment The proposal is to grant relief for changes made to qualifying payment credit and interest deduction which are discussed in other sections of this document.

32 Income Tax Personal Tax Individual employed under single employer Proposal Employment income will be taxed under the PAYE scheme and such will be the final tax. Provision for the application of directions and refunds will not be available. Income from employment is chargeable to tax at standard rates giving relief to Qualifying Payment and interest deduction and credit is given for PAYE tax withheld. Individual employed under several employers Proposal Employment income from the main employer o Normal PAYE table will apply. PAYE tax treated as final tax. Employment income from other employments o Tax withheld at 16% o Aggregated with other income (if any) and tax computed under normal progressive rates. o Individual entitled to a credit for tax withheld. All income aggregated and taxed under normal progressive rates. Individual entitled to a tax credit for tax withheld. Comment This has been introduced to simplify the tax administration system.

33 Income tax Personal Tax Rates of Tax Proposed rates of tax applicable to an individual from the year of assessment 2010/2011 is as follows. Tax Slab (Rs.) Rate (%) First Rs. 500,000 4% Next Rs. 500,000 8% Next Rs. 500,000 12% Next Rs. 500,000 16% Next Rs. 1,000,000 20% Balance 24% Tax Slab (Rs.) Rate (%) First Rs. 400,000 5% Next Rs. 400,000 10% Next Rs. 400,000 15% Next Rs. 500,000 20% Next Rs. 500,000 25% Next Rs. 500,000 30% Balance 35% Comment Tax rates were last revised via the budget for The proposal widens the slabs and also reduces income liable to tax at the higher rates significantly.

34 Income Tax Personal Tax Withholding Tax on Director s fee Proposed Payments to directors in excess of Rs. 25,000 per month, is to be subject to tax at 16%. Currently payments are liable to tax at 10%.

35 Income Tax Personal Tax Filing of Returns Proposal intimated that the requirement to file tax returns would be withdrawn on individuals where the only source of income was employment income. PAYE tax deducted will be the final tax. Currently an individual is not required to file a tax return if profit from employment does not exceed Rs.1, 000,000 and PAYE tax has been deducted by the employer. Comment The proposal seeks to reduce the administrative burden of the Department of Inland Revenue.

36 Economic Service Charge Synopsis of the proposed changes Exemptions Proposal Distributors as defined in the ESC Act Dealers in lottery Unit trust or mutual fund All air lines and shipping lines Small and medium enterprises Currently liable to ESC Threshold Rs. 25 Mn per quarter Rs. 7.5 Mn per quarter Administration Submission of returns Annually Quarterly - on or before the twentieth day of the month immediately succeeding the end of that relevant quarter, Comment The proposed changes were introduced in order to mobilize savings, promote investments in SMEs, air lines and shipping lines.

37 Rate changes Turnover Proposed BOI enterprises (liable to income tax) Apparel exporters BOI trading Houses Manufacturers of textiles to apparel exporters 0.1% 0.1% Exempt / concessionary rate or others Exempt from income tax (including tax holiday companies) During the period which losses are made Subject to tax at concessionary rates Wholesale or retail trade other than manufactured or produced by the seller (except distributors or dealers in motor vehicles or liquor) Primary conversion of any tea, rubber or coconut plantation including desiccated coconut, coconut oil or fiber, copra and sheet rubber, but excluding any conversion which produces ant alcoholic beverage. 0.25% 0.25% 1% 0.5% 0.5% 0.5 % Commercial operations Advertising Agents 0.5% 1% Other (including dealers in motor vehicles, liquor, tobacco and petroleum) and turnover of businesses which are defined under the gazette notification. 1% 1% Comments The existing rates have been simplified to four categories.

