ECONOMYNEXT – Sri Lanka has halted giving tax breaks under the Port City Act and the Strategic Development Project Act and pledged to amend the laws to define rule-based criteria and reduce the length of tax holidays, under an International Monetary Fund program.
The SDP Act in particular had come under fire for alleged corruption in negotiating a long tax holiday. Unusually it also gave tax free salaries to key executives, while persons earning over 100,000 rupees were paying income taxes elsewhere.
The SDP Act will be amended by August 2025, under a program structural benchmark.
The Port City Act will be changed by October 2025, ” in consultation with IMF staff, to introduce transparent, rules-based, best-practice aligned eligibility criteria for time-bound incentives.”
”'[U]nchecked and overly generous tax exemptions have been detrimental to Sri Lanka by foregoing too much tax revenue and were one of the causes of the crisis,” the IMF report said.
“A tax exemptions framework should give reasonable incentives for foreign investment but cannot substitute for labor, legal, governance, land, and other reforms to provide a welcoming and stable investment environment.”
Sri Lanka has high corporate tax rates (30 percent plus) compared to rates in dollarized East Asian nations (Cambodia 20-pct) or countries with monetary stability (Vietnam 20-pct, Thailand 15-pct) and currency boards (Hong Kong 16.5 percent, Singapore 17 percent, Brunei 16.5-pct no personal tax, Macau 12-pct) due to lack of currency crises from ‘independent’ central banks with aggressive ‘monetary policy’ which de-stabilizes state finances without war.
Taxes are raised in an ad hoc manner under IMF stabilization crises after each currency crises triggered by narrowly targeting a policy rate.
People who were expecting a ‘peace dividend’ after the end of a war, ended up with high taxes and collapse of the currency from 113 to 360 (now 300 under deflationary policy) and default from the mid-corridor and potential output targeting instead, critics say.
Analysts have called for restraints to be brought into monetary policy discretion of the central bank (a true ‘Constitution’ to restrain the agency and reduce its ‘flexibility’ to print money and slam high inflation targets on the public under central bank independence) so that ad hoc tax hikes under IMF stabilization crises are avoided.
Currency crises separately also scare away investors, as the central bank imposes exchange controls instead of allowing interest rates to go up temporarily to maintain exchange rate credibility and avoid offsetting interventions with printed money to target the policy rate.
In Sri Lanka the exchange ‘rate as the first line of defence’ (and interest rate as the last line) triggered capital flight and caused social unrest and strikes and has been a recurring feature especially after large volumes of money was printed to target a mid-corridor/single policy rate from 2015, effectively abandoning a scarce reserve regime, analysts have pointed out.
”'[U]nchecked and overly generous tax exemptions have been detrimental to Sri Lanka by foregoing too much tax revenue and were one of the causes of the crisis,” the IMF report said.
“A tax exemptions framework should give reasonable incentives for foreign investment but cannot substitute for labor, legal, governance, land, and other reforms to provide a welcoming and stable investment environment.”
Though a commitment was given earlier not to give new exemptions, Business of Strategic Importance (BSI) designations granting tax exemptions to 24 companies (four as Primary Businesses, three as Duty Free Businesses, and 17 as Secondary Businesses) were gazetted without consulting IMF staff, Sri Lanka admitted.
Considering the legal and reputational risks, the authorities will approve the project and they will not be reversed.
The Port City, which is dollarized like Cambodia and is expected to have monetary stability unlike the rupee mainland area, however is competing with currency-board-like regimes like Dubai which has 9 percent corporate tax and n a threshold. Small firms and startups (about 30 million rupees in profits) are exempt.
There are however fears that mainland firms may shift to Port City, leading to a leakage of taxes. But some Sri Lankan businesses are setting up offices in Dubai in any case, according to anecdotal evidence due to high taxation, monetary stability and exchange restrictions.
Sri Lanka has pledged to provide monthly information on recently provided tax exemptions to the IMF.
“Upholding these commitments will be crucial in demonstrating the authorities’ dedication to enhancing the tax exemptions regime,” the IMF said. (Colombo/July04/2025)
