How to Start an Overseas Business in Sri Lanka | Business Impact of Foreign Exchange and Tax Regulations on Business Expansion from Sri Lanka to Overseas Markets

This article delves into the foreign exchange regulations and tax policies that affect the expansion efforts of Overseas Businesses in Sri Lanka. in overseas markets. It focuses on resident investors and does not cover investments made by entities other than private limited companies or alternative forms of foreign exchange transactions.

Foreign Exchange Regulations

Under the Foreign Exchange Act, eligible resident investors are permitted to establish and maintain overseas offices, branches, or projects (referred to as overseas offices) in foreign countries.

Limits on Outward Investments

Capital transactions for outward remittances must be conducted through an Outward Investment Account (OIA), which is opened and maintained by the eligible resident investor through an authorized dealer or a restricted dealer. These transactions are subject to limits specified in issued directions and the provisions of the Foreign Exchange Act.

For companies or partnerships investing in overseas offices/branches, the limit is set at USD 300,000 per calendar year or an equivalent amount in other designated foreign currencies. However, the usage of outward investment accounts for payments has been suspended since June 2022, following a gazette notification by the finance minister at that time.

Additionally, the gazette order imposes a maximum limit of USD 20,000 or its equivalent in other designated foreign currencies for outward remittances on capital transactions made through Business Foreign Currency Accounts or Personal Foreign Currency Accounts held by resident individuals in Sri Lanka, during the effective period of the notification.

Repatriation of Income and Liquidation Proceeds

Any income and capital proceeds from investments must be brought back to Sri Lanka through the same outward investment account used for the initial investment, within three months from the date of receipt.

Incentives for Resident Investors

Eligible resident investors are allowed to utilize funds up to fifty per cent (50%) of the value of capital gains from previous outward investments credited to their outward investment account, without being subjected to the permitted limits. However, this incentive has also been restricted by the aforementioned gazette notification since June 2022.

Other Terms, Conditions, and Reporting Requirements for Foreign Investments

1. Prior to each outward remittance, the investor must obtain a clearance letter from the Head of the Department of Foreign Exchange through an authorized dealer or a restricted dealer. Investors planning subsequent foreign investments must provide a certificate obtained from a Fellow member of the Institute of Chartered Accountants of Sri Lanka or a Charter holder of the Chartered Financial Analyst (CFA) Institute, outlining the progress and status of their previous investments, along with supporting documents. The Head of the Department of Foreign Exchange will issue the clearance letter upon being satisfied with the progress of the previous investments.
2. The Board of Directors of an investment company that has invested in an unlisted company outside Sri Lanka must evaluate the progress of such investment annually and submit a report to the Head of the Department of Foreign Exchange, including details on the investee's profit or loss, dividends declared by the investee, or dividends received by the investor. This report must be submitted on or before March 31 of the following year or as specified by the Head of the Department of Foreign Exchange for a particular investment.
3. In order to be eligible for permitted investments under foreign exchange regulations, investors must maintain a sound financial position and performance. They must also provide a recommendation from a Fellow member of the Institute of Chartered Accountants or a Charter holder of the Chartered Financial Analyst Institute, in line with the directions issued by the Central Bank. Additionally, the feasibility of the proposed investment must be demonstrated to the Head of the Department of Foreign Exchange.

Tax Regulations

Determining Applicable Taxes for Foreign Subsidiaries/Branches

To ascertain the applicable taxes for foreign investments, companies must submit relevant agreements, business details, business process details, and organizational charts in writing to the tax policy unit of the Inland Revenue Department. Subsequently, the tax policy unit will consult with the interpretation committee and provide details regarding the taxes applicable to the specific foreign investment.

Tax Clearance Requirements for Outward Remittances in Foreign Currency

For foreign currency remittances, a tax clearance must be obtained from the Inland Revenue Department (IRD), except in cases mentioned in the negative list under the Inland Revenue Act. The tax clearance certificate issued by the IRD must then be submitted to the bank to initiate the remittance process.

