Country

• Geographic Location & Climate
• Population & Languages
• Education & Skills
• Contributory Funds

Government

• Executive
• Provincial & Local Government
• Legal System
• Currency & Banking
• Exchange Control

Economy & Business Climate

• GDP
• Tourism
• Investing in Sri Lanka

Types of Business Organizations

• General
• Companies
• Sole Propriertorship, Partnership & Others

Accounting & Auditing Requirements

• Accounting Profession
• Legislative And Institutional framework

Taxation

• Chargeability
• Indirect Taxes
• Direct Taxes
• Custom Duties
• International Treaties & Agreements

Introduction

This booklet, where the information has been presented in summary form, is intended to serve as a general guide to the businessman or potential Investor in Sri Lanka.

The booklet is a general guide to Sri Lankan law. However, these laws may change from time to time. They may be subjected to interpretation by the Sri Lankan Courts or amended or repealed by Parliament. It is therefore, strongly recommended that the businessman or potential investor obtain the assistance of Local Professional advisors before proceeding to do business with or invest in Sri Lanka.

While all reasonable care has been taken in the preparation of this booklet, no responsibility can be accepted for any inaccuracies it may contain whether caused by negligence or otherwise or for any loss howsoever caused or sustained by the person who relies on it.

Country

Geographic Location & Climate

Sri Lanka, (Democratic Socialist Republic of Sri Lanka), is an island in the Indian Ocean, lying off the southeastern tip of the Indian subcontinent. Colombo situated on the western coast, is the largest city and the commercial capital of Sri Lanka. Sri Lanka measures 435 km north to south & 224 km east to west, covering a total area of 65,610 sq.km. The island's strategic location in the Indian Ocean on the major air & sea routes between Europe & the Far East gives it an advantage as a global logistics hub. Sri Lanka has a pleasant tropical climate with two climatic zones - the wet & the dry. Temperatures range from 23-30 degrees Celsius in the lowlands & 10-20 degrees Celsius in the hill country. The average temperature in the country is approximately 27 Celsius.

Population and languages

The population of Sri Lanka is about 20mn. (2004 estimates). Sri Lanka is a multi-ethnic, multi religious country with a diverse & rich culture. The Sinhalese, the majority community, comprise 74.0% of the country's estimated 20mn population. The other ethnic groups that are part of Sri Lanka's social fabric are the Sri Lankan Tamils, Indian Tamils, Moors & other minorities including Malays & Burghers. Each of these groups has its own identity, customs & traditions. The two official languages are Sinhala & Tamil. Sinhala is the language of the majority of the population. Tamil is widely used in the northern & eastern parts of the country. English is widely spoken & understood in the urban centers. It is the language of business & commerce.

Education & Skills

Schooling is compulsory for children from 5 to 13 years of age. Education is state funded and offered free of charge at all levels, including the university level. The government also provides free textbooks to schoolchildren. Literacy rates and educational attainment levels rose steadily after Sri Lanka became an independent nation in 1948. The government gave high priority to improving the national education system and access to education. The adult literacy rate now stands at 93 percent. The language of instruction is either Sinhala or Tamil. English is taught as a second language. We have the highest literacy rate in South Asia (93%) and approximately 50% of the students who have completed their higher education are trained in technical and business disciplines.

The Sri Lankan work force accounts for 35% of the total population. English is widely spoken in the country and is the main language used by the business community. As a result of extensive investment in education & welfare programs by successive governments, any foreign Investor will find our work force is highly skilled, energetic & intelligent and adaptable /trainability is high in the region.

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Contributory Funds for Employees

Every employer is required to contribute to the following Funds

Government

Executive

The President of Sri Lanka is head of state, Chief Executive, and commander in chief of the armed forces. The President is elected for a six –year term and serves no more than two terms. The President appoints the Prime Minister and the cabinet of Ministers, all of who must be members of legislature. The legislature of Sri Lanka is a unicameral (single-chamber) body called Parliament, has 225 members, who serves six-year term.

