COLOMBO (EconomyNext) – Sri Lanka Finance Minister Ravi Karunanayake defended a deadly retrospective tax slammed on companies, which analysts fear is a tactic that is likely to be followed by future administrations to finance their election promises.
The tax was supposedly to take back ‘ill-gotten’ gains.
"It may be on the short run we have been offensive in certain areas but we have put fundamental reason as to doing so as well," Finance Minister Ravi Karunanayake said.
"We will ensure when we say it is one-off that it is one-off unless the market decides to behave in a different way."
Karunanayake was speaking at a forum organized by the Ceylon Chamber of Commerce Friday the day after he presented the govenrment budget which announced the tax .
Ill-gotten Super Gains
Ceylon Chamber Chief Suresh Shah had earlier referred to a windfall type 25 percent levy labelled ‘super gains tax’ slapped on companies which supposedly had ill-gotten gains.
Shah said not all companies had made such gains and he was concerned about the perceptions created in the country that all businesses had ill-gotten gains.
Practices followed by the United National Party led administrations such setting up state companies under the Companies Act instead of an Act of Parliament and the executive presidency itself had been abused by subsequent administrations against the people with interest added.
Karunanayake said the budget was done in a few days to give effect to the ‘political aspirations.’
"Our intention was not to distort the market, but ensure that if there had been any ill-gotten gains in certain areas, certainly there won’ be any mercy on them," he said.
"But any area where there is a genuine error we will be the first to say sorry and get it corrected."
Indrajith Coomaraswamy an economist and former Treasury official said there was a debate whether it was better to increase the overall tax rate rather than have a one-off rate.
"As we go forward we need learn lessons to see whether we have done it the best way."
A retrospective tax means that all shareholders who bought shares on the basis of expected profits per share for the current and reported earnings will find that the profits are not true and their investment decisions were wrong, an analysts who declined to be named said.
No Witch Hunt
"In my opinion it is not a good thing do," economist Laxman Siriwardene said. "It should not create a precedent. It should be transparent to a company what they have to do.
"The only saving grace is taxation is better than printing money."
There were also perceptions in the market that the retrospective tax and other large one off levies were ‘revenge’ taxes imposed on firms linked to or who supported the previous regime or refused campaign finance, an analyst who declined to be named for fear of reprisals said.
It may have opened a Pandora’s Box for the budget to be used to wreak vengeance by future administrations, critics say.
The claims of being ‘one-off’ bring back memories when an ad hominem or targeted expropriation law was brought against several companies including many owned by unarmed citizens with connections to the United National Party.
"The problem now is that there is no opposition. The opposition anyway is clueless about these issues," one banker said. "The media is also with them. People like Harsha (de Silva) who spoke on behalf of economic freedom and rule of law is also with them. Please don’t quote me."
Minister Karunanayake confirmed that the super gan tax was based on the 2013/2014 financial year but insisted that there was no witch hunt.
"We have looked at 2.0 billion rupees (in profits) from a transparent basis. There is no witch hunt on anybody, it is just on what is declared."
He said tax exempt companies will not be included, and there were "effectively 42 companies", but were awaiting returns to see the exact number.
No profit warnings have so far been issued by any company in the stock market, as it is uncertain which listed firms will get hit. December quarter results are just coming in.
In Sri Lanka some firms including banks have a financial year ending in December and most others March.
Minister Karunanayake said that the ill-gotten gains tax applied only to single entities and not to consolidated group results.
"We are only using a one-off to clear the dead past," Karunanayake said. "We have inherited this. If we can say we can write off what was done in the previous regime, we do not need to have this super tax.
"But owing to the fact that you took everything sitting down for 11 years – you won’t have white vans running around hereafter – so please look at the state the economy is in. Help us to take this forward. That is why we said we are taxing 2 percent for the benefit of 98 percent."
New Structural Problem
Coomaraswamy however said the new current expenditures initiated by the regime would be permanent streams compared to the one-off tax that would bring some money this year and would have to be fixed later.
"The interim budget has put in place streams of recurrent expenditures, in terms of reliefs offered," he said. "But a lot of the revenue measures are one-off and that is a structural challenge that needs to be addressed."
The self-created massive salary hike to state workers had reversed gains in containing current expenditures over several years, needing more money to be taken from the citizens to be used to finance current state expenses by raising the revenue to gross domestic product ratio.
Sri Lanka’s stocks took a battering on Friday falling 2.6 percent mainly due to the retrospective tax. Stocks were already falling on the basis of the election manifesto of the administration especially the massive salary hike promised to state workers.
Analysts say retrospective taxes, which is a law that applies to the past, are among the worst types of violations of rule of law that a legislature of elected rulers, who control the police and the prisons, can impose on an unarmed citizenry who are like helpless serfs, however rich they are.
A billion rupee tax imposed on sports television stations believed to be targeted at a channel connected to the last regime which was set up with blatant state privileges also go against a fundamental principle of taxation, particularly in South Asia, which is the ability to pay.
"The Ruler should act like a bee which collects honey without causing pain to the plant," says the Mahabharata, a principle that has been articulated not only by Ved Vyas but also by Chanakya (Kautilya) in his work Arthashastra and has been followed by Sri Lankan kings as well.
Rule of Law
The very nature of rule of law is predictability. While ignorance of the law is not an excuse, no man can be subject to a rule that did not exist for him to follow in the first place. Economist and philosopher F A Hayek explained this succinctly in his work Road to Serfdom:
"Stripped of all technicalities [the rule of law] means the government in all its actions is bound by rules fixed and announced beforehand—rules which make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances, and to plan one’s affairs on the basis of this knowledge."
The new administration came to power promising to restore rule of law by reducing the arbitrary powers of the President and re-appointing a constitutional council to re-dress the arbitrary mis-use of the public service that was possible after an independent public service was destroyed.
The key tool of the executive presidency was the directly appointing ‘impermanent’ secretaries to ministries driving the last nail into the coffin of a previously independent public service and killing off the institution of permanent secretaries which was already hit by a constitution in 1971.
The impermanent secretaries are either completely servile to the ministers and have to do wrong things to remain in office or they are very powerful and act like ministers in arbitrary ways.
Critics say if there were permanent secretaries President Mahinda Rajapaksa would not have been able appoint his brother as defence secretary.
Minister Karunanayake promised a clean administration going forward.
"We are a responsible government and we want the economy to move, not in the hands of a few, open it for a clean operation to go forward," Karunanayake said.
"It is going to be an open government, there will be no necessity for one lot to be moving around the Finance Ministry, the Prime Minister or the President.
"When you look at it initially, I know some of the businessmen in the upper echelons have got a little concerned. But 98 percent of the country is extremely happy."