The Sri Lanka SVAT impact is creating significant challenges for exporters, as removal of the VAT-exempt system discourages backward integration and increases cashflow pressures, threatening competitiveness in apparel, tea, and other key export sectors.
Sri Lanka SVAT impact may disrupt apparel and tea sectors, prompting urgent BoI intervention
Sri Lanka’s export sector is grappling with mounting challenges as the Sri Lanka SVAT impact begins to bite, threatening backward integration and investor confidence. The Board of Investment (BoI) is actively seeking solutions to mitigate the adverse effects of removing the Special Value Added Tax (SVAT) system, according to Chairman Arjuna Herath.
Historically, SVAT allowed local producers to sell goods to exporters without charging VAT, effectively facilitating a zero-rated system that preserved cashflow and reduced financing costs. Its removal has disrupted this balance, placing significant financial strain on exporters who must now pay VAT upfront on locally produced inputs. For industries such as apparel and tea, which operate on thin margins, these additional costs could undermine competitiveness and erode profitability.
Herath emphasized that countries like Vietnam and Taiwan provide valuable lessons in sustaining export-driven industries. In these nations, sales to firms operating in free trade zones—including intermediate goods—are zero-rated. This ensures suppliers receive input credits while exporters avoid upfront tax burdens, creating a more competitive environment for domestic production.
“Imported inputs in Sri Lanka are already free of VAT, similar to other East Asian competitors,” Herath explained. “However, the lack of VAT relief on locally produced inputs discourages backward integration. The apparel sector has invested heavily in domestic textile production, particularly in the Eravur zone, but without SVAT, these investments face significant financial pressures.”
To address this, the BoI has submitted proposals in the current budget and engaged with the Inland Revenue Department to explore provisions that could allow deemed exporters within the zones to benefit from zero-rated VAT. “We are actively engaged in finding solutions to this anomaly,” Herath said.
The SVAT removal has broader implications beyond apparel. Sri Lanka’s tea producers, for instance, must absorb upfront VAT payments, increasing cashflow costs even if refund periods are shortened. Industry reports indicate that tea prices fell by roughly 100 rupees per kilogram following the SVAT removal, though expectations exist for partial recovery once VAT refunds are processed. Smallholders and local buying offices may also struggle, potentially shifting purchases abroad if domestic input costs remain uncompetitive.
Export analysts warn that industries with thin margins, like apparel, may be forced to halt backward integration altogether, opting instead to import inputs. While industrial exporters might pivot to imports to maintain competitiveness, sectors like tea must continue sourcing locally, creating a persistent financial strain.
Sri Lanka’s experience mirrors the historical challenges faced by Taiwan in the 1950s. Facing monetary instability and protectionist import tariffs, Taiwan initially used tax rebates and subsequently established free trade zones to support exporters. These interventions allowed domestic industries to expand production, improve competitiveness, and integrate into global supply chains—lessons that are increasingly relevant for Sri Lanka today.
Understanding the origins of VAT provides context for current debates. Modern VAT was pioneered by France in the 1950s and later adopted widely across Europe. Despite criticisms in other countries, including the United States, where VAT is sometimes mischaracterized as an export subsidy, it has become a central instrument for regulating domestic tax and promoting economic stability. In Sri Lanka, inconsistent VAT policies and frequent tax adjustments following balance-of-payments crises have heightened uncertainty for exporters.
Current corporate tax rates in Sri Lanka, at 30 percent, are also notably higher than in East Asia or Scandinavia, where stable monetary policy allows for rates closer to 20 percent. Critics argue that high taxes, compounded by SVAT removal, discourage foreign investment and threaten domestic industrial growth, particularly in sectors that rely on integrated supply chains.
If left unresolved, the Sri Lanka SVAT impact could undermine years of investment in backward integration, forcing exporters to rethink domestic sourcing strategies and potentially relocate production abroad. The BoI’s proactive engagement and budgetary proposals are therefore critical to maintaining the country’s export competitiveness and sustaining industrial development.
In conclusion, the removal of SVAT has highlighted vulnerabilities in Sri Lanka’s export framework, particularly for industries dependent on domestic inputs and integrated production systems. Timely intervention, policy clarity, and targeted tax measures will be essential to preserve backward integration, stabilize cashflows, and ensure that Sri Lanka remains competitive in global markets.