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Tax Reforms

The comprehensive tax amnesty was a major success with over 50,000 declarations received, which is more than 10 times the number received under any previous amnesty. The Revenue Authority, being established to take over the Inland Revenue, Customs and Excise Departments will strengthen the process of tax administration in a systematic and fair manner, broaden the tax base and increase revenue collection.

Economic Service Charge

There are around 32,000 registered companies in the country. Less than 9,000 of them filed income tax returns for the year 2001/ 02 and just 2,850 of them paid income tax. In other words, less than 10% of the companies in the country pay income tax while the rest, who also use the same infrastructure and other services provided by the Government, make no contribution whatsoever towards meeting the cost of these services.

This also applies to other forms of businesses such as partnerships and sole proprietorships. We cannot permit this state of affairs to continue. Every business must make some payment towards Government revenue collection, even if the amount is small. We cannot place greater burdens on businesses that already pay tax.

Therefore as a transitional measure to achieving a ratio of income tax to GDP that is comparable to that of other countries. It is proposed with effect from April 1, 2004, to impose on all entities carrying on any trade, business, profession or vocation that have a turnover in excess of Rs 20 million or total assets in excess of Rs 10 million and which have been in commercial operation for more than two years, an Economic Service Charge (or ESC) of 1%, payable on turnover or total assets. Each business will be permitted a one time choice of whether the 1% ESC should be applied to turnover or total assets.

The ESC can be set off against income tax payable for the year, limited to the full amount of tax payable without any carry forward provision. The minimum ESC payable by an entity which is liable to this charge will be Rs 100,000, and the maximum amount payable will be Rs 20 million. A request will be made to BOI companies to submit to the ESC from 2005/ 06 as a measure of fairness in view of their enjoying the same infrastructure and other Government services in conducting their business.

We expect to collect Rs 3,000 million in revenue during 2004 with the introduction of this Economic Service Charge.

Personal Income Tax

The tax free allowance for individuals will be increased to Rs 300,000 from the present Rs 240,000 and the subsequent tax slabs broadened.

The tax slabs for terminal benefits from all such benefits will be expanded so that the first Rs 3.5 million will be free of tax.

Details of these two measures, which will substantially reduce the tax burden on individual tax payers and retirees.

These measures are estimated to reduce revenue by Rs 300 million.

Value Added Tax

At present, VAT is charged at two rates of 20% and 10%. Seventy percent of the revenue collected by the Government from VAT comes from the 20% band, which includes a large number of items that are consumed by the average consumer. The high rate of 20% is, in some cases, a cause for tax evasion. Furthermore, the dual rate distorts prices in the economy and creates problems relating to VAT collection and refunds.

The drop in revenue collection in 2003 is largely attributable to complications caused by the two band system. The upper rate of 20% and the dual band system acts as a deterrent to growth in the business and industrial sectors.

Therefore, from January 1, 2004 we will move to a single unified VAT rate of 15%.

The turnover threshold of Rs 500,000 per quarter for payment of VAT will be raised to Rs 750,000 per quarter and the annual threshold will be increased to Rs 3 million. Certain changes will be introduced in the present refund system to simplify administration.

The new unified VAT rate will result in price changes, with the majority of items reducing in price.

A publicity campaign will be launched to inform consumers, traders and retailers of the need to bring down prices in line with the reductions in the upper VAT rate from 20% to 15%.

With increased compliance resulting from the lowering of the upper band and the elimination of problems relating to VAT refunds, the Govern- ment expects to collect Rs 2,000 million in additional revenue.

I have been particularly mindful of ensuring that the resulting increase of the lower band from 10% to 15% will not increase the cost-of-living. A detailed analysis has been done. Many essential items are exempt from VAT.

Hotel Room Tax

We had previously intended to introduce a hotel room tax of 10% of the room charge for all hotels classified as 3 stars and higher by the Ceylon Tourist Board. However, because of the large negative impact on the sector due to the recent political actions we have now decided to defer the imposition of this tax.

Levy on Cellular Mobile Subscribers

We are currently faced with large revenue leakages from the non payment of VAT on mobile cellular phones. An annual levy of Rs 300 per mobile phone subscriber will be imposed instead of VAT on the purchase of mobile phones, starting January 1, 2004. VAT will continue to be payable on the cost of calls.

It is estimated that the revenue yield in the first year will be Rs 600 million with increasing yields expected from the anticipated rapid growth of mobile telephony.

Withholding Tax

Commencing January 1, 2004 the present exemption limit of Rs 9,000 per month or Rs 108,000 per year for withholding tax on interest income per deposit will apply to the total interest income from all deposits in any individual bank or financial institution made by a person or a corporate entity.

However, the withholding tax free limit will be raised to Rs 25,000 per month or Rs 300,000 per year in aggregate from all deposits of individuals whose sole or main source of income is interest from deposits.

Such individuals must obtain a direction from the relevant Government authority for this purpose.

This measure will assist pensioners from January 1, 2004.

Commencing April 1, 2004, a 10% withholding tax will be levied on any annuity or royalty paid by any person or partnership in excess of Rs 50,000 in any month or Rs 500,000 in any year and a 5% withholding tax on any management fee or similar payment.

This withholding tax can be set off against the final liability to tax of the recipient. The proposed changes in withholding taxes are estimated to increase revenue by Rs 500 million.

Tax Administration and Compliance

In order to widen the tax net and improve tax compliance I propose to introduce the tax administration and compliance measures listed in Annex 4, which includes measures relating to VAT. This will result in Rs 400 million in additional revenue.

Increase in Pensions

It is only fair and just that pensioners be included in any revision in public sector salaries. Therefore pensioners will be granted a 10% increase in pensions from January 1, 2004. This is the largest increase granted to pensioners during the past 10 years.