Due to the Withholding Tax (WHT) imposed on payments received by non-residents, the company must submit a tax clearance certificate issued by the IRD to the bank in order to process outward remittances. The WHT rate will be determined based on the provisions of the Inland Revenue Act but will be subject to the provisions of double tax avoidance agreements.

Payments to resident individuals will be subject to the Advance Personal Income Tax (PAYE/WHT) as per the provisions of the Inland Revenue Act. Invoices and related agreements must be submitted to both the IRD and the bank in all the aforementioned circumstances.

Note: The above information is based on the current regulations and should be verified with the relevant authorities for any updates or changes.

Analysis of interest rate and monetary policy in Sri Lanka (1977 to up-to-date)

Introduction

Monetary policy is controlling of the availability and cost of liquidity in the economy with the intention of achieving certain macroeconomic goals including faster economic growth, higher level of employment, low inflation and balance of payment equilibrium.(Colombage, 1993)
The responsibility of operating monetary policy is held with monetary board in central bank of Sri Lanka by the monetary law act. Since establishment of central bank up to 2002 the monetary policy was operated with the objectives of stability of domestic value of money, stability of external value of money, to promote & maintain high level of production, high employment, real income & promote full development of the productive resources.(CBSL, 1990). Since those previous objectives made a conflict in monetary management in 2002 objectives of central bank has been reformulate as stability in price and economy, stability in financial system. Monetary policy of central bank is mainly focused on achieving price stability.
Monetary policy instruments.
Central bank of Sri Lanka uses different instruments to control the money supply of the economy. Those can be classified as,

1.Market intervention
a.Open market operations
b.Bank rate
2.Portfolio limits
a.Reserve requirements
b.Credit ceilings
3.Other instruments
a.Prior import deposits
b.Moral suasion

Open market operation, bank rate and reserve requirement are indirect type of control while credit ceilings, prior import deposits and moral suasion are direct type of controls. Though traditional central banks in developing countries used direct controls since lack of having a developed financial market, now many central banks including Sri Lanka using indirect instruments as monetary economists Argive that direct control instruments create market distortions and they are less effective compared to indirect ones.(Colombage, 1993)
After 1977 the Quasi money hold by people began to rise hugely. Quasi money consist mainly savings and time deposits. This mainly happen because of the positive real interest rate and liberalization of financial sector. In 1970 the M1 was 63.15% of M2. But when it comes to 1985 the percentage has been reduced up to 38.79%. And after introducing electronic payment systems the money in circulation of Sri Lanka become smaller portion in M2. In 2016 the money in circulation was 15.79% of M2 [Table1].(Colombage, 1993)
In closed economy model handling monetary policy is less complex compared to a liberalized one. Due to fixed exchange rate system and restrictive financial systems the control of money supply was less complex. So previous monetary authorities used interest rate, reserve requirement and credit control as main monetary policy instruments. And prior to 1977 the intermediate target of monetary policy framework was narrow money. After liberalized economy that lead to liberalized financial sector and relatively flexible exchange rate system, made monetary policy much more complex with previous policy instruments. So in 1984 CB shifted towards open market operation from interest bank rates & statutory reserve ratio in controlling money supply since those instruments failed to achieve desired outcomes. They were able to mop up the excess liquidity in the economy which had arisen from high tea prices & excessive government expenditure. Also in 1988 because of the savings and time deposits considered as much liquidity asset that directly affect money supply of economy, the intermediate target of monetary policy rearrange as broad money from narrow money.
In 1981 central bank introduced national credit plan (NCP) in the objective of setting monetary and credit targets with forecasting monetary bases. The NCP has prepared annually to guide monetary management of CB. Same year secondary market for treasury bills has been introduced that led to development of TB market.(Karunathilake, 2000)
In order to widening open market operations repurchase agreement system has been introduced in 1993. In reverse repo agreements central bank can sell treasury bills that in position with them to public with the agreement to buy back after a specified duration. In 1995 central bank introduced reverse repurchase agreement system in OMO.
Monetary board of CBSL is having the responsibility to handle monetary policy and in 2001 monetary policy committee (MPC) was appointed to advised monetary board by studying monetary aggregates within the economy. They meet monthly & evaluate economy & recommend suitable policies.
In 2003 active open market operation system introduces with many attractive functions. Establishing daily auction system, maintaining interest rate corridor with repo and reverse repo rates & Outright Sales/Purchases of government securities to address long term (structural) liquidity imbalances.(Wijesinghe, 2005)
In 2009 with the intension of accelerating economic activities the penal rate charged on reverse repo transactions when participating institution exceeded the maximum no of times that could access to reverse repo window in a month has been removed and the 100% margin deposit requirement  for opening letters of credit imposed in 2004 which later in 2008 raised up to 200%, is removed in 2009.