Provincial and Local Government

The country is divided into 9 provinces, (in 1989 more Central Government powers were vested with Provincial Councils) where the members are elected to serve 5 years. Provincial members are given limited powers in education, health, rural development, social services, agriculture and local taxation. A Governor appointed by the President heads each province. Local Government also includes Local authorities i.e. Municipal, Urban, Village Councils, which has limited powers in local arrears.

Legal System

Sri Lanka’s judiciary consists of a Supreme Court, Court of Appeal, High Court, and a number of subordinate courts. Sri Lanka’s legal system reflects diverse cultural influences. Criminal Law is fundamentally British. Basic civil law is Roman - Dutch law.

The principles of English law is applied in relation to Bills of exchange, Sale of Goods, Partnership, Companies, Insolvency, Banking, Maritime matters, Insurance etc.

Currency and Banking

The monetary unit in Sri Lanka is the Rupee (Rs), which consists of 100 Cents (U.S.$1 = Rs.100 Approx. or Euro 1 = Rs.138 Approx). The Central Bank of Sri Lanka, is the monetary authority of the country, the sole bank of issue, also acts as a financial adviser to the government and administers monetary policy. Banking in Sri Lanka is of high international standard and more than 15 foreign banks have branches here. Significantly, some of these branches have been established for more than 100 years. Sri Lanka also has over ten local banks including two large state banks. Two development finance institutions and several merchant and investment banks are also active.

Exchange Control

The Central Bank of Sri Lanka is the monetary authority of the country. It ensures financial stability by the prudent use of monetary policy instruments and manages the automated cheque clearing system for the Commercial banking system. It also determines the daily buying and selling rates for the US Dollar against the country's Rupee and the rates are published daily. The exchange rates of other major international currencies are fixed by supply and demand within the commercial banking system.

Under The Exchange Control Act, the Central Bank functions as the agent of the Government through the Controller of Exchange. Currently the Controller regulates transactions in foreign currencies of a Capital nature only. i.e. Sale or purchase of a Capital Asset. Current or non-capital transactions are liberalized.

An export oriented enterprise, which has entered into an Agreement with the Board of Investment of Sri Lanka (BOI) under section 17 of the BOI Law and granted exemptions from exchange control regulations may:

• Open and operate a foreign currency account with any foreign currency Banking Unit (FCBU) of a commercial bank.
• Borrow offshore.
• Open and operate a Sri Lankan currency account with any commercial bank.

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Economy and Business climate

Sri Lanka has experienced modest economic growth since independence in 1948. The economy relied on agricultural exports until the 1980s, when export-oriented manufacturing grew in importance. The civil war in Sri Lanka has discouraged foreign investment and constrained economic progress since the early 1980s.

GDP

The gross domestic product (GDP), the total value of all goods and services produced, has grown at an average annual rate of about 3 percent since 1948. The relatively slow growth of the population helped create a greater per capita gain despite the modest growth of the economy. Economic growth has been uneven in the ensuing year as the economy faced a multitude of global and domestic economic & political challenges. Overall, average annual GDP growth was 5.2% over 1991- 2000. However in 2001-2003 period it was dropped drastically and recovered to 5.2%in 2003. Projections for 6.4% growth in 2004 did not account due to political instability, which influenced the negative performance.

Tourism

Sri Lanka’s tropical climate, scenic beaches, and historical sites are prime tourist attractions. By the 1970s, sizeable investments were devoted to the building of infrastructure for the tourism industry, including hotels and resorts. Tourism declined after 1983 as a result of the civil war and related security concerns. About 560,000 tourists, mostly from Europe and India, visited Sri Lanka in 2004.

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Investing in Sri Lanka

1. Business climate
   Sri Lanka offers the most friendly business climate & is ranked as the most liberalized economy in South Asia.
   
2. Direct Investment
   Sri Lanka was the first in the South Asian region to promote foreign investment. Foreign investment is an important element in Sri Lanka's economic growth and is therefore actively encouraged.
   
   Approval is required from the Board of Investment (BOI) prior to the establishment of a foreign business venture in Sri Lanka. The BOI is an autonomous agency and is the primary government body responsible for foreign investment. The BOI grants concessions to companies satisfying certain eligibility criteria. Investors are provided with preferential tax rates, constitutional guarantees on investment agreements, exemptions from exchange control and 100% repatriation of profits & capital.
   
