• If taxes become unbearable, people will challenge their legitimacy
• Any tax system has to be based on the principle of capacity to pay
• People who want to pay tax may not even have the money to do so
• Post-economic crisis the entire landscape of taxation has changed
• Sri Lanka has had multiple crises, the worst being the financial crisis
• Taxation must encourage savings, investments; direct economic activity
• Basic needs and aspirations cannot be fulfilled for the multitudes
• SL has never got balance right between direct and indirect taxes

The current tax system is neither fair nor reasonable, asserted Gajma & Co. Senior Partner N.R. Gajendran, in an interview with The Sunday Morning, adding that any tax system had to be based on the principle of capacity to pay.

“It is very difficult to say it is fair and reasonable because it has become unbearable. What is important is, if the taxes become unbearable, the legitimacy of the tax will be challenged and questioned by the people,” he warned.

Apart from the impact on individuals – with people reduced to skipping meals and looking for alternatives in terms of consumption – he said that the current tax system would also see businesses turning away from Sri Lanka.

“Taxation is not merely revenue generation. It has to encourage savings and investments. It has to direct economic activity… This can’t go on for long because businesses have to make investments. Fiscal consolidation is important, but now we are hell-bent on only revenue consolidation.”

Commenting on whether Sri Lanka had got the balance right between direct and indirect taxes, Gajendran said: “We have never got it right and we will never get it right the way it’s going… In other countries, people pay income tax at 40-50% but they don’t grumble much because they see value for the money they pay. Here, there is a concern; if you ask people, they wonder why they should pay tax because of malpractice and corruption. That has to be corrected.”

Towards this end, with elections in the offing, he called on political parties to give an assurance that, to the best of their information and knowledge, their people standing for election were men and women of integrity.

Following are excerpts of the interview:

How do you view Sri Lanka’s current tax system, post economic crisis? Is it fair and is it feasible?

A democratic country needs revenue, because that’s the only way you can provide for some essential needs and satisfy the aspirations of the people – like education, healthcare, other facilities that have to be provided which the private sector will not embark on, and certain investments and expenditure which are mandatory for the government because others will not look at them.

Post economic crisis, the entire landscape of taxation has changed. There is no question about it. You don’t need any experts or protagonists to give their views because if you speak to the people, everyone is affected. Most media coverage is about taxes. That is because it has all come together and become unaffordable and unbearable.

We have had multiple crises, the worst being the financial crisis, which people say is even more severe than the conflict-related crisis we had, because this crisis made us bankrupt. After the crisis, the value of money depreciated almost instantly, to the point where the rupee depreciated by almost 80-100%. It was at around 180-200, then it was 360, and now it has come to 330. 

We are essentially an importing country. Most of our consumption goods, investment goods, and intermediate goods are imported. When the rupee depreciated, the value of money dropped. If people had Rs. 100,000 before the crisis, if you do the calculation and ignore the income taxes, it will be about Rs. 40,000 now.

Earlier you would have had only Value-Added Tax (VAT) at 8% and the effective rate would have been 4% because of exemptions and the high thresholds. You would have had Rs. 96,000 for consumption. Now if you had the same Rs. 100,000, some 20% or more would go for consumption taxes. Similarly, if you factor in the income tax, it was 18% for individuals and now it has become 36%. 

It has all come together and it is very difficult to say it is fair and reasonable because it has become unbearable. What is important is, if the taxes become unbearable, the legitimacy of the tax will be challenged and questioned by the people. 

Do you agree with the current income tax threshold or should it change and how? What do you see as being ideal?

Income tax is a progressive form of tax. Any tax system has to be based on the principle of capacity to pay.

In terms of the tax threshold, if you have an income of over Rs. 3.6 million a year – more than Rs. 300,000 a month – you are hitting 36%. Even up to Rs. 3.6 million, the tax is about Rs. 450,000. Unless or otherwise you are in the formal net, people who want to pay the tax may not even have the money to do so. The principle of capacity to pay is being impaired altogether. 

Of course the Government has its challenges; that is another matter we have to look into. There was a lot of expectation that the thresholds would be increased in Budget 2024. People who do odd jobs can earn Rs. 100,000 in certain months, but a lot of these jobs have been lost because Small- and Medium-sized Enterprises (SMEs) have been wiped out with the rupee depreciation. 

How to change and how much to change – I think certain people have analysed this and shown how the same amount of tax can be achieved with a different combination.

Do you feel that the Government is turning to taxation as an easy revenue generator? Won’t this drive away or discourage businesses and investors?

That’s an important question. Taxation is not merely revenue generation. It has to encourage savings and investments. It has to direct economic activity. This is fundamentally very important. Any investor – local or foreign – will look at what relief they get by investing in Sri Lanka. 

‘Exemptions’ has been a taboo word, but certain legitimate commercial expenditure has to be recognised and given expenditure-based relief. Look at Amazon – it had a profit of $ 10 billion, never paid any tax, and had a tax credit of $ 157 million. It came under a particular incentive scheme. 