Future development
Since in 1980s central bank has adopted a monetary targeting framework to address the defined objective of enabling price stability by influencing monetary aggregates by addressing reserve money. But recent years with the weakening relationship between money and inflation several central banks whole around the world has adopted flexible inflation targeting policy instead of monetary targeting framework. Central bank of Sri Lanka now working to meet requirement of such framework that enable to shift at inflation targeting framework.(CBSL, 2010)

Prerequisites that needed for adapt Inflation targeting monetary policy.(Perera, 2007)
•CB should have independence specially in legally.( specially mandated to achieve price ability)
•Low and stable fiscal deficit with freedom from fiscal dominance.
•Well understood channels between policy instruments and inflation.
•Flexible exchange rate system.
•Effective inflation forecasting models.
•Developed financial system with policies that enhance transparency of central bank.

Interest rate
Interest rate liberalization
Before 1977 the interest rates were kept low in formal sector than organized sector by interest rate ceilings, subsidized credit allocation and high reserve ratio. This lead to have a negative real interest rate throughout the years before 1977. These financial repressions undertaken by central bank are removed through interest rate liberalization. This created a chance to formal financial sector to attract more deposits as well as could lend more to public. This reduced the effectiveness of interest rate as a policy instrument. (Colombage, 1993)
Since interest rate not allowed to adjust for inflation real interest were negative before 1977.with the raise of bank rate from 6.5% to 10% all commercial banks rose their deposit rate together. The 12 month fixed deposit rate was doubled from 7% to 14%. [Table 2]
Policy interest rates
Central bank uses bank rate, repurchase rate, reverse repurchase rate as policy interest rate which help to affect all other interest rate in market. Bank is not very active today since the penalty rate is high. Repo rate and reverse repo rate is the main policy rates CB used to affect to all other interest rates and ultimately on money supply by affecting interbank call money market liquidity.
Interest rate corridor
Central bank operates repo and reverses repo agreements to control the liquidity in call money market. The call money market rate adjusts according to the liquidity in the call money market. Repo and reverse repo rate act as a corridor to AWCMR. Before 2014 repo & reverse repo rate was determine by the auction bids. Later it was named as standard deposit facility rate & standard credit facility rate and rates have been determined by CB. [Figure2]
Limitations in monetary policy of Sri Lanka
•Less sensitivity of people to interest rates. [Figure 5]
•Commercial banks keeping excess reserves.
•Financial cost of statutory reserve.
oStatutory reserves held in CB does not creating any profit to commercial banks though the money raise by interest bearing sources.
•Continuous budget deficit of government.
•Underdeveloped money & capital markets.
•High volatility in exchange rate in Sri Lanka.
•External effects.(political influence)

 

Unemployment and causes in Sri Lanka Economy (1977 to up to date)