This increase will cost the Government Rs 2. 5 billion.

Further, the recently set up Pensions Reform Office is presently studying various options to address anomalous situations where persons who have been retired for many years receive substantially smaller pensions than lower grade employees who retire later, because of salary scale changes that have occurred since the retirement of the first group.

Increase in Salaries of Public Officers

The Tissa Devendra Commission report published in mid- 2002 carried out a detailed review of the public service salary structure and related issues. The trade unions and the opposition have been calling for the implementation of the recommen- dations in the report. Budgetary constraints, however, did not permit this. With the improvement of the economy we are now in a position to do so on a phased basis during the coming three years.

As part of this process, I will be appointing a Salary Review Committee to review the recommendations in the Devendra report to rationalise and amalgamate salary scales and to enhance selected scales because of anomalies or changes in circumstances. The Committee will also study options for rationalisation and closure of government entities. Its recommendations will be proposed for implementation with the next budget.

Meanwhile, commencing January 1, 2004 the Government will grant every public officer a monthly increase of 10% of his present salary or Rs 1,250, whichever is higher. This will also apply to employees of the Police Department, the armed forces and corporations.

Further benefits will follow in 2005 and 2006.

The Rs 1,200 interim allowance granted in 2000, and the Rs 1,000 or 10% of salary interim allowance granted in 2001, will be incorporated into the base salary of each scale by 2006. With this incorporation, lower level public sector employees will be on salary scales substantially higher than those recommended in the Devendra report. Consequently their pensions will also be higher. The higher increments recommended in the Devendra report will also be introduced by 2006, in stages.

The rate of movement to the full Devendra scales will be subject to the condition on voluntary retirement that I will speak of shortl.

Where public sector or corporation employees in any individual subsector have been granted increases in salaries or allowances during the past three years, beyond the allowances granted to all public officers in 2000 and 2001, these increases will be set off to calculate the additional monthly amounts to be paid to such employees during 2004, 2005 and 2006. This process will eliminate the differences that have arisen between the salaries of such employees and public sector employees as a whole.

The cost of the 2004 salary increase is estimated to be Rs 12. 5 billion.

Voluntary Retirement Scheme

We do not intend to implement the 30% reduction in the lower and middle grades of the public sector recommended in the Devendra report without a suitable safety net, since there will be hardships due to the resultant high unemployment. To overcome this problem we will introduce a Voluntary Retirement Scheme, or VRS, on January 1, 2004 with a suitably designed staggered compensation package which ensures that employees who accept the VRS will continue to receive monthly ex- gratia payments equivalent to their salaries and allowances.

An employee accepting the VRS will receive an up front payment equal to one year's remuneration, consisting of the retiring salary and the 2000 and 2001 allowances. The employee will also receive monthly payments equal to his salary at retirement plus the 2000 and 2001 allowances until he reaches the retirement age of 55 years. Thereafter he will receive the applicable pension.

Employees will also be relieved of Rs 24,000 of outstanding distress loans at the time of retirement. Any balance outstanding on loans will be recovered from future monthly payments, with a one year grace period without deductions. Employees with no distress loans or loans less than Rs 24,000 will be paid equal monthly payments over two years so that they enjoy the same total benefit as those whose loans have been written off.

Our target is to reduce 100,000 public sector employees by 2004 and a further 200,000 by 2006 from the lower and middle income grades.

Numerous indirect savings will accrue to the Government as a result.

The cost of the up front payment for the staggered compensation package is estimated to be Rs 8 billion, of which Rs 2 billion is already included in the voted budgetary estimates.

Enhancement of Interest Rates on Deposits by Senior Citizens

In view of the difficulties faced by retirees and senior citizens because of the reduction in deposit interest rates, special deposit schemes have been introduced through the National Savings Bank and the two state commercial banks for senior citizens, where such persons receive a higher rate of interest on deposits.

Unemployment Benefit Insurance Scheme

The Government will provide Rs 1,000 million as initial funding for an unem- ployment benefit insurance scheme to be set up during the coming year. When fully operational the scheme will be funded by contributions from employers and employees.

Housing Loan Scheme for Public Sector Employees

A loan scheme for public servants, in addition to the existing scheme, will be facilitated by the Government through the National Savings Bank for the purpose of construction, purchase, extension or repair of a house, purchase of land to build a house, or to repay a loan obtained from a recognised financial institution for housing purposes. The maximum loan available will be Rs 1 million, the interest rate 9.5% per annum, and the repayment period a maximum of 20 years. Instalments for repayment will be recovered from the salaries and remitted to the Bank.

Increase in Fertilizer Subsidy

It is proposed to increase the subsidy given to fertilizer from Rs 2,000 million to Rs 3,000 million from January 1, 2004. This will mean that the total subsidy on a bag of Urea will increase from Rs 300 to Rs 450. Rs 3,000 million is the largest fertilizer subsidy granted in the last decade.

Agricultural Loan Relief for Farmers

The two state banks have, at the request of the Government, already instituted a scheme whereby farmers who have obtained loans from these banks for agricultural purposes and found it difficult to repay these loans due to crop failures and other valid reasons will be granted relief by the banks. Under the scheme farmers will be able to reschedule their loans for repayment over six growing seasons and the interest rate on the rescheduled loans will be a very attractive 4% per annum.

Garment Sector Productivity Improvement

A garment sector productivity improvement project will be implemented in 2004 through the Joint Apparel Association Forum. This will include a grant towards an inter- national campaign to promote the industry and an interest free loan for the training and development of production staff. The cost of this project is Rs. 150 million.

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