ECONOMYNEXT – Withholding tax will have to be deducted from listed corporate bonds which are in existence, a tax official said, raising concerns over the risk of doing business in Sri Lanka, selective implementation of the law, with the possibility of some bonds being taxed twice.

The taxation changes of bonds including government debt, under a new income tax law also raised the question of indirect expropriation, according to some analysts, though uncertainty prevails.

“The 5 per cent withholding tax rate is applicable at the time of payment of interest,” Thanuja Perera, consultant to Sri Lanka’s Finance Ministry told a forum organized by the Ceylon Chamber of Commerce refereeing to corporate debt.

“So payments made after this date – after April 01, 2018 – will be subject to the 5 per cent withholding tax.”

Under a new income tax law interest on private corporate debt will be taxable, with a final 5 per cent tax being deducted from individuals and standard taxation for companies with the withholding tax being an advance payment.

Sri Lanka made interest on bonds issued from January 2013 tax free in a blatantly interventionist move to ‘promote corporate bonds’ which was used by large investors as a tax shelter.

Selective Implementation?

A boost to the investment climate was made by the state going through tax holidays already granted under the Board of Investment concession as befits a free country.
Tax holidays themselves, where different persons engaged in the same activity is treated differently, may amount to an undermining of just rule of law, liberty advocates say.
However in reversing the tax free status of bonds already issued, Sri Lanka is going against the policy of allowing tax holidays already granted by the Board of Investment to run its course, raising questions over selective implementation of the law.

The income tax law, to which many changes were made to the original draft, in the so-called ‘committee stage’ is not available in final form yet.

There is a lot of uncertainty in corporate and gilt markets, where participants are seeking clarity.

For example in a more damaging fallout, there is the risk that some corporate bonds, issued before 2013, where withholding tax has been already paid, being taxed twice.
Sri Lanka’s Hatton National Bank issued 10 year bonds in September 2011, expiring in 2021.

At the time the prospectus informed shareholders that withholding taxes have been paid.
“In terms of Section 135 of the Inland Revenue Act No 10 of 2006 as amended by Inland Revenue (Amendment) Act No 22 of 2011 the Issuer of any corporate debt security is required to remit withholding tax at the rate that may prevail at the relevant time on the entirety of the interest which may accrue on such corporate debt to the Inland Revenue Department at the time of the issue of such corporate debt security,” the prospectus said.
“Pursuant to such a deduction and remittance being made there would be no further withholding of any tax by the Issuer on any interest being paid on such corporate debt security.”

Prospective investors were informed that there is interest rate risk (the bonds were fixed rate), re-investment risk (of coupons), default risk and liquidity risk.
The possibility of the government deducting a withholding tax at a later date was not listed as a risk.

Own Goals?

There are not many tax paid bonds in existence now as most have expired. There are more tax free bonds, but they are also expiring progressively.

Some liberty advocates and those who want to reduce investment risks of the country, and create a safer and more predictable business environment, are puzzled why bureaucrats and politicians are pushing up risks of investing in Sri Lanka by retrospective taxes, or practices which could amount to indirect expropriation in ‘own goal’ types of actions.