Businesses express concerns on faltering demand amid higher tax rates

• Biz have begun to feel impact of tax hikes on demand, even before new direct taxes hit their P&L 
• Sri Lankans are now footing a heavier tax bill after experts pounced on low taxes for economy’s crash 
• Biz seen exiting SL for better destinations, which offer favourable taxes and better doing business conditions

Businesses have started to feel the heat from higher taxes, even before the new and elevated corporate income tax came into effect from January 1, as the respondents to the Central Bank’s monthly survey of business sentiments expressed heightened concerns about faltering demand amid higher 
tax rates. 

According to the survey findings, the respondents raised concerns about “the impact of tax increases on demand conditions”. 

Both direct and indirect taxes were raised in multiple cycles, starting from last June, mostly outside the national budget process to raise revenue to bridge an unsustainable budget gap under what is referred to as revenue-based fiscal consolidation programme proposed by the International Monetary Fund (IMF).

Sri Lanka ran back-to-back blowout budget deficits from 2020 through 2022, largely due to the sub-optimal economic activities resulted from two years of pandemic-related restrictions, subsequent collapse of the economy and tax cuts, which were introduced in December 2019, to provide fiscal stimulus to the then moribund economy.

 However, as the country ran out of foreign currency reserves, mostly due to exogenous factors and partly due to the internal issues faced during this period, which resulted in massive economic, social and political upheaval that succeeded in unseating the then president, prime minister and government, the new officials decided to reverse the low tax policy and replace it with a heavy tax regime. 

As a result, businesses are seeing a slump in demand, as higher taxes bite into disposable incomes of the people, which have already been thrashed by runaway inflation and margin compression, due to hyperinflation seen in costs. 

In this backdrop, some businesses have set up offices in favourable tax destinations such as Singapore, Hong Kong and the UAE, while the exporters are seeking to relocate their operations elsewhere.

Businesses were contending with months-long hyperinflation, due to over 100 percent increase in their costs, the monthly Producer Price Index showed. Higher taxes could become the final nail, which could change their fortunes drastically. 

However, Central Bank Governor Dr. Nandalal Weerasinghe, in a post-budget forum in November, defended the higher taxes on corporates, saying that lower taxes hadn’t helped the economy in bringing the desired results in the last three years. 

Sri Lanka nearly doubled the Value Added Tax from 8 percent to 15 percent, removed exemptions, raised telco levy, introduced Social Security Contribution levy of 2.5 percent, brought back the withholding tax on deposit incomes and raised the income taxes on both corporates and individuals, effective from January 2023.

While some are leaving the country’s exponential taxes amid the cost of living crisis, corporates also appear to be joining the bandwagon by exiting the country for better destinations, which offer favourable taxes and better doing business conditions.