Viewpoint : Sujeewa Mudalige
Tax simplification has always aroused interest. This concept entails the simplification of the structure of the whole tax system or of one tax in particular, as well as the streamlining of administrative procedures in relation to taxpayer assistance, tax determination, assessment, collection and auditing.
Simplification in relation to income tax would require the design of as simple a tax structure as possible that is easily understood by both the taxpayer and the administration. This would give greater stability, as a simple system would imply few changes, imposing less burden on the taxpayers with reduced compliance costs.
In practice, however, taxation is not that simple. To some extent, complexity is unavoidable, because a tax system would cover a wide range of rules and regulations. It is often the case – particularly in a developing country such as Sri Lanka – that the tax system, primarily income tax, becomes complex over time. Much of this complexity arises from political decisions, following pressure for further relief and tax concessions based on economic and social considerations.
The Inland Revenue Act (IRA) – Law No. 10 of 2006 – and the preceding IRAs were complex primarily because taxation was used as an instrument to achieve economic and social goals rather than being related to the function of raising revenue. As a result, the tax laws were subject to frequent changes, commencing from 1951, designed to grant incentives in the form of tax holidays, preferential rates, relief and credits, as well as exemptions for specified institutions. Each concession added a further layer of complexity to the law.
The new IRA, Law No. 24 of 2017, departs from the earlier practice of granting relatively liberal tax exemptions and concessions. The new act grants only limited tax relief, in the form of investment allowances and accelerated depreciation, targeting investments based on their quantity. It is also noteworthy that these relief efforts are included as a schedule to the act under “Investment Incentives”, facilitating reference to this.
In the previous acts, the array of exemptions, relief and concessions were clogged up in the body of the act, causing some confusion. Of course, this is not something novel, given that the Value-Added Tax Act and Nation Building Tax Act incorporate the exemptions in their schedules. Another source of complexity in the previous acts was the multitude of corporate tax rates, which caused confusion and to some extent inhibited the functioning of the corporate tax system. The new act provides for a three-tier corporate rate schedule: a standard rate of 28%, a lower rate of 14% applicable to small and medium-sized enterprises, exports, agriculture, tourism, education and IT sectors, and a higher rate of 40%, applicable to firms dealing in betting and gaming, liquor and tobacco. A uniform tax rate would have been simpler and in line with standard international practices, but the three-tier structure reduces some of the complexity that has characterised the corporate income tax system.
The new act has also simplified expense deductibility rules. The previous act, while providing a general rule on deductibility of expenses in ascertaining profits or losses, list a range of deductible and non-deductible expenses in trades, businesses, professions or vocations. This tended to create ambiguity in applying the deductibility rules. The new act provides a general rule on deductibility of expenses – with the disallowance of capital expenses – and contains a very limited list of deductions made in calculating a person’s income. This simplification would ease the calculation of profits and income, and therefore be helpful for taxpayers.
It is accepted that a certain level of complexity in the tax law and administrative procedure is unavoidable, and that there must be a balance between the desired level of simplification and nuance. Law No. 24 of 2017 moves in this direction. However, once the new act comes into force, it is critical that frequent modifications are avoided, for, it is said, the worst enemy of simplicity in tax law is not complexity but instability.
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