Background of unemployment in Sri Lanka after 1977

After 1977, Sri Lanka has moved towards liberalization and reformed the economy into a
country which will gain maximum benefits from globalization. This reformation has profoundly
affected Sri Lankan employment, unemployment, and underemployment. According to
A.G.W. Nanayakkara, unemployment consists of persons who are without work, currently
available for work, actively seeking for work for pay or self-employment. As another definition,
according to the Central bank’s series of Consumer Finance Survey (CFS), persons in
unemployment contains those who had no work during the reference period but are
actively seeking employment or available for work, if action is found. (L.L.Gunaratne, 1993).
After the reformation in 1977, until 1990s unemployment among male was higher than 50%
(Table 1). But after 1990 this has changed, and around 50% of unemployed were females
(Figure 1). The main reason for this higher unemployment among female may be because many females refuse to work far away from their residences (Nanayakkara, 2004).
Many research findings say that many females are not very flexible with the number of hours
they have to work in the workplace; especially overtime activities. And many organizations
still refuse to hire female as employees due to the child baring role and the endless chores
she has to perform due to the patriarchal role in the family. The unemployment rate among
females who have G.C.E (O/L) and above educational qualifications is about 11.25%
(Statistics, 2015). Which means many unemployed females are educated. Due to that, they are
very selective of the job and waiting for the right position, and that takes a lot of time. Due to
these reasons unemployment of female is high in the country.

Underemployment of different age groups takes different significance. In the year the 1990s, the
highest unemployment rate was reported among the age group of 15-19 (Table 2). But the
unemployment percentage of the age group of 15-19 has been gradually decreasing since
2000. At the age of 15-19, many people are students and sit for the G.C.E. (O/L) and G.C.E.
(A/L) Examinations. Therefore, many of them are considered economically inactive. Out of
all the students who sit for the G.C.E (O/L) examination, only about 40% will get qualified to
sit for the G.C.E (A/L). This means most of the people who are in the age group of 15-19 will
enter into the labor market to find jobs. But due to their lack of education, lack of skills and
practical knowledge, many of them fail to find a job. Because of that, the unemployment rate
in this age group is high. Even after the age of 19, there is a high unemployment rate recorded
in the 1990s (Table 2). It is around 30%. In the 1990s the reason for this issue was, even many
students fail to gain university entrance after G.C.E. (A/L) they somehow continued their
higher studies in various streams and did not consider in entering into the labor force until
the age of around 24. Since 2000, the same reason can be applied. But the percentage rates
are slightly lower than that of in the 1990s, and it is around 15% (Table 2). Since 2000 the
education and employment trend had a different direction. Students who have not gained
university entrance have started gaining many other professional qualifications while being
an employee. This is why the unemployment rate has decreased since 2000 for the age group
of 20-29. The primary reason for youth unemployment also lies with this age group. People
who enter higher education at the age of 20-24, enter into the labor market, after
completing higher studies, at the age of 25-29. In the current era, many job opportunities’
Required period is below 25year. While companies are hiring employees, many suitable
candidates are still studying. This has become one of the crucial reasons why they were
unable to gain employment, especially in private companies (Nanayakkara 2004). According to
many surveys, another reason for this youth unemployment in the private sector is the lack of
knowledge in English communication. Many private companies require English as an essential
requirement.

As shown in table 4, the highest unemployment rate is recorded under the G.C.E (A/L &
Above) category. As Guaratne and Herath (1993) say, the unemployment in the 1980s was very
lower among those who had a deficient level of education and a higher level of education. The
reason is at that time, people who had a more moderate level of education were not able to be very
selective about the job, and grabbed the very first opportunity they had to earn
money. The primary issue of unemployment by education that is discussed by Guarantee and
Herath (1993) is that a large number of dropouts with secondary or post-secondary levels
of education and the difficulties faced by these individuals in obtaining employment. By that
time, the number of dropouts has been increased due to the increase in educational
opportunities. Those students were with some academic training but with less practical
training. That has become a barrier, and due to that, they were unable to be employed.
Table 4 shows the unemployment rate by education level from the year 1990-2015. The highest
unemployment rate is reported under the highest level of education. However, out of all the
unemployed persons, more than 40% are people who were only educated up to grade 10
(Nanayakkara 2004). Therefore, the policymakers should not only pay attention to the job
creation targeting the youth with higher education qualities but also the child who does not
have the G.C.E (O/L) qualification.

