Tax Guide for US Expats Living and Working in Sri Lanka
Who Is Liable For Income Taxes in Sri Lanka
Resident individuals are taxed on worldwide income. Resident employees earning remuneration from employment exceeding Rs. 600,000 are subject to income tax. Non-residents are taxed on income derived from Sri Lanka only.
Individuals are considered resident for tax purposes if they are present in Sri Lanka for more than 183 days in a tax year. A resident guest and a dual citizen are subject to tax only on income derived in Sri Lanka.
Income subject to tax. The taxation of various types of income is described below. For a table outlining the taxability of income items.
Employment income. Taxable compensation includes any wages, salary, allowance, directors’ fees, leave pay, pension, shares of a company received through a share option scheme (see below), or similar compensation, as well as the value of any benefits given to an employee (or to his or her spouse, child or parent), directly or indirectly, in money or in kind. Taxable benefits and payments include travel and entertainment allowances, taxes borne by the employer on behalf of the employee, the personal use of a company- provided automobile, the value of housing provided by the employer and payments for medical expenses.
The value of the benefit to the employee from the allotment or the grant of the shares (that is, the exercise of the option and transfer of ownership of the shares to the employee) is taxable as employment income. The taxable amount equals the fair market value of the shares on the date of exercise of the option less the amount paid by the employee for the shares, if any. Effective from 1 April 2011, the exemption granted to employee share option schemes approved by the Commissioner General of Inland Revenue is withdrawn. Certain travel benefits, such as the value of benefit from a motor vehicle provided by the employer or an allowance not exceeding Rs. 50,000 instead of the provision of a motor vehicle are not taxable, effective from 1 April 2011. The cost of passage for non-citizens with respect to employment duties is also not taxable.
Effective from 1 April 2011, amounts received from approved or regulated provident funds as terminal benefits from employment are exempt from income tax.
Effective from 1 April 2011, the employment income of government-sector employees is taxable, except for the following items:
- Pensions or retirement benefits
- Benefit from a motor vehicle provided by the employer or an allowance up to Rs. 50,000 per month instead of a motor vehicle
- Rental value of an official residence provided by the government
Directors’ fees not included in payroll are subject to withholding tax at rates of 10% and 16% on payments less than Rs. 25,000 per month and exceeding Rs. 25,000, respectively.
Compensation derived by certain government employees, diplomatic representatives and officials employed by international agencies such as the United Nations is exempt from tax.
Compensation earned by resident individuals in foreign currency for duties performed abroad is exempt from tax if the funds are remitted to Sri Lanka.
Income earned by individuals and partnerships for services rendered in or outside Sri Lanka to persons outside Sri Lanka is exempt from income tax if such income is remitted to Sri Lanka less reasonable expenses. If such exempt income is invested in treasury bonds denominated in foreign currency, a duty concession of up to 25% on the import of a vehicle by the professional is granted. This concession also applies to Sri Lankan professionals living overseas who invest foreign currency in treasury bonds.
Emoluments earned by a resident individual from employment on a ship that is owned or chartered by an offshore-registered company or that is deemed to be a Sri Lankan ship under the Merchant Shipping Act is exempt from income tax.
Income earned in foreign currency by a resident individual from services rendered outside Sri Lanka in carrying out a construction project is exempt from income tax if such income less any reasonable expenses are remitted to Sri Lanka through a bank.
Income from employment under “qualified persons” received by “qualified individuals” in foreign currency is taxed at a concessionary rate of 20%. In this context, “qualified persons” are persons or partnerships whose profits are exempt from income tax under Section 13 (ddd) of the Inland Revenue Act.
Payments made to government employees for emergency or priority services or special tasks are exempt from income tax.
Employment income resulting from participation in an international event in Sri Lanka by a noncitizen is exempt from income tax.
The employment income of pilots who are citizens of Sri Lanka is taxed at a concessionary rate of 20%.
Income of noncitizen artists and entertainers is subject to tax at a rate of 12%.
Self-employment and business income. Individuals deriving profits from any source of self-employment or business income, other than profits of a casual and nonrecurring nature, are subject to income tax.
