ECONOMYNEXT – Sri Lanka’s Board of Investment is actively engaged in trying to removing the negative impact on charging value added tax on locally produced inputs, which is discouraging backward integration, Chairman Arjuna Herath said.
Sri Lanka’s apparel industries have complained that the removal of the SVAT system which allowed local producers to sell goods to exporters in a kind of VAT exempt system, has been removed, triggering cashflow needs and interest costs for exporters.
In countries like Vietnam and Taiwan, sales into export firms in free trade zones are zero ratedjust like for export. Under a zero rate, no VAT is charged, and suppliers are also entitled to input credit.
Imported inputs are free of VAT in Sri Lanka like in other competing countries in East Asia.
Apparel industry has warned that they will have to halt backward integration to compete with the rest of the world.
The apparel industry has invested heavily in backward integration, where the zone in Eravur has been set up to produce textiles, Herath said.
“We have actually submitted a budget proposal this time for the budget to avoid this anomaly,” Herath said.
“We have taken up with the Inland Revenue Department as well. They have recognized that, within the provisions, whether they may have some leeway to look at this within the zone for deemed exporters on a deemed exporters basis to do this.
“So, we are actively engaged on this.”
In counties like Vietnam, and also Taiwan which virtually invented the concept of free trade zones in the early 1960s sales into firms in zones including for services are zero rated, not only final exports.
Like Sri Lanka, Taiwan was a country that had monetary troubles due to bad central bank in the 1950s export manufacturing could not be done due to import tax protection that hit inputs.
After initially giving tax rebates to get over the problem of protectionism, Taiwan started free trade zone near Kaohsiung port to help exporters escape protectionism. At the time VAT was not found outside of Europe it was not a problem for export powerhouses in Europe.
Modern VAT was invented by France which initially tested it in Ivory Coast in 1954. France adopted it in 1958. VAT later spread within the European Economic Community and the UK adopted it in 1972.
Knowledge of VAT seems to be poor in the US, where President Trump has criticized it as an unfair export subsidy.
Sri Lanka’s exporters have said that the removal of the SVAT system has also hit local buying offices.
Like closing backward integration factories, and halting purchases from suppliers outside zones, buying offices may also be forced to move abroad, due to the removal of SVAT industry, analysts say.
While some export sector may be able to absorb the loss, areas with thin margins like apparel, may be hit worse.
Sri Lanka’s tea producers have also said the will have to take on interest cost through reduced selling prices the cashflow cost that exporter bear when paying VAT upfront even if the refund period was reduced.
When SVAT was removed, tea prices fell by aroud 100 rupees a kilogram, though there are expectations of some recovery in prices when the VAT refunds come.
Unlike in industrial goods, where exporters can stop buying from local suppliers and easily import inputs, tea plantations and small holders will still have a market, though prices may reduce to match the cashflow costs of exporters.
Sri Lanka has a history of raising taxes, after balance of payments crises are triggered by the central bank which engages in ‘monetary accommodation’ and ‘eased monetary policy’, which critics say are euphemisms used for inflationary rate cuts or money printing.
Currency crises has also led to rising income tax, which has in turn created a requirement for low taxes for foreign investors and export firms.
Sri Lanka’s corporate tax is 30 percent, compared to 20 percent for countries with monetary stability in East Asia and also Scandinavia. (Colombo/Oct26/2025)
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