Sri Lanka – Tax Reforms and VAT on Digital Services

June 28, 2024

On June 13, 2024, the International Monetary Fund (IMF) took a significant step by publishing a report on Sri Lanka's tax system reforms. These reforms, set to become effective from January 1, 2025, aim to enhance fiscal sustainability and reach a tax-to-GDP ratio of at least 14% by 2026.

These reforms are part of a series of changes in Sri Lanka since 2021. The initial results have been promising, with the economy recovering, inflation remaining low, and revenue collection improving. However, additional reforms are necessary given the ongoing debt restructuring and the economy's current fragility.

Key Tax Reforms

The tax reforms set to be implemented in Sri Lanka include introducing new taxes, adjusting existing ones, and removing certain exemptions. One of the biggest and most significant novelties regarding VAT is the introduction of VAT on digital services and items currently subject to the particular commodity levy (which will be removed).

The previously established Simplified Value Added Tax (SVAT) scheme will be abolished and fully repealed by April 2025. This is part of the ongoing efforts to fix the VAT refund system, and businesses that used to benefit from this scheme will need to adjust to the standard VAT system. Unfortunately, this may lead to increased administrative burdens and tax liabilities for these businesses.

Recognizing the current inefficiencies in the VAT system, the Sri Lankan government is committed to making significant improvements. As noted in the report, the overall efficiency of the VAT system in Sri Lanka still needs to improve, and VAT compliance needs to be stronger.

To address this, Sri Lanka will develop a VAT compliance improvement program in 2025 to detect and deter noncompliance. This proactive approach aims to reduce evasion and ensure more effective VAT collection, leading to an increase in government revenues.

Conclusion

For years, Sri Lanka has been working closely with the IMF to implement new tax regulations to reduce public debt and reform inefficient tax systems. After the changes to VAT law that occurred at the beginning of 2024, when the standard VAT rate increased from 15% to 18%, these proposed changes represent the next steps in tax reform and consolidating the fiscal system in Sri Lanka.

Source: International Monetary Fund (IMF), Sri Lanka Inland Revenue

What are the key tax reforms introduced in Sri Lanka effective January 1, 2025?

Effective January 1, 2025, Sri Lanka implemented significant tax reforms aimed at enhancing fiscal sustainability and achieving a tax-to-GDP ratio of at least 14% by 2026. These reforms include the introduction of Value Added Tax (VAT) on digital services and the removal of certain exemptions. Additionally, the Simplified Value Added Tax (SVAT) scheme is set to be abolished by April 2025, transitioning businesses to the standard VAT system.

How does the introduction of VAT on digital services affect consumers and businesses?

The imposition of VAT on digital services means that consumers will now incur VAT charges on digital products and services provided by both local and foreign suppliers. Businesses offering digital services are required to register for VAT, charge the applicable rate on their services, and remit the collected tax to the Inland Revenue Department. This aligns Sri Lanka with over 100 countries that impose VAT on non-resident digital services.

What is the current VAT rate in Sri Lanka, and has it changed recently?

As of January 1, 2024, Sri Lanka increased its standard VAT rate from 15% to 18%. This adjustment was part of broader efforts to boost government revenue and address economic challenges.

What is the status of the Simplified Value Added Tax (SVAT) scheme?

The SVAT scheme is scheduled for abolition by April 2025. This move aims to rectify inefficiencies in the VAT refund system. Businesses previously benefiting from SVAT will need to transition to the standard VAT system, which may result in increased administrative responsibilities and tax liabilities.

How is Sri Lanka addressing VAT compliance and efficiency?

Recognizing existing inefficiencies and compliance challenges wit, the Sri Lankan government plans to develop a VAT compliance improvement program in 2025. This initiative aims to detect and deter noncompliance, thereby enhancing effective VAT collection and increasing government revenues.

How do these reforms align with Sri Lanka's economic objectives?

These tax reforms are integral to Sri Lanka's strategy to rand reform inefficient tax systems. By expanding the tax base and improving compliance, the government aims to strengthen fiscal stability and support economic growth.

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