Self-employment or business income, which consists of income from a trade, business, profession or vocation, is subject to tax at the rates. Taxable income consists of net income after deducting certain expenses.
Partnerships are taxable on their distributable profits and other income at a rate of 8%. The partnership tax is payable on the excess of Rs. 600,000 of the divisible profits. The individual partners can claim a credit for their pro rata share (based on the profit-sharing ratio) of the income tax and Economic Service Charge (see Section B) paid by the partnership against their individual income tax liabilities.
Agriculture, including primary processing income, is taxed at a maximum rate of 10%. Income derived from manufacturing of animal feed, promotion of tourism, livestock and construction is taxed at a concessionary rate of 12%.
Income from the provision of educational services is taxed at a maximum rate of 10%.
Income from a business carried on for storage, software development and supply of labor is taxed at a maximum rate of 10%.
Fifty percent of profits and income derived from sales or any other transactions with respect to a book written by an individual is exempt from income tax for a one-year period beginning with the date of first publication.
Fifty percent of the profits and income derived from the production of a drama is exempt from income for a one-year period beginning with the date of the first public performance.
Profits and income derived from a song or musical composition derived by the lyricist, the composer or the singer is exempt from income tax.
Investment income. Interest (if tax has not been withheld), royalties and rental income are included with other taxable income and are taxed at the rates.
Rental income earned by an owner of a residential house with a floor area of at least 1,500 square feet (139.35 square meters) is exempt from income tax for five years, beginning with the year in which construction is completed, if the construction is completed before 1 April 2008. If the floor area of the house is less than 1,500 square feet, the duration of the exemption is increased to seven years. For a residential house completed after 1 April 2008, rental income is exempt for five years if the floor area is less than 500 square feet.
Interest income accruing from money deposited in a Treasury Bond Investment External Rupee Account is exempt from income tax.
Certain items of investment income are not included in an individual’s taxable income.
Dividends paid by a resident company to individuals are subject to a 10% withholding tax, which is considered a final tax.
The withholding tax rate on interest paid by banks and financial institutions to individuals varies according to the amount of annual assessable income declared by the individual to the bank or financial institution.
If no declaration is made, the withholding tax rate is 8%. This is the final tax on such interest.
A final withholding tax at a rate of 10% is imposed on interest income from corporate debt securities at the time of issuance of the security. The issuer must estimate the interest component that would accrue on the debt security and withhold the 10% tax up front at the time of issuance.
Interest income up to Rs. 500,000 that accrues to a resident individual over 60 years of age from deposits made into a special deposit account in a state bank is exempt from income tax.
Interest or discounts arising or accruing to any nonresident citizen of Sri Lanka on the purchase of Motherland Development Bonds denominated in foreign currency issued by the government of Sri Lanka is exempt from income tax.
Interest or discounts on Sri Lanka Development Bonds denominated in U.S. dollars, which are issued by the Central Bank of Sri Lanka, is exempt from income tax.
Interest or discounts on sovereign bonds that are denominated in foreign currency and issued on or after 21 October 2008 by the government of Sri Lanka to nonresident persons is exempt from income tax.
Dividends and interest on investments made outside Sri Lanka are exempt from income tax if such income is remitted to Sri Lanka through a bank.
Royalties paid to nonresidents are subject to a 15% withholding tax. The withholding tax rate for interest generally ranges from 10% to 20%. These rates may be reduced by applicable tax treaties.
Profits and income derived from the sale of sovereign bonds by nonresident persons are exempt from income tax.
Profits and income derived from the sale of Sri Lanka Development Bonds are exempt from income tax.
Deductions
Deductible expenses. Deductible expenses are limited to bad debts, including unpaid salary.
Personal deductions and allowances. The total statutory income of an individual for a year of assessment consists of total profits and income from all sources, after deducting allowable expenses.
In calculating taxable income, deductions from statutory income are permitted for annuities, rent, royalties and interest (restricted to interest on housing loans and business loans) and certain other amounts, including the following:
- A tax-free allowance of Rs. 500,000 (also applicable to nonresident citizens).