38 Value Added Tax VAT Rate Proposal It is proposed to reduce the luxury VAT rate of 20% to 12%.As a result there will be only 2 VAT rate in Sri Lanka i.e. 12% and zero %. Under Section 2 (1) of the VAT Act, the supply of goods or services or import of goods as referred to in the fourth schedule to the VAT Act other than goods or services chargeable with the tax at zero per centum was taxed at 18% (luxury rate) commencing from 1 st January The above rate was increased to 20% with effect from. 2 nd August At present the following are liable for VAT at 20%. The supply and import of air conditioning machines, refrigerators, dishwashing machines, washing machines, vacuum cleaners/floor polishers, kitchen waste disposers, food grinders and mixers, ovens and cookers, hair dryers/hair dressing equipment, video player (VCD, DVD), cameras, radio, casette and Music systems, television, motor vehicles, other than motor cycles, bicycles, three wheelers and passenger transport buses, lorries, trucks and any other vehicles used for the transport of goods, watches/clocks, musical instruments, equipment for games, jewellery, aerated water other than aerated water made out of o ginger, nelli or ayurvedic plants cultivated in Sri Lanka, and liquor including ethyl alcohol and other spirits referred to in Harmonized of Commodity description Numbers or for custom purposes the supply of services by hotels, guest houses, restaurants or similar institutions in so far as such services are provided for the holding of wedding receptions and other receptions, which includes the hiring of halls for the holding of wedding receptions or other receptions other than services provided for the holding of professional conferences, seminars or similar events. Comment This will be effective from 1 st January The proposal would simplify the VAT system by elimination of multiple rates and the prevalent rule with regard to claiming of input tax. (at present only 12% could be clamed as input though VAT has been accounted at 20%.

39 Value Added Tax Exemptions Proposal It is proposed to exempt the following; Description Effective from a) Supply of Telecommunication services 01/01/2011 locally manufactured briquettes and pallets using bio mass 01/01/2011 waste Any goods ( including importation) or services to a specific 01/01/2011 project carried on, out of foreign funds or donation received by the government, as approved by the minister considering the economic benefit to the country Proposed Any goods or services by an institution set up by the ministry of defence for the rehabilitation of disabled soldiers, so far as the activities are carried out by the participation of such soldiers 01/01/2011 Locally developed software 01/01/2011 Services being receipts from re-insurance by way of commission or compensation in a insurance business 01/01/2011 Leasing facilities for: 01/01/2011 Motor coaches with seating capacity not less than 28 passengers seats and used for public transport services Lorries; or Tractors; b) the import or supply of- 01/01/2011 Coal specified under HS code no under , , 01/01/2011 and ; Bitumen under HS code no /01/2011 Machinery and equipment for leather or footwear industry 01/01/2011 or manufacture of bags under HS headings codes , , Exempt High-tech medical and laboratory equipment under HS Codes and item under HS hading from through Environment and tourism sectors Hybrid and Electronic vehicles under HS codes 01/01/ /01/2011

40 , 01/01/ , , , , , , , , , , , , , , , and motor homes under HS Codes , and taxi Meters under HS Codes To promote international shopping items under HS Code 01/01/ , , , , , , , , , , , , , , , , , , , , , Fashion Jewellery items under HS Codes under 01/01/ , , , , Machinery and equipment for manufacture of grain mixed 01/01/2011 bakery products under HS codes Numbers and Machinery and high-tech equipment imported for the 01/01/2011 telecom industry which are specifically identified and approved by the ministry of finance. Light weight electrical and electronic items 01/06/2010 Fruit seeds 16/08/2010 Chicks under HS Codes and /10/2010 Meat of fowls under HS Codes , , /10/2010 and Eggs (in shells fresh or preserved) under HS Codes 13/10/ and Eggs, not in shell, including egg white and egg yolks under 13/10/2010 HS Code , , , , and Exempt Comments Part II of the 1 st schedule of the VAT Act should be amended to provide legislative enforceability for these amendments.

41 Value Added Tax Input Tax Restriction Proposal It is proposed to extend the present restriction of 85% of the out put tax to 100% in relation to claiming input tax against output tax. In terms of Section 22 (10) of the VAT Act which was introduced with effect from 1st January 2007, claimability of VAT input was restricted to 85% of output VAT and excess if any to be carried forward and claim in the future subject to the same restriction. Comment The proposal would benefit the low value addition suppliers. However the proposal does not reintroduce fundamental principle of VAT as the input VAT in toto can not be claimed by the supplier.

