A massive transformation in the indirect tax structure of this country through the new bill

KPMG Sri Lanka, in its May 2026 tax analysis report, indicates that a massive transformation is expected in the country's indirect tax structure through the new draft bill issued on April 29, 2026, aiming to amend the Value Added Tax Act No. 14 of 2002. These new proposals, presented with the primary objectives of broadening the tax net, subjecting foreign digital services to VAT, and strengthening the tax law enforcement process, will come into effect as law after receiving parliamentary approval.

According to these new tax amendments, the annual income threshold for VAT registration, effective from July 01, has been reduced from LKR 60 million to 36 million, and the income threshold for a relevant tax period has also been lowered from LKR 15 million to 9 million. As a result, many small and medium-sized wholesale and retail businesses that previously earned below this threshold will now fall under the VAT net, which will become a significant economic burden on small-scale entrepreneurs.

Additionally, VAT is set to be introduced from July 01 for digital services provided by foreign service providers without a residence in Sri Lanka to local consumers. Accordingly, these foreign service providers are obligated to register within the country's tax system and submit reports. However, if the party receiving the digital service is an entity already registered for VAT with proper documentation, the tax will not apply to them.

A strict decision has also been made regarding the financial services sector, with the VAT rate in this sector directly increased from 18% to 20.5% from July. It is expected that this increase in the tax burden on the financial sector will significantly impact the prices of all other services. Furthermore, the draft bill includes provisions to redefine certain terminologies like "Padinadi" in line with the Inland Revenue Act, and to ensure that dividend income of entities not specifically mentioned is not considered business profit under the VAT framework.

This also proposes targeted concessions to encourage exporters. Entities providing services to foreign clients through garment buying offices and receiving payments in foreign currency will be entitled to a zero-rate tax concession from October 01, 2025. However, if tax payments for machinery, equipment, or vehicles imported for a specific project are delayed and not settled within one month of the project's completion, the opportunity to claim input VAT credits for them will be lost.

It has also been proposed to grant VAT exemptions for supplies made to entities designated as "Strategically Important Businesses" within the Colombo Port City. This suggests that while large-scale businesses receive significant tax concessions, the heavy tax burden on the general public remains unchanged. Nevertheless, while traders eligible for registration under the new act can claim input tax credits for their remaining stock for sale, every registered business is mandated to adopt secure Point of Sale (POS) systems that instantly record transactions, issue invoices, and collect data within three months from the stipulated date. Furthermore, by allowing taxpayers to submit VAT schedules continuously during the relevant period, and not just at the end of the tax period, the tax process is expected to be maintained with greater transparency.

Penalties imposed against tax law violators have also been significantly strengthened, with the maximum fine for offenses increased from LKR 25,000 to LKR 1 million. Additionally, provisions have been made to impose imprisonment of up to six months for offenses such as fraudulently claiming tax refunds and failing to provide valid documents, and to empower the Commissioner General of Inland Revenue to publicize taxpayers' identification information to facilitate tax administration.

The Department of Inland Revenue, which surpassed its tax revenue target of LKR 2,202 billion in 2025 by earning a record LKR 2,244 billion, has been given a massive new target of LKR 2,402 billion for 2026. To achieve this and further strengthen tax compliance, the relevant authorities are currently working with Customs, and a Memorandum of Understanding has been reached between the two parties for conducting joint audits and exchanging data. As a continuous step to further broaden the tax base, tax authorities also plan to increase the number of Taxpayer Identification Numbers (TINs) issued, currently at 12 million individuals, to 17 million in the future.