Taxing Problem

June 18, 2006 (LBO) – Sri Lanka’s financial sector has been a favorite target of fiscal authorities during the past few years. In addition to an increase in the income tax rate, the sector also has a debit tax on cheque transactions, a turnover tax on credit cards, and another income tax based tax called the financial sector Value Added Tax (VAT).

The so-called financial VAT which has hit small banks hardest.

Some banks now have effective tax rates as high as 60 percent, which is undermining capital generation and could be a potential source of banking sector instability in the future.

The Money Report’s Shehara Jayasinghe spoke to Fitch Ratings’ Banking Sector Analyst, Gerard Wickrema to find out more about the issue.

Q: Banks, in theory, pay 35 percent on tax. How high is this rate?

A: If you look at the trends for the six largest banks, it has gone from about 27 percent in 2003, – effective tax rates – to around 45 percent in 2005.

This is largely because there are two components of tax; one is the financial VAT on financial services, the other is the corporate income tax.