42 Value Added Tax Deductibility of unabsorbed VAT input credit as at 31 st December 2010 against income tax. Proposal The unabsorbed input VAT credits as at 31 st December 2010 be deductible against income tax as follows.; Input credit related to revenue expenditure Deduction in four equal annual installments to be set off in four years from year of assessment 2010/11 subject to the provision of Section 25, 26 of the Inland Revenue Act. Input credit related to capital expenditure To be treated as part of the capital assets for the purpose of capital allowances No provision in the IR Act to claim the unabsorbed VAT input connected to the 85% restriction. Comment Proposal is not clear with regard to the unabsorbed carried forward VAT inputs which will incur from 1 st of January This proposal does not benefit tax payers who are exempt from income tax.

43 Value Added Tax VAT Suspension Scheme Proposal Monitoring of the scheme to be transferred to a separate unit established under the Department of Inland Revenue. Commencing from 1 st January 2005, TQB and EDB was introduced as monitoring authority of the VAT suspension scheme Comment This would make the scheme more effective and convenient for the participant.

44 Value Added Tax New Scheme of VAT Suspension Proposal It is proposed to introduce a special category of supply made to following persons under a scheme of VAT suspension. The scheme will be monitored by the new unit to be established under the Department of Inland Revenue to administer the VAT suspension scheme. Registered person carrying out any special project exempted under the VAT Act. Exporter of any goods or services other than supplies covered under the existing suspension scheme Deemed exporter Person providing value added supplies to any articles to be exported. Comment The proposal would provide cash flow advantage to tax payers who are covered by the scheme

45 Value Added Tax Optional VAT Proposal It is proposed to vary the rates applicable for optional VAT during a period of 12 years, change the rates applicable to optional VAT period in which the business could remain in the status of optional VAT as follows; Period Rate Registration end of the 3 rd year 2% 4 th year to 6 th year 4% 7 th year to 9 th year 8% 10 th to 12 th year 12% At present the tax payers whose aggregate turnover is below 3 million may opt for registration under the scheme. Comment Optional VAT Scheme does not provide for claiming of input credits and functions as similar to the turnover tax system.

46 Value Added Tax VAT on Financial Services Proposal It is proposed to reduce the applicable rate from 20% to 12%. Value addition for tax purposes to be calculated after the deduction of VAT on Financial Service payable. To preserve uniformity the Commissioner General to issue guidelines on o Basis of calculation of the profit liable to VAT on Financial Services o The adjustment to be made. Bi annual return and monthly payments VAT on Financial Services was introduced under the Chapter III A of the VAT Act with effect from January 1, 2003 made by any specified institution which carries on a business of supplying financial service. With effect from 1 st July 2003 it was extended to any person carrying on business of supplying of financial service. At present both returns and payment are made on monthly basis. Comment This proposal would reduce the tax burden in the financial service industry. The elimination of the requirement file annual return would reduce the compliance burden.

47 Value Added Tax Administrative Provisions Proposal The following changes are proposed in relation to the VAT Administration; VAT Refunds will be directly credited to the Bank account of the tax payer 15 days refunds scheme to be removed and a suspension scheme to be introduced. A proper mechanism to cross check input credit will be introduced Provisions will be introduced to disregard the claim of refunds in case where there is no response within a reasonable time. Certain provisions applicable to income tax appeal to be extended to VAT Act as well. The principals tax liability to be imputed on the agent. 5 year time bar provision in relation to fraud and willful evasion to be removed. VAT Advance payment scheme (WHT) to be removed. A Section similar to 179 (2) of the Inland Revenue Act to be introduced in the VAT Act as Section 43 (1) time frame for deferment of proceedings more than 30 days due to a pending appeal. Penal provisions to be introduced for o non payment VAT of self assessment basis o failure to furnish Financial VAT Return.

48 Nation Building Tax Changes to the Tax Rate Proposal It has been proposed to reduce the Nation Building Tax from 3% to 2%. The threshold in relation to NBT reduced to Rs.500,000/- per quarter. The present restriction in the deduction of 2/3 of NBT as an income tax deductible expenditure is removed. In relation to the following categories the applicable threshold would be Rs.12.5 Mn. per quarter: Operating a hotel, guest house, restaurant or other similar business. Local value added agricultural produce, rice based products; Local educational institutions; Supply of labour (manpower) or employment NBT is currently charged at 3% and the applicable threshold is Rs.650,000/- per quarter. As per prevailing income tax law 2/3 of the NBT payable is treated as a non tax deductible expenditure. The effective date of the above should be clarified.

