Opinion: Are Tax Concessions Really the Best Way to Attract Investment to Sri Lanka?

By Advocata Institute

Attracting foreign investment is a priority for Sri Lanka as it seeks to strengthen growth, create jobs and expand exports. Yet the growing reliance on tax concessions deserves reconsideration. Preferential tax treatment can encourage some investments, but it carries a fiscal cost, creates disparities between businesses and does not guarantee the benefits governments expect.

Tax concessions are revenue foregone that could fund public services and infrastructure or reduce borrowing. They also tilt the playing field towards selected businesses. The central question is not how much investment a concession attracts, but whether that investment would have come anyway and whether the benefits justify the revenue forgone.

Strategic Investments Still Need to Justify Their Tax Benefits

The Colombo Port City illustrates these concerns. It already enjoys significant locational, infrastructural and regulatory advantages, including proximity to Colombo’s financial districts, modern infrastructure, planned airport expressway connectivity and a more flexible labour framework. Additional tax concessions on top of these raise questions about necessity and justification.

Concessions to port terminal operators also warrant scrutiny. Sri Lanka’s location on major East-West shipping routes is its ‘oil in the ground’, and the Port of Colombo has been an established maritime hub for over a century. Granting terminal operators tax holidays of up to 25 years raises the question of whether the country is capturing the full value of its strategic location.

Colombo West International Terminal (Pvt) Ltd, which operates the West Container Terminal, received a 25-year corporate income tax exemption under the Strategic Development Projects Act through a government-to-government arrangement rather than an open tender. Colombo International Container Terminals (CICT), which operates the South Terminal and was chosen through competitive tender, also enjoys a 25-year tax holiday. Private investment and expertise are valuable, but the government must ask whether the scale and duration of these concessions are proportionate, given that modern port operations are highly automated and generate limited direct employment.

Tax concessions should not be granted simply because an investment is large. The government must establish what additional benefits it will generate and whether they justify the fiscal cost.

The Long-Term Costs of Generous Investment Incentives

Generous incentives granted under earlier regimes can create lasting advantages for beneficiary companies. Long-standing concessions under Section 17 of the Board of Investment (BOI) Law, with tax-free periods followed by extended preferential rates, illustrate this.

According to their financial statements, Overseas Realty (Ceylon) PLC, Dialog Axiata PLC and Mobitel (Private) Limited received 15-year tax exemptions under BOI agreements signed in 2005, 1997 and 1994. After these expired in 2020, 2012 and 2009, each became eligible for a 2% tax on turnover for a further 15 years. These arrangements end in 2035 for Overseas Realty and 2027 for Dialog, while Mobitel’s expired in 2024.

Such investments may generate wider benefits through employment and related activity, but these must be weighed against the scale and duration of the relief. Long-term concessions should not continue by default and should be reviewed periodically to confirm that the intended benefits have materialised.

Selective concessions for real estate raise similar concerns. Havelock City (Private) Limited received a 15-year income tax exemption under a 2016 BOI agreement, while many other commercial developments proceeded without one. Several residential developers in the Port City, including Prime Melwa Port City (Pvt) Ltd, Home Lands Port City (Pvt) Ltd, Marina Hotel Holdings (Pvt) Ltd and ICC Port City (Pvt) Ltd, have received substantial exemptions and incentives unavailable to comparable projects elsewhere. This disadvantages competitors and raises questions about the criteria for qualifying.

The concern is sharper where incentives support luxury developments that largely cater to wealthier buyers and rely heavily on imported materials and fittings. With Sri Lanka needing to strengthen its external position, the government should ask whether import-intensive property is the best use of tax concessions, judging cases by their employment, foreign exchange earnings and economic linkages rather than the scale of investment.

More broadly, differential tax treatment distorts resource allocation. Capital and labour should flow to where they generate the greatest returns to society, but preferential rates raise the after-tax returns of favoured activities relative to others, even when they are not the most productive. The wider the variation in effective tax rates, the greater the inefficiency.

The Port City BPO (Private) Limited received a 25-year tax holiday for an initial investment of USD 500,000, with a commitment to create 2,500 jobs within five years. Employment is an important justification, but it matters whether these jobs go to the domestic workforce. Recent reports that over 14,300 foreign worker visas have been issued under the Port City framework raise questions about who benefits. This highlights the need for greater transparency and monitoring by the Colombo Port City Economic Commission (CPEC) to ensure commitments are met. A 25-year exemption for a modest initial investment requires clear justification, and the resulting domestic employment, investment and economic activity must be proportionate to the revenue forgone.

The Inland Revenue Act also provides a 150% enhanced capital allowance for investments exceeding USD 3 million, rising to 200% in the Northern Province. Although intended to encourage capital formation, this may favour capital-intensive projects without generating much employment, as with renewable energy investments in the North, where natural solar and wind advantages can attract substantial capital but create few direct jobs.

Sri Lanka should move towards a more targeted framework that rewards measurable outcomes. For example, tax credits could encourage net job creation, employee training and the recruitment of underrepresented groups, particularly women, aligning incentives with broader development and labour market goals.

Changing Global Tax Rules Strengthen the Case for Reform

Changes in the international tax environment strengthen the case for reform. Under Pillar Two of the OECD/G20 Base Erosion and Profit Shifting (BEPS) framework, large multinational groups with annual consolidated revenue of at least €750 million face a 15% global minimum effective tax rate. Where eligible companies pay lower effective rates in countries such as Sri Lanka, another jurisdiction may collect the difference as additional tax. Some concessions may therefore no longer deliver their intended benefits to the countries offering them.

Sri Lanka should therefore compete on fundamentals: policy stability, efficient public services, reliable infrastructure, a skilled workforce and predictable regulation, rather than preferential tax treatment.

This does not mean tax incentives have no role. They should be reserved for clear market failures that prevent socially beneficial investment. For instance, airport infrastructure in an underdeveloped area can support tourism, hospitality and related industries even if direct financial returns alone would not attract private investors. In such cases, support may bridge the gap between private and social returns. The form of support matters, however. Direct grants or tax credits with defined limits are preferable to broad concessions that can cause substantial, open-ended revenue losses. Tax concessions should be considered only after assessing whether a market failure exists and whether a more targeted, fiscally predictable alternative could achieve the same goal.

Strengthening the Governance of Tax Incentives

Sri Lanka also needs stronger institutional oversight of how incentives are designed, approved and monitored. The IMF’s 2024 Governance Diagnostic Assessment recommends that the Department of Fiscal Policy play a central role in evaluating and guiding incentive design. Institutions such as the Board of Investment and the Colombo Port City Economic Commission may be better placed to assess commercial potential, but the fiscal implications of their decisions must be considered within the government’s broader revenue priorities.

International experience offers examples. The Philippines has progressively reformed its framework through the Tax Incentives Management and Transparency Act of 2015, the CREATE Act of 2021 and the CREATE MORE Act of 2024. These provide central oversight through the Fiscal Incentives Review Board, cost-benefit analysis in approvals, and reporting requirements under which beneficiary firms disclose incentives received and outcomes such as investment, employment and exports. This makes fiscal costs and economic results visible and enables evaluation of whether incentives deliver.

Ultimately, success should not be measured by the volume of capital entering the country or the number of businesses receiving concessions, but by the quality of investment and its contribution to productive employment, productivity, technology transfer and broader economic activity. Sri Lanka needs an incentive framework that is transparent, targeted, time-bound and regularly evaluated, with clear evidence that the benefits outweigh the fiscal costs.

The objective should not be to offer investors the most generous tax concessions, but to create an environment in which investing in Sri Lanka is attractive even without them.