   The Sri Lankan government permits up to 100% foreign participation in many sectors of the economy, and the BOI provides automatic approval for such investments. Investment in certain restricted sectors is subject to screening and approval is given on a case-by-case basis if the foreign investment exceeds 40%. Attractive tax incentives are available for Investors, depending on the Industry & capital investment in Sri Lanka, such as Tax Holidays & Tax concessionary rates, duty exemptions.
   
   Further, there is no capital gain Tax in Sri Lanka at present.
   
   The BOI is the only organization a foreign investor should contact & its services include proving advice & assistance at every stage of the Investment process.
   
   The services provided are:
   
   • Information & guidance for project application procedure, coordinating approvals from other Agencies.
   • Evaluating applications, granting approvals, with concessions where applicable.
   • Providing assistance during start-up, site selection, advising on factory buildings /technical matters, arrange support services e.g. Water, power, waste treatment & telecommunication etc.,
   • Making recommendation to Immigration Authorities for issuing Resident Visas.
   • Facilitating Import/Export clearance
   • Advising on Environmental norms/approvals
   • Assistance in good Industrial relations & formation of Employees’ councils.
     
3. Portfolio Investment
   In the recent past investing in Capital & Share Market in Sri Lanka has shown a rapid growth.
   The Securities and Exchange Commission (SEC) regulates the securities market in Sri Lanka & grants License to Stock Exchanges, Stockbrokers & dealers etc,. Foreign investors can freely purchase up to 100 percent of equity in Sri Lankan companies in permitted sectors. In order to facilitate portfolio investments, country funds and regional funds are also allowed to invest in Sri Lanka's stock market; after prior approval. These funds make transactions through Share Investment External Rupee Accounts maintained in commercial banks. (SIERA)
   The Colombo Stock Exchange (CSE), while small by big emerging market standards, is one of the most efficient in the region. A fully computerized clearing and settlement system was introduced through the establishment of a Central Depository System (CDS) in1991. In 1997,the CSE commissioned a state of the art computer based automated order matching system. The CDS was linked real time with the Automated trading system. These developments placed the CSE alongside the most technologically advanced exchanges in the world. In1998 CSE became the first South Asian member of the world federation of Stock Exchanges. The CDS also gained the membership in the Asia-Pacific Central Securities Group (ACG) in the same year.
   
   The CSE officially launched its Debt trading System (DEX) in March 2004. DEX enables the trading of corporate debt instruments and the beneficial interest of Govt. bonds and treasury bills through the exchange. DEX has advanced features such as scripless trading real-time exposure management, multiple settlement cycles and compatibility with web based technologies. Fifteen local and foreign joint venture brokers currently operate at the CSE.
   
4. Real Estate Investment
   Foreign Investments in real estate in Sri Lanka, including interest in properties, do not require any approvals. However, a 100% Transfer Tax on the value of the property is payable, except in purchase of condominium properties above 3rd floor, acquisition of land for development for more than 100 residential units, for Hospitals, infrastructure and non citizens maintaining over US$ 150,000 in Foreign Currency Government securities Accounts.
   In the like manner, in the case of a Company, if more than 25% of the issued Share Capital is held by non-citizens company is liable to pay this 100% transfer tax.

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Types of Business Organizations

General

Sri Lankans may establish their businesses in Sri Lanka through any of the following forms:

Foreign Investors may establish their business presence in Sri Lanka through any of the following forms:

In Sri Lanka, the law that governs the creation & operation of companies Act of 1982, which is based on the principles of the English Companies Act 1948.

Companies

In Sri Lanka most common forms of Companies are, Private & Public Limited Liability Companies, and are the most suitable for Foreign Investors in Sri Lanka due to the following

1. Liability of each Shareholder is limited to the amount he has undertaken to pay for his shares or by way of guarantee.
2. Limited Liability in the event of Insolvency.

