Debate over creeping services protectionism in Sri Lanka hots up
ECONOMYNEXT – Sri Lanka is seeing creeping protectionism in services trade with taxes being charged on electronic payments to limit competition with domestic online firms, even as the country tries to dismantle existing protection given to crony hard goods producers.
Sri Lanka has upped a tax on credit card payments to 3.5 percent through a so-called Nation Building Tax, when a good or service is purchased online and stretched it to debit cards, expanding protectionism in to the service sector areas that has seen dynamism and is exposed to competition.
Finance Minister Mangala Samaraweera said the tax would apply to services such as Uber, online advertisements such as on Facebook.com and also hard goods purchased from online portals abroad.
A key reason for the new tax was that companies like PickMe were paying domestic taxes, while online portals were not, according to officials.
But the tax also applies to purchases made while travelling abroad, weakening the justification of online firms not paying domestic taxes while selling within Sri Lanka.
Sri Lanka’s Federation of Information Technology Industry of Sri Lanka also wrote to the finance ministry saying a majority of SME businesses use foreign services for part of their operations.
"With the enactment of this proposal, both the ICT industry and the country will be affected," FITIS said in a statement.
The tax will hinder the digital transformation of the country, the statement said.
In Sri Lanka, secretly hatched taxes have been routinely slammed on the people through budgets, though the 2019 budget was much better than earlier ones.
By charging ad hoc digital protectionist taxes to help PickMe or Takas.lk, the entire tax system gets distorted, generating cascading unintended negative consequences.
It is also not clear why additional taxes have to be charged from the payment cards also for hard goods, when Sri Lanka’s existing border taxes are supposed to apply when goods are cleared.
If border taxes are not applied due to administrative hassles (cost benefit trade-offs) or for other reasons, it is a bad practice to add new taxes which cannot be reclaimed, on charges for all payments, including those made while traveling abroad, analysts say.
Sri Lanka had also slapped a new para-tariff called economic service charge (ESC) on imports, because some importers were ‘vanishing’ in another tax complication to make up for shortcomings in tax administration.
Deshal de Mel, advisor to the finance ministry said the digital tax would not apply to purchases from local online portals like Takas.lk.
Director of Fiscal fiscal policy K A Vimalenthirarajah gave an unusual justification saying foreign companies do not pay income taxes unlike local firms.
Though many excuses have been given for trade protectionism in Sri Lanka and in other countries, that sellers located abroad did not pay corporate income tax in two locations is a new excuse.
De Mel said he did not expect charging NBT in place of corporate income tax from foreign companies to fall foul of double taxation agreements.
"If there was a problem, it should have been a problem when the tax was at 2.5 percent," he told reporters in Colombo.
Uber for example, is exporting service to Sri Lanka out of Holland.
Sri Lanka already had a 2.5 percent tax on some foreign spending by credit cards.
The creeping services sector taxes, where competition already exist, are coming as Finance Minister Mangala Samaraweera is battling crony hard good producers to cut import duties and move towards a neutral VAT regime.
While there is a case to charge VAT from all sellers in the country, the 3.5 percent tax could further complicate Sri Lanka’s existing VAT and NBT regimes.
Like border taxes on hard goods, which already exist, analysts say restaurants selling on Uber eats already pay value added tax if their volumes are big enough to fall within the VAT threshold.
If taxi owners or public transport was subject to value added tax or income tax they should also be taxed through the standard tax system, instead of through ad hoc tax shortcuts. The revenue of the portal is only a percentage of total revenue.
There is a case to charge VAT from revenues of platforms like Uber, or Facebook, if their total revenues fall within the threshold, analysts say.
But there is no case to charge an import duty on services that aims to tilt the playing field towards domestic players like Takas or Pick Me, critics say.
Online portals may also present an opportunity for tax offices to collect value added tax, if and when services qualify for such taxes on existing rules. Even now, domestic taxes are charged from customers on booking engines, but it is not clear whether the tax office has a system to collect them.
Value added tax has a process which ensures that VAT is collected both from firms that pay VAT and to some extent also from those that do not.
The VAT system works on the principle that small firms who are exempt cannot reclaim their VAT.
An ICT firm that purchases part of their services will pay the full VAT and NBT if they sell their output domestically and if they are liable for VAT.
But an NBT of 3.5 percent on services purchased will raise their costs as it is not recoverable, distorting a global value chain if they are small firm using cards to make payments.
Advertising expenses in Sri Lanka are also already subject to limits as allowable expenses for income tax, and it is not clear why a distinction has to be made in the case of online agencies.
Sri Lanka’s passports already have less value compared to those of East Asian countries, where visa-free travel is possible. The digital protectionism will also reduce the value of Sri Lankan payment cards, making them inferior to the rest of the world.
Like in the case of hard goods, when molly-coddled through protectionist taxes, Sri Lankan service sector firms may also lose their ability to compete abroad while start-ups catering to foreign markets will see their costs pushed up.