- An additional tax-free allowance of Rs. 100,000 if the only source of income is employment income.
- An allowance for qualifying payments, which is limited to Rs. 75,000 or one-third of assessable income, whichever is lower. Qualifying payments for individuals include certain approved investments and life and medical insurance premiums.
- Approved donation relief, limited to donations made to charities established for the provision of institutionalized care for the sick and needy.
- Insurance premiums paid under special insurance policies covering incurable diseases (excluding such premiums paid outside Sri Lanka for policies issued outside Sri Lanka).
- The amount of principal repaid on an approved housing loan or expenditure from the taxpayer’s own funds to purchase or construct the taxpayer’s first house after 1 April 2001, subject to a limit of one-third of assessable income or Rs. 100,000, whichever is lower. Excess amounts may be carried forward for nine years. The relief is limited to expenditure incurred before 1 April 2011.
Deductions of annuities, royalties and interest on housing loans are not allowed with respect to employment income.
No qualifying payment relief is granted with respect to employment income.
Relief for losses. Losses from a trade, profession or vocation (other than a loss carry-forward) may be deducted from statutory in come. A business may set off loss carry-forwards and losses incurred during the current year, against the total statutory income, subject to a limitation of 35% of the total statutory income in that year, and the balance may be carried forward indefinitely.
Capital losses were abolished, effective from 1 April 2004.
Losses generated through intragroup transactions that have no economic substance are disallowed.
B. Other taxes
Transfer tax on immovable property. Transfer tax at a rate of 100% is imposed on transfers by noncitizens of immovable property, except for apartments above the fourth floor in a condominium property (paid for by inward remittances of foreign currency), land for housing in excess of 100 units, hospitals and large-scale infrastructure projects and other items specifically exempted in an order published in the Government Gazette. The tax base is the sales price. Individuals residing abroad who were previously citizens of Sri Lanka and who invest in Motherland Development Bonds are also exempt from transfer tax on the acquisition of property in Sri Lanka.
Economic service charge. An Economic Service Charge (ESC) is payable by every person who carries out a trade, business, profession or vocation in Sri Lanka. The ESC is imposed at a rate of 1%, 0.5%, 0.25%, 0.1% or 0.05% of the turnover, depending on the type of enterprise. Turnover for a quarter exceeding Rs. 25 million is subject to ESC. The maximum ESC liability is Rs. 30 million per quarter.
Nation Building Tax. Nation Building Tax (NBT) is payable by persons who carry on the business of manufacturing or importing or who provide services. Certain specific exemptions are provided. The tax rate is 2%, which is applied to total turnover if the turnover exceeds Rs. 500,000 per quarter. For turnover from certain specified goods and services, NBT liability results from turnover exceeding Rs. 25 million per quarter.
Value-added tax. The standard rate for value-added tax (VAT) is 12%. A 0% rate applies to exports of goods and services. Certain goods and services are exempt from VAT.
Stamp duty. The government stamp duty which was abolished, effective from 1 May 2002, was reintroduced, effective from 3 April 2006. The reintroduced stamp levy is imposed on the following:
- Specified instruments executed, drawn or presented in Sri Lanka
- Specified instruments executed outside Sri Lanka with respect to property in Sri Lanka and presented in Sri Lanka
It does not apply to the following:
- Instruments and documents already subject to debits tax
- Letters of credit that are subject to Ports and Airport Development Levy
- Specified instruments exempted by gazette notifications
The stamp duty on the transfer of immovable property continues to apply.
C. Social security
Sri Lanka’s social security contribution rates rarely change. Most employees are covered by the Employees’ Provident Fund (EPF) Act of 1958. The act requires employees to contribute 8% of total earnings and employers to contribute 12% of employees’ earnings. In addition, employers must contribute an amount equal to 3% of each employee’s total earnings to the Employees’ Trust Fund (ETF). This contribution is not deducted from the employee’s earnings.
When employment ends, a gratuity is payable to employees under the Payment of Gratuity Act of 1983, which equals half of one month’s salary for each year of service. To qualify, an employee must have worked for the employer for more than five years.