Sole Proprietorship, Partnerships and others

Foreign investors cannot invest in business as Sole proprietorships, enter into Partnerships or joint ventures (other than on foreign funded projects for Govt. Agencies) etc, where the formalities of commencing a business are less but not recommended since the liability for debts are unlimited.

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Accounting & Auditing Requirements

Accounting Profession

The Institute of Chartered Accountants of Sri Lanka (ICASL) was established under the Institute of Chartered Accountants Act.No.23 of 1959 by the Parliament. Council of the Institute is responsible for the management of its affairs, for the issue of Sri Lanka Accounting and Auditing Standards, and for the registration and control of the maintenance of the professional standards and discipline by the persons practicing or acting as accountants in Sri Lanka

Legislative and institutional framework

Companies Act No 17 of 1982 has a mandatory requirement to all the Companies to have their Financial Statements audited by a member of Institute of Chartered Accountants of Sri Lanka or Registered Auditors.

Figure 1: depicts the legislative and institutional framework that governs Sri Lankan accounting and auditing arrangements.

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Taxation

Chargeability

In Sri Lanka, a resident is taxable on world income, and any other person is only on income arising or derived in Sri Lanka

Indirect Taxes

Value added Tax system was introduced on 1st August 2002. Other taxes include Turnover Tax, Debit Tax, & Economic Service Charge. For clarity, the table below states the rates applicable.

VAT

Value Added Tax is charged on destination principle & is liable on supply of goods & services in Sri Lanka. It is a consumption tax, thus goods imported into Sri Lanka and goods & services supplied within the territorial limits of Sri Lanka are the subject matter of this tax.

Zero Rate is applicable on Exports and Supply of services in Sri Lanka to be consumed outside Sri Lanka (includes services provided by a Garment Buying office)

VAT is not collected on listed Exempt Supplies of Goods & Services and no input credit available.

A special rate of 25/= p. piece of garment supplied to the Local market by a BOI manufacture cum Exporter with the approval of BOI/Director General of Customs.

ECONOMIC SERVICE CHARGE (ESC)

A new tax was introduced called ESC from 1st April 2004, which could be setoff against Income Tax of the same year, with the provision to carry forward the unutilized balance for the next two years.

Every person or Partnership in every trade business, profession or vocation whose aggregate Turnover (excluding sale proceeds of capital assets & VAT) Rs.50 mn. in the relevant year is liable, and ESC Payable is limited to Rs.50.mn that year.
For clarity, the table below states the rates applicable.

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Direct Taxes

Individuals	Companies	Others

Non Citizen Employees

Non Citizen Employees are deemed to be non-residents for a period of 3 years from the commencement of employment in Sri Lanka. In this period they will be liable Sri Lanka Income at normal rates & Employment income taxed at concessionary rate of 15% and if they continue to be employed further 2 years taxable @ 15%.

Withholding Tax

Following are some of the withholding tax rates applicable at present

Customs Duties

Presently following rates are applicable

Absolutely essential items & items not manufactured in Sri Lanka are exempt.

Duty Free imports are granted for machinery to acquire new technology where new Companies invest over Rs. 5 mn and existing Companies invest over Rs. 2 mn

International Treaties & Agreements

Sri Lanka’s tax treaties have generally followed the following two basic principles granting for relief:

(a) the foreign tax credit principle, (b) the exemption principle

Under the foreign tax credit principle the country of residence imposes tax on a resident’s total income inclusive of foreign income but allows a set off or credit against the foreign tax paid by the resident on his foreign source of income. Where the foreign tax is lower than the domestic tax ,only the excess of such tax is payable to the country of residence, where the foreign tax is high ,no tax is collectible in the country of residence.
Under the exemption method, income exempted is not taken in to consideration for the determination of tax to be imposed on the taxpayer’s other income.
Tax Sparing Credit relief is also provided in some double taxation agreements, to prevent the loss of double taxation credit negating the incentives offered to taxpayers in the form of tax holidays and tax concessions in developing countries. Such credits are generally given for Dividends, Interest or Royalties or tax spread under a tax holiday or on the profits of subsidiaries out of which dividends have been paid.
Some Representative tax rates are:

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