Now here we are not saying that you have to give exemptions, but there must be expenditure-based relief for areas like people’s training, branding, going green, agro processing, and research and development. They say tax competition between countries is bad, but other countries are giving certain incentives. With this current system, there is no capacity to save. It doesn’t incentivise saving and investment. You have to first save to invest. 

When we were small, we were told that when we earn money, first we must invest, then we must save, and if we have any balance, we can spend. Now, when basic needs and aspirations cannot be fulfilled for the multitudes, there is no ability to save, leave aside investments. 

This can’t go on for long because businesses have to make investments. Even the larger businesses are trying to rebase themselves out of the country. Other countries are giving incentives. We have to relook at this. Fiscal consolidation is important, but now we are hell-bent on only revenue consolidation. 

Fiscal consolidation has two components; one is revenue and the other is expenditure. Expenditure has not been looked at much. We have 1.4 million Government servants; we have another 400,000-500,000 pensioners. We may be having two million people to serve 22 million people. But are the people satisfied with the services they get from State institutions? It’s a sad state of affairs.

Around three-quarters of the increase in tax revenue is expected from taxes on domestic goods and services. However, given the cost of living, domestic consumption will surely fall. In this backdrop, can the Government achieve its tax revenue targets? 

One factor is that consumption can fall and the other is that the economy can shrink. Even if consumption doesn’t fall and the economy doesn’t shrink further, people are going to look for alternatives when consuming. The tax on goods and services only in terms of VAT is being expected to raise about Rs. 720 billion in additional revenue in 2024. It’s going to be a tall order. 

If you’re talking about Rs. 720 billion in additional revenue, if you monetise that figure at 18%, it is about Rs. 4 trillion. Our economy is Rs. 31 trillion. Don’t forget that there are still so many indirect consequences because there are some 90 odd things being removed from the list of exemptions and being brought into liability.

If you take agriculture, for example, even though the output is exempt – primary produce is exempt – all inputs going in are VAT-able. That is going to add up. There is a need to relook at this; not to erode the tax base, but to relook, particularly from the expenditure side. 

In 2019/2020, we had about Rs. 2.9-3 trillion expenditure just before the crisis; this year it is going to be Rs. 7 trillion. We are a bankrupt country and we are still borrowing. The total borrowing for 2023 was about Rs. 5 trillion and in 2024 it is going to be about Rs. 7.5 trillion. 

At the moment we are having a situation of calm – there are no power cuts, queues for fuel, or shortage of medicines, but people don’t have medicines when they go to hospitals and there are no doctors or nurses to serve them. They are in a quandary. 

Has Sri Lanka got the balance right between direct taxes and indirect taxes?

We have never got it right and we will never get it right the way it’s going. Indirect taxes – which are easy to collect, being on turnover/the top line – are increasing. Direct taxes are on the bottom line so you have to go through revenue and expenditure. You have to get the mix right but that does not mean you should eliminate indirect tax and get everything from direct taxes.

In other countries, people pay income tax at 40-50% but they don’t grumble much because they see value for the money they pay. Here, there is a concern; if you ask people, they wonder why they should pay tax because of malpractice and corruption. That has to be corrected. 

This is going to be a tough year, an election year. I think one challenge that the media also can pose to political parties is to ask if the leadership of political parties can give an assurance that, to the best of their information and knowledge, their people who are coming forward and standing for election are not questionable people and that they are men and women of integrity.

Accountability has to be there. So many things are said before an election. That also has to be brought in. If we don’t deal with this malpractice, we are not going to come out of this problem.

At the current tax rates and given the cost of living, can people actually afford to eat if they pay taxes?

A few days ago I was in Dehiattakandiya. The people were saying that they need Rs. 50,000-60,000 per month to live but most of them can’t make that amount due to various reasons.

In families with two school-going children, for example, the elders are skipping meals – more than one meal, in fact. They will look for alternatives but it is a tall order for the lesser-privileged and the poorer segments, who are impoverished people. 

Do you see the Government following suit while calling on the people to make sacrifices for the sake of the country?

If you look at what is happening in the Legislature, the Parliament, don’t you feel ashamed? Can children look at parliamentary proceedings? They are supposed to be our leaders; the epitome of the Legislature. See how they behave and the larger-than-life life that they have. It looks like they are in a different world.

How do you view the introduction of the Taxpayer Identification Number (TIN) for everyone above the age of 18 and do you anticipate wide compliance?

This is causing a lot of issues. You are asking people over 18 years of age to register. Do you mean to say that all these people numbering several million can register? Do you mean to say that if you don’t register, the commissioner general can impose this Rs. 50,000 fine?

Say the people register and they are paying their tax, at least at the lower rung. We need Rs. 1.5-3 trillion to meet the shortfall; where do we get this?

In the early ’90s, our tax to GDP was about 22-24%. Now it has come down to 11%. Say you bring in all the people who are evading, say you bring in all the teachers and lawyers and doctors. The question is, can you bridge this 10%? Even next year they are saying we will be at 14% tax to GDP.

Our national economy is Rs. 31 trillion; 10% is Rs. 3.5 trillion, 5% is Rs. 1.5 trillion. If we have Rs. 1.5 trillion, we will be out of the woods. Where is this money? The media should ask. Where is this money?