EPF and ETF benefits, as well as gratuity benefits paid under a uniform scheme, that exceed the exemption limit of Rs. 5 million (if the period of contributions exceeds 20 years) or Rs. 2 million (in other cases) are taxed at a maximum rate of 10%. However, gratuity payments for retirement in excess of a certain amount are taxed at normal tax rates. This amount is equal to the greater of Rs. 1,800,000 or the average salary for the last three years of employment, multiplied by the number of years of service.
Compensation received under approved voluntary retirement schemes or retrenchment schemes is exempt up to Rs. 2 million. The balance, if any, is taxed at concessionary rates.
Compensation under a non-uniform scheme for loss of employment is taxed at a rate of 20%.
E. Double tax relief and tax treaties
Sri Lanka has entered into double tax treaties with the following countries.
Australia
Italy
Russian Federation
Bangladesh
Japan
Belgium
Korea (South)
Saudi Arabia*
Canada
Kuwait
Singapore
China
Malaysia
Sweden
Denmark
Mauritius
Switzerland
Finland
Nepal
Thailand
France
Netherlands
United Arab Emirates*
Germany
Norway
Hong Kong*
Oman*
United Kingdom
India
Pakistan
United States
Indonesia
Poland
Vietnam
Iran
Romania
* These treaties cover international air transport only.
In general, these treaties provide for the elimination of double taxation if both Sri Lankan tax and foreign tax are due on the same income. If remuneration is received by a resident of a foreign state for employment exercised in Sri Lanka, the remuneration is taxable only in the foreign state if, in general, all of the following conditions apply:
- The recipient is in Sri Lanka for a period not exceeding 183 days in the relevant fiscal year.
- The remuneration is paid by a nonresident employer.
- The remuneration is not borne by a permanent establishment or a fixed base maintained by the employer in Sri Lanka.
To learn more about the history, culture, economy and other information about Sri Lanka
We have been preparing US income tax returns for US Citizens and permanent residents living in Sri Lanka for over 15 years. As a US Citizen or permanent resident (green card holder) you are required to file a US return each year regardless of the fact that you file and pay taxes in your residence country. The expatriate earned income exemption ($100,800 for 2015) can only be claimed if you file a timely tax return. It is not automatic if you fail to file.
We have scores of clients located in Sri Lanka and know how to integrate your US taxes into the local income taxes you pay. Any income tax you pay there can be claimed as a dollar for dollar credit against the tax on your US return on the same income.
As an expat living abroad you get an automatic extension to file until June 15th following the calendar year end. (You cannot file using the tax fiscal year for US tax purposes). You must pay any tax that may be due by April 15th in order to avoid penalties and interest. You can get an extension to file (if you request it) until October 15th.
There are other forms which must be filed if you have foreign bank or financial accounts; foreign investment company; or own 10% or more of a foreign corporation or foreign partnership. If you do not file these forms or file them late, the IRS can impose penalties of $10,000 or more per form. These penalties are due regardless of whether you owe income taxes or not.
There are certain times you may wish to make elections with respect to your Corporation or Investment Company which will give you US tax benefits. There are other situations where forming a US corporation to receive your business income may be more advantageous than using a corporation in your resident country. We can help you with these decisions.
If you are self-employed, you will have to pay US self-employment taxes (social security). If you are a bona-fide employee you do not have to worry about paying US social security on your wages earned in Sri Lanka.
We have helped hundreds of expats around the world catch up because they have failed to file US returns for many years. Unfortunately, unlike India, Canada, UK, etc. you must also file so long as you are a US citizen or resident. You can if you follow proper IRS and State Department procedures surrender your US Citizenship and therefore cut off your obligation to pay US taxes in the future. You must surrender that Citizenship for non-tax avoidance reasons and then can usually not return to the US for more than 30 days per year for the subsequent ten years.
Let us help you with your US tax returns, US tax planning and other US tax and legal concerns. Download our expat tax questionnaire or request a request a consultation by phone, skype or email