Understanding tax recovery in Sri Lanka

The CGIR has the legal right to institute action to recover the tax from the tax-defaulters. Once taxes have gone into default, the CGIR must commence recovery action within 5 years, failing which it will be time-barred

Aiming to demystify the intricacies of the tax recovery process in Sri Lanka, a webinar by KPMG Academy in Sri Lanka delved into the nuances of taxes in default, details of the notice of demanding payment issued by the CGIR, various enforcement actions that the Inland Revenue Department (IRD) may impose for collection of taxes in default as well as the liability and obligations of authorized representatives of an organisation. 
While the objective was to educate the business community and general public on the tax recovery procedures in Sri Lanka, the team of experts from KPMG highlighted both the legal authority of the Commissioner-General of Inland Revenue (CGIR) as well as the rights and duties of taxpayers throughout the recovery process.
This article, developed based on the webinar, sheds light on the tax recovery process in Sri Lanka.

What is tax in default? 

When a tax is not paid by the date on which it became due and payable, the CGIR will issue a Notice of Demanding Payment. Upon issuance of the Notice of Demanding Payment the tax in default does not arise. However, the tax is considered as being in default if payment is not made within 21 days after service of said notice. The CGIR then has legal right to institute action to recover the tax from the tax-defaulters. Once taxes have gone into default, the CGIR must commence recovery action within 5 years, failing which it will be time-barred. 

Are there any circumstances when taxes are not considered as being in default? 

If there is a payment arrangement in place with the CGIR, or if an extension of payment has been requested and granted (usually for an initial period of 6 months, at the discretion of the CGIR) the taxes will not be in default. 

Notice of Demanding Payment vs Notice of Tax In Default

A Notice of Demanding Payment is the document issued by the CGIR informing the taxpayer that the tax due has not been paid as per the records maintained by the IRD, and failure to settle the amounts specified within 21 days of service of the letter will result in actions to recover taxes due.
If such a letter (demanding payment of outstanding taxes) is issued under the old Inland Revenue Act No. 10 of 2006 or VAT/other Acts, it would have the title of Notice of Tax in Default instead. This requires a different type of response than the Notice of Demanding Payment, in the form of a letter of objection to be submitted within 30 days from service of the letter.  

Statutes of relevance 

While analyzing the legal provisions governing the recovery process, it was highlighted that the Inland Revenue Act No 24 of 2017 (New IRA) came into effect on 01.04.2018, with a significant impact on taxpayers as it replaced existing tax law and its long-established practices. Along with the enactment of the New IRA came the repealing of the Inland Revenue Act No 10 of 2006 (Old IRA) and introduction of transitional provisions regarding the interaction between the two acts. 
With reference to the subject matter at hand, it was highlighted that any recovery proceedings commenced under the Old Act regarding collection of taxes may continue as if the New Act had not come into force. Alternatively, the CGIR may also recover such taxes by carrying out fresh proceedings under the New Act. As such, being aware of the Acts and specific sections under which notices have been raised, as well as taking note of these transitional provisions are essential when responding to the CGIR.
Other statutes including the VAT Act, Social Security Contribution Levy Act and Default Taxes (Special Provisions) Act have specific sections applying to the recovery of taxes in default. 

Commonly used methods of recovery of taxes in default

There are a number of tax recovery methods defined by law, that the CGIR can implement – some used more commonly than others. These include court proceedings, liens, offsetting against payments, execution against taxpayer’s property, pursuit of third-party debtors, sale of seized property, departure prohibition orders, priority in bankruptcy, preservation of assets, non-arms length transferees and transferred tax liabilities.
One of the more commonly used methods is the pursuit of third parties (including debtors, employers, banks etc.) who owe or hold money due to the defaulting taxpayer. In this case, the CGIR can serve notice in writing to a third-party, instructing them to make payments from funds held on account of the defaulter, within a stipulated time. This concept can extend to employers – where notice may be served to the employer asking him to pay salaries / wages due to the taxpayer / employee to the CGIR instead (in this case, the 1st Rs. 75,000 would not be subject to withholding, however amounts beyond that may be remitted directly to the CGIR). Failure to act on the instructions of the CGIR would render the third party personally liable for amounts payable to the IRD. 
As part of the crackdown on defaulters, the CGIR may place a legal claim against a taxpayer’s bank accounts by issuing a bank seizure notice, requesting the bank to remit money held in the taxpayer’s bank account to the CGIR. 
Bank seizure notices can also be served on joint accounts if both parties are tax defaulters or a single party has the right to withdraw all funds in the account without authorization of the other party. As lackluster performance has been observed regarding the collection of income taxes in Sri Lanka, with over Rs. 900 billion in total arrears of taxes, penalties and interest due, the IRD is under severe pressure lately. As such, the bank seizure notice is a tool being used more frequently in a bid to enhance income tax collection, said KPMG Tax and Regulatory Expert Suresh Perera addressing the topic.
Other methods use by the CGIR include the commencement of court proceedings to recover amounts outstanding, creation of a lien in favour of the CGIR (a relatively new concept introduced in the New IRA where a lien – i.e. a right to keep possession of all property belonging to the taxpayer - can be created, for which the CGIR has to issue a notice of intention to register the lien), execution against and sale of taxpayer property and issuance of departure prohibition order (if the CGIR is of the opinion that the tax defaulter is likely to leave the country without settling amounts due, measures may be taken to prevent such persons from leaving Sri Lanka) to name a key few. 
Tax recovery procedures implemented under the VAT Act are very much in line with the New IRA as detailed above. However, not much sympathy is awarded to the defaulting taxpayer in a court of law, since VAT is a tax collected from a customer, that is due to be remitted to IRD (and defaulting such payments would make one unjustly enriched).
It is important to understand who, as representatives of institutions, may have to take on personal liability for the recovery outstanding taxes. Section 146 of the New IRA defines the representatives for each type of entity for instance, directors/principal officers/agents of a company, partners of a partnership, trustees of a trust, guardian/manager of a disabled individual and authorized agents/principal officers of a non-resident. 
Section 149 also details how a manager of an entity – i.e. a director, secretary, CEO, CFO or any other principal officer can attract personal liability under certain circumstances regarding outstanding taxes of the company, to the extent of any assets in the possession/under the control of said representative. At the same time, with proper due care, shields can be used to defend the loss of personal assets. As such, representatives should be mindful about their obligations of maintaining ample records, filing of returns and payment of taxes in a diligent manner.