49 Nation Building Tax Proposal The following categories of business which were previously exempt from NBT have been brought in to charge. Services of star hotels above the rank of three star Any person registered for optional VAT New Exemptions It has been proposed to exclude the following from NBT: a) Institutions Government Institution (Departments) Sri Lanka Airlines Air Lanka Catering Services b) Goods or Services Supply of any goods including importation or services to a specific project carried on out of foreign funds or donations received by the government as approved by the minister; Importation of raw materials and packing materials for the manufacture of ayurvedic preparation subject to the approval of relevant authority; Services provided to the port or airline in relation the international transportation; Services provided in relation to the ship building for the international market for payment made in foreign currency; Services of sub contractors in a construction contract; Telecommunication services; Supply of locally developed software; Import or supply of following articles; - Bitumen under HS code No Tractors

50 Nation Building Tax Policy Changes on NBT Changes in the NBT Rate Turnover of rice manufactured out of locally produced paddy is reduced to 1.5% (w.e.f but prior to ) Excepted Articles/Services for NBT Importation of gold excluded from NBT (with effect from ) The plant, machinery and equipment imported for the use of large scale infrastructure development projects which have been approved by the Hon Minister of Finance as beneficial for the economic development of Sri Lanka on temporary basis on condition that goods will be re-exported after the completion of work, and the services obtained from foreign consultancies in respect of these projects. Import of chicks for breeding under HS code and other chicks under HS code , with effect from Export Development Rebate paid through the Department of Commerce with effect from Any international event approved by the Minister of Finance (with effect from 12 th May 2010) Import of foreign currency notes and HS codes (with effect from 01 st June 2010) Import of chicks for breeding, other chicks meal of fowls eggs and egg yolk with effect from 13 th October 2010.

51 Customs Duty Proposal Rate changes (effective 23 November 2010) Telecom / ICT/ BPO Industry Customs duties on software have been removed. The WTO decision on the valuation of carrier media containing software for data processing equipment will be implemented. HS Code rate ( % ) Proposed rate ( % ) or or 5.00 Free Confectionary and Bakery Products Manufacturing Customs duty on certain raw materials used for the production of confectionary / bakery products to be removed or reduced as follows: HS Code rate ( % ) Proposed rate ( % ) Free Free Free Free Free

52 Agriculture Sector To improve agriculture through new technology and post harvest storage and transportation systems, Customs duties on related goods will be abolished/reduced while nurturing the local industries. HS Code rate ( % ) Proposed rate ( % ) Free Free Health, Pharmaceuticals and Cosmetics (including Ayurvedic products) Customs duties on naso gastric tube feeding preparations to be abolished and custom duties on certain glass and plastic bottles used for packing of pharmaceuticals and cosmetics including Ayurvedic preparations and process will be reduced. HS Code rate ( % ) Proposed rate ( % ) Free Vehicles assembly To support vehicle assembling industry, with local value addition, Customs duty on parts and components will be reduced. HS Code rate ( % ) Proposed rate ( % )

53 Instruments and Apparatus for Health, Education and Scientific research Customs duly will be abolished on instruments and apparatus for health, education and scientific research, covered under the Chapter 90 of the Harmonized System. Tourism and Construction Industry Customs duties on selected goods (such as vehicles referred to as Motor homes ) and raw materials goods and will be reduced. HS Code rate ( % ) Proposed rate ( % ) Free Branded Products No import duties and VAT for internationally branded items in order to promote Sri Lanka as an attractive destination for international shopping (only liable for PAL and NBT).