Overall Unemployment Trend in Sri Lanka After liberalization, and the reasons for the
reduction of unemployment

After the economic policy reformation, the trend of unemployment shows a downward
pattern (Figure 2) which indicates that unemployment has been reduced. Even though the rate
of unemployment has decreased in the 1990s, it was higher than 10%. Only after 1998, the country
was able to maintain the unemployment rate below 10% (Table 1). The reduction of this rate was
a result of many programs undertaken by the government after the liberalization.
The first program undertaken by the government to reduce unemployment is the Export
Processing Zone (EPZ) in 1978 in Katunayake, Biyagama, and Koggala. By the end of the year
1992 the total direct employment created by EPZ is more than 77,000 (Saravanandan, 2004).
In 1992, 200 export-oriented garment factories program was introduced. By that, well-organized factories were set up in the rural area. In that year the highest foreign exchange
earner was the garment industry, and out of all the employed people 33% of them were from
the textile and garment industry (Saravanandan, 2004).
In 1995 as a continuation of the EPZ a new step was taken, and that is called the ‘New
Industrialization strategy for Sri Lanka’. Under this step, five new export processing zones
and one industrial park was established. This has also highly contributed to the reduction of
unemployment.
Another main development program which contributed to the reduction of unemployment in
Sri Lanka is the Mahaweli Development Program. By achieving the primary purpose of the
whole program; make irrigation facilities for cultivation in the dry zone, the Mahaweli program
was able to increase the agricultural sector production. Due to that, many people who were
unemployed in the dry region became employed, and the overall unemployment of the country
decreased.
There are more reasons other than projects undertaken by the government, such as foreign
employment. Labor migration has started in the 1980s with the liberalization (Saravanandan,
2004). By the end of the year 2015 there, about 1 million people working in foreign countries and
foreign departures in that year is more than 260,000. Another reason for the decrease in
unemployment is recruitment into armed forces due to prolonged hostilities during the 1980s
(Saravanandan, 2004). Around 240,000 people were recruited to armed forces due to this
reason (Saravanandan, 2004).

Under-Employment
“Underemployment” exists when a person’s employment is inadequate, about
specified norms or alternative employment, account being taken of his occupational skill
(training and working experience)” (Statistics, 2006). Estimation of underemployment is
difficult due to the visibility issues. Visible underemployment can be determined by
comparing the number of days that a person actually worked, with the number of days that
the person was willing and able to work. If the number of days the person actually worked is
less than that of willing and able to work, visible underemployment exists (L.L.Gunaratne,
1993). According to Gunaratne & Herath (1993), in the 1980s out of all the people, who were
considered as employed, around 40% were underemployed. This means that at the 1980s around
50% of the labor force (10% unemployment and 40% underemployment) was not fully
contributing to the economy. In the 1990s the average underemployment rate is around 21.7%
and in 2000s it is around 21.6% (Karunaratne, [no date]). According to Karunaratne, the
behavior of underemployment is affected by many factors, and out of the 50% of the
reasons were the nature of work, reduction in economic activity, off-season activity.

Causes for unemployment
By considering all the factors, there are several reasons for unemployment in Sri Lanka. One
is that from the very beginning to up to date, the Sri Lankan education system has not been
modified according to the needs of the labor market. The skills that the person gain from the
system mismatches with what the market needs. Another one is that lack of job
opportunities for the educated youth, which can highly contribute to proper economic growth.
(Due to the age when they complete their university education, lack of skills in English
language, private sector reluctance to hire graduates over the misconception that they are very
radical, etc.).

Some suggestions to overcome the unemployment problem:
As for the youth unemployment due to age mismatch, universities should enroll students as
soon as the G.C.E (A/L) examination ends. Skill development education should be given to
the students from the very beginning, and the skill development strategies should be modified
according to the demand in the market. Industries that create a significant number of job
opportunities, such as the High-tech industry, should be encouraged. The youth who wish to be
self-employed in agriculture or non-agriculture sector should be supported by providing the
infrastructure facilities and providing them credit facilities which can be easily obtained.
As a conclusion, the Sri Lankan economy is gradually decreasing the unemployment rate after
the open economy policy adoption. But still, the frustration due to unemployment has not
been reduced but slightly increased. What Sri Lanka has is not the problem of lack of job
opportunities, but the lack of creation of candidates who are suitable to grab the opportunity.
What the economy should do is, to improve the skills and capabilities within the people while
creating job opportunities.