29 November, 2020

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Re-Evaluate The Long Term National Cost Benefits Of Tax Exemptions & Fixed Exchange Rate Hedge Proposed To Be Granted To Non Residents

By Chandra Jayaratne

Chandra Jayaratne

An open letter to President Gotabaya Rajapaksa,

Re-Evaluate the Long Term National Cost Benefits of Tax Exemptions and Fixed Exchange Rate Hedge Proposed to be Granted to Non Residents

In the longer term interests of the nation and its people, kindly re-assess, before firm formal legal/regulatory commitment, the long term national cost benefits of the recently announced

– tax exemptions to be granted to foreign investors who are non-residents, in respect of dividends and loan interests, effective from the dates as announced

– incentives, to apply at a future repatriation point of investments in loans and other investments (as identified at present and / or intended to be extended in the future) offered to foreign investors who are non-residents, guaranteeing them the application of the rate of exchange at which the loans and investments were originally made by inward remittances, provided such investments are made within a specified time frame and meet set minimum value criteria as set.

The incentives offered to non-residents appear justified by the rationale that Sri Lanka currently needs foreign direct investments and investments in loans and stocks/shares in order to support growth and job creation objectives of the government. Provided that the additional incentives offered bring about new and enhanced inward real foreign exchange flows via investments in loans, new business investments and or as investments in stocks/share, both incentives proposed to be granted appear fully justified; as at it will purportedly fill in a much needed present void in balance of payment support framework and also assist in meeting the debt obligations of the country. Here one concern stands out as to whether foreign investors and non-residents currently enjoying higher investment returns under Dollar denominated Sri Lanka Sovereign Bonds will opt to invest in Rupee denominated Sri Lankan loan stocks and bonds which at present carry relatively low yield rates.

It is however essential that professional cost benefit assessments are made prior to the extension of such incentives, in order to validate and confirm that the extension of the new incentives will lead to substantial new incremental real foreign exchange inflows; and also that the long term cost benefit analysis justifies the proposed new incentives being granted. Further, it is essential that via a professional socio economic and regulatory risk assessments, all potential and lurking risks and regulatory sensitivities, if any, are identified and appropriate risk mitigation steps, limitations, know your customer and other prevention of money laundering processes are embedded within the proposed investment schemes and associated procedures.

The new government under your leadership had earlier removed, for both local residents and foreign non-resident investors, the withholding tax on dividends and interests. Thus these investors already receive dividends and investment income gross and tax payers amongst them become liable to tax on the gross income at applicable tax rates. Here however, it may be pertinent to note that the withholding of tax on investment income as a final tax was an excellent mechanism for ensuring the collection of taxes with the least administrative effort or cost to the Inland Revenue Department / the State. The removal of withholding tax, be it for residents or non-residents, with only residents being rendered chargeable to local tax, not only negates this benefit; but creates collection challenges in addition to increased costs and also goes against the precept of equity.

With the new incentive of an exemption from tax on dividends and loan interests now granted, foreign investors and non-residents will receive their investment income in a remittable form out of Sri Lanka gross, without any payment of tax to the state of Sri Lanka, whilst local investors will pay their due share of tax and contribute to the state revenue.

There were other options open to the government, instead of the above blanket exemption and some of them are summarized below:

Dividends

The 14% final withholding could have been continued, with foreign investors of treaty countries  continuing to benefit from lower treaty rates in Sri Lanka, in most cases at 10% (some even at  5%), with credit against home country tax, so not impeded by higher 14% rate.

Or

Dividends on foreign equity inflows made after a particular date could have been reduced to 10% (the treaty credit being available and thus no impact on total tax exposure of the non-resident investors)

Or

Exempt only in respect of new investments into identified business sectors with higher national priorities and needs and / or operating in areas of the country where development and job creation priorities justify such an exemption

It must also be noted that the current proposal benefits even multinationals that have invested in Sri Lanka many decades ago and are serving mostly local customers and are engaged in distribution of consumer and household products with lower net value addition to the nation and its people.

Interest and Investment income

Withholding tax set as a final tax could have been continued with the applicable rate increased to 10%.

Here the most important issue for your consideration is that Sri Lanka as a State with several concluded Double Tax Treaties, could have imposed a reduced withholding tax of say 10 % on all dividends and investment income and made the net income in the hands of all investors, irrespective of whether they are local or foreign non-resident exempt, recognizing that;

– the foreign and non-resident investors of countries with double tax treaty arrangements with Sri Lanka, could have claimed a tax credit in their respective countries from their Revenue Authorities and thus been in the same situation on a net cash flow basis

– The Sri Lanka’s revenue loss today by extending this new incentive would have thus been avoided

– The newly granted incentive in fact enriches the Revenue of the receiving State

– Retaining the status quo maintains the equality amongst all investors in Sri Lanka, irrespective of residency.

Your attention is also drawn to the need for a further careful review by You, of the long term cost benefits and re-estimation of the estimated new real investment incremental inward remittances ( ie. not funds repatriated and reinvested) due to the guaranteeing of the application of the rate of exchange at which the investments/loans were originally made by inward remittances. In addition, it will be important to look at this additional investment incentive from the eyes of foreign investors who are already in business investments in Sri Lanka made prior to the incentive application date, who will be discriminated due to having made their local growth value adding investments earlier. These older investors will be at a competitive disadvantage in relation to new investors and will evaluate the consistency of policy and equality of treatment as negative perceptions. In addition, this incentive if it were to be later offered as a general incentive to investments in shares and other equity transactions, several challenges may arise in the implementation thereof in relation to regular disinvestment options, major shareholding restructures, buy out options, mandatory offerings, regular dividend remittances, rights issues, bonus issues (share splits) etc.

It must be assessed that the contingent liability undertaken by the State in granting this incentive will be more than compensated by the value addition expected from the real incremental new investments consequent to the grant of the incentive. Further, since this new incentive will create for the future State expenditure, a contingent liability in the premium hedge guarantee, this contingency will need to be annually provided for in state expenditure provisions, in keeping with best practice state accounting standards.

Trust you and your advisory team will give due consideration to this submission

Yours Sincerely,

Chandra Jayaratne

CC

Prime Minister and Minister of Finance

Secretary to the President

Secretary to the Treasury

Governor Central Bank of Sri Lanka

Commissioner General of Inland Revenue

Chairman, Ceylon Chamber of Commerce

Secretary, Monetary Board

Secretary, National Economic Council

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