54 HS Code rate ( % ) Proposed rate ( % ) Free Free

55 Electric and Highbred Electric Vehicles To reduce the cost of fuel and damage to the environment, use of electrically operated vehicles and highbred electric vehicles will be encouraged by reducing prevailing Customs duty to a lower duty, on all such vehicles covered within the Chapter 87 of the Harmonized System as follows. Proposed 15% 30% 15% 15% 5% zero Depreciation table for used motor vehicles The depreciation table for the used motor vehicles of HS headings 87.01, 87.02,87.03, and will be revised as per the WTO Valuation Agreement. Period of Use Proposed Depreciated FOB value HS Code HS Codes 87.01,87.02, and Less than or equal 6 months 90% Nil Nil 6 months to 1 year 80% 90% 90% 1 year to 1.5 years 75% 80% 80% 1.5 years to 2 years 70% 80% 70% 2 years to 2.5 years 65% 75% 65%

56 2.5 years to 3 years 60% 75% 60% 3 years to 3.5 years 55% 70% 55% 3.5 years to 4 years 50% 60% 50% 4 years to 4.5 years 45% 55% 50% 4.5 years to 5 years 40% 50% 50% 5 years to 5.5 years 35% 40% 35% 5.5 years to 6 years 40% 30% 6 years to 6.5 years 30% 40% 25% 6.5 years to 7 years 40% 25% Over 7 years 40% 25% New Exemption Imports of goods to a specific project carried on, out of foreign funds or donations received by the Government as approved by the Minister giving regard to the economic benefit to the country Negative list The duty free imports on concessions granted by BOI agreements will be applicable only if local supplies of the following are unable to meet the required quantities. - Cement - Asbestos Sheets - Spare parts for Motor Vehicles - Wires & Cables - PVC Pipes & Fittings - Paints - Furniture including pantry cupboards - Steel - Tiles (Floor, wall & roof) - Granite - Electrical Fittings - Aluminum Extrusion - Lubricants Tariff Reductions under Free Trade Agreements The tariff reductions under the Free Trade Agreements entered into with Pakistan and South Asia Free Trade Agreement (SAFTA) will take effect from 23 November 2010.

57 Modernization of Customs Upgrading of systems & facilitation of operations Proposal The Customs has initiated an project to upgrade its existing ICT system to the advanced version of the ASYCUDA World software package. This system is expected to introduce the following administrative changes, Reduction in the number of copies of CUSDEC s from 5 to 2 in order to minimize the high transaction costs As a part of the new features in the aforesaid software, it is proposed to introduce the cargo accounting function which was abandoned sometime back. A centralized electronic copy will be shared among various customs divisions so that shipping agents are not required to submit hard copies to each customs office. Reductions in the number of visits required to be made to the Customs Electronic Data sharing of Customs data with the Census & Statistics Department and other government institutions. This is expected to reduce the frauds taking place in VAT refunds and vehicle registration. In additions the following action plan is proposed in facilitating the operations at Customs, Minimize the time for import clearance by implementing a risk criteria formulated, based on cargo intelligence techniques in order to ensure that violations of such criteria will be examined whilst allowing those complying to clear up faster. Introduction of a simplified procedure to register individuals with the Customs Computer System Using ICT to further reduce the forgeries in import cargo clearance process Introducing Electronic Payment Facility for CUSDECS Reception of electronic regulatory approvals An electronic reception ( a web based system) to transmit duty waivers granted by the Treasury to the Customs Introduction of exclusive customs bonded areas. To establish this area a designated geographical zone will be set up to deposit import cargo without paying duties and thus will result in lowering costs incurred in establishing bank guarantees for bonded cargo. These bonded warehouses will introduced with electronic communication and monitoring systems for effective management and flow of bonded goods.

58 Comment This software package is primarily aimed at developing an effective and efficient customs administration which is essential to the welfare of any country. This system will fast track the customs clearance and will combat any fraud, and illegal trafficking of prohibited and restricted goods. This system will provide vital statistics on foreign trade essential for economic planning and encourages international trade. Source:-

59 Excise Duty Proposal Excise (Special Provisions) Act No. 13 of 1989 Excise Duty rates have been revised to take into consideration the removal of Regional Infrastructure Development Levy (RIDL) and Social Responsibility Levy (SRL) on imports The concessions given to public sector employees have been published in Gazette Order bearing number 1680/25 dated 19 November 2010 Section 3 of the Excise (Special Provisions) Act No. 13 of 1989 imposes Excise Duty on every article manufactured or produced in Sri Lanka at rates published in Gazette Orders from time to time. Goods purchased from Custom Duty free shops are not liable to the duty. The Minister has the power to grant exemptions from Excise Duty by Order published in the Gazette. Comment This revision of Exchange Duty rates is to compensate for the erosion of revenue due to removal of RIDL and SRL on imports.