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TAX NEWS - JUNE 2010

Sri Lanka Tax: Tax Cuts A Bonanza For The Rich

On June 1 2010, Sri Lanka government announced the welcome news of a slash in taxes for all imports. In addition to removing the surcharge of 15 % levied on all imports, electronic items have further received a tax cut of an additional 10%. Taxes levied on vehicles have been cut by up to 50%.

The tax cuts are part of the government's efforts at simplifying the tax system to widen the country's tax infrastructure and boost revenue. This comes after IMF requirements of fiscal reforms were made clear in order for the release of the third tranche of the IMF credit facility. But fears have already been expressed of inflation, driven by demand led spending lifting its ugly head. The rupee could also get devalued further based on increased demand for US dollars. There are also doubts as to how far retail demand and the use of state funds can drive up a market before a correction takes place. Already however, investment in the stock market has increased and it remains to be seen how solid a commitment foreign investors will make in leading firms.

Speaking to The Sunday Leader, leading economist Dr. Harsha De Silva said 'The current tax cuts are a part of the government's efforts to manipulate the level of taxes in order to increase revenue and reduce the budget deficit in time to receive the IMF credit facility'. Speaking based on the Lasser Curve, De Silva went on to add that 'the level of taxes levied on motor vehicles had reached an exorbitant amount, resulting in strong discouragement of vehicle imports. This was doing more harm to government revenue than good, since a reduction in taxes would result in more imports.'

The government also has the recommendations of the taxation commission to deal with. The IMF has instructed the government to look at simplifying and standardising the country's vastly complicated tax infrastructure in accordance with the findings of the commission.

The slash in taxes has had an impact on the stock market almost instantaneously. The day after the tax cuts were announced, turnover of the Colombo Stock Exchange reached Rs. 9.6 billion ($84 million); the highest since a record high turnover on April 1, 2008. The All-Share Price Index hit an all time high of 4,321.23 points, surpassing its previous high of 4,281.97 on May 21. It closed 41.59 points, or 0.98 percent firmer at 4,300.39. The market is up 27% so far, making it Asia's best performer. Meanwhile share prices of motor companies have skyrocketed, by normal standards.

In another twist, a ship carrying 400 used Japanese vehicles landed at the Colombo harbour on the 3rd of June. These vehicles, almost all purchased by leading car retailers in Sri Lanka, were all imported from Sterling Japan, a Japanese vehicle exporting firm. The sheer number of the exports has led customs officials to believe that these vehicles were brought down with prior knowledge of the tax cuts.

Considering that for the whole of last year, only almost 300 brand new vehicles and under 500 used vehicles were imported, the notion of anyone importing up to 400 vehicles in one go strikes somewhat of an absurd note. Especially when you consider the fact that the process of importing must be initiated at least a month in advance.

The reduction in taxes is yet to fully translate into reduced prices for consumers closer to the bottom of the pyramid. As yet, the reforms are largely seen as a tax reduction for the rich. Motor cycles, a form of transport used by a large majority of small to medium enterprises have not received any tax breaks while three wheelers have received up to 41% in the same. The effects of this change in the used car market will be telling, with current owners seeing the value of their vehicles decrease. On an overall basis, this piece of tax reform is seen as a positive move towards a more market oriented economy.
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