Income Tax for SMEs in Sri Lanka: Complete 2026 Guide

Sri Lankan SMEs must manage several tax obligations, including corporate or personal income tax, quarterly income-tax instalments, withholding tax and, where applicable, VAT.

For the year of assessment 2026/2027, important changes include the discontinuation of the Statement of Estimated Tax Payable, revised capital-gains tax rates and expanded withholding-tax requirements for payments to independent service providers.

VAT Registration Threshold for SMEs

The proposed reduction of the VAT and Social Security Contribution Levy registration thresholds from Rs. 60 million to Rs. 36 million was not implemented.

The general VAT registration thresholds remain:

VAT registration may also be required where there are reasonable grounds to expect the relevant threshold to be exceeded.

This means that a business earning between Rs. 36 million and Rs. 60 million annually is not automatically exempt from VAT. It may still be required to register if its taxable supplies exceed Rs. 15 million during a quarter.

Businesses may also apply for voluntary VAT registration even when their taxable supplies are below the compulsory registration thresholds. Commercial importers and exporters must register for VAT regardless of their turnover.

VAT on Non-Resident Digital Service Providers

From 1 July 2026, non-resident persons supplying digital services through electronic platforms to customers in Sri Lanka must register when:

• their digital-service supplies exceed Rs. 60 million during a 12-month period; or
• their supplies exceed, or are likely to exceed, Rs. 15 million during a quarter.

The same Rs. 60 million annual and Rs. 15 million quarterly thresholds apply to this digital-services regime.

Corporate Income Tax Rates

The main company income-tax rates are:

The 15% rate may apply to income from services provided to be used outside Sri Lanka where payment is received in foreign currency and remitted through a bank to Sri Lanka.

It may also apply to qualifying foreign-source income earned in foreign currency and remitted through a Sri Lankan bank. Businesses should retain bank remittance records, contracts, invoices and evidence showing that the services were intended for use outside Sri Lanka.

Previous BOI and Concessionary Tax Rates

Businesses should not assume that historic concessionary rates granted under the previous Inland Revenue Act remain available indefinitely.

The Inland Revenue Amendment Act states that concessionary rates carried forward from the Inland Revenue Act No. 10 of 2006 cannot apply after 31 March 2025. Businesses relying on old BOI agreements or tax concessions should therefore review their current tax position.

Income Tax for Sole Proprietors

A sole proprietor pays income tax as an individual rather than paying corporate income tax.

From the year of assessment beginning 1 April 2025, qualifying resident individuals and non-resident Sri Lankan citizens are entitled to personal relief of Rs. 1,800,000. Personal relief cannot be deducted against gains from the realisation of investment assets.

After applying the available personal relief and other permitted deductions, the following progressive rates apply:

Qualifying foreign-source income and qualifying income from services used outside Sri Lanka may be taxed at a maximum rate of 15%, subject to the foreign-currency and bank-remittance requirements.

Withholding Tax Rates

SMEs may be required to deduct withholding tax when making certain payments.

Where the Rs. 100,000 monthly threshold is exceeded for qualifying rent or service-fee payments, withholding generally applies to the full payment, not only the amount above Rs. 100,000.

Service Fees Paid to Independent Individuals

The categories of resident independent service providers covered by the 5% withholding requirement were expanded with effect from 3 June 2026.

The expanded list includes professions and service providers such as auditors, valuers, artists, musicians, event organisers, photographers, videographers, therapists, counsellors, electricians, dentists, veterinarians, social-media specialists, information-technology specialists, advertising agents, advisers, translators, writers and debt collectors.

The requirement generally applies where payments to the relevant resident individual exceed Rs. 100,000 during a calendar month.

Interest-Income Self-Declaration

A resident individual receiving interest from a bank or financial institution may submit the prescribed self-declaration where the individual does not derive taxable income for the relevant year of assessment.

This should not be described simply as an Rs. 1.8 million assessable-income test. The individual must satisfy the conditions in the declaration and should not submit false or misleading information. A false declaration may result in a penalty of up to Rs. 200,000 and the loss of the ability to submit another declaration.

Withholding agents must also issue withholding certificates to recipients free of charge.

Quarterly Income-Tax Instalments

An instalment payer must normally make four quarterly income-tax payments:

The Statement of Estimated Tax Payable previously submitted with the first instalment has been discontinued for years of assessment beginning on or after 1 April 2026.

Quarterly instalments for 2026/2027 are generally calculated based on the income tax payable for the immediately preceding year of assessment, 2025/2026.

Where the taxpayer had no taxable income in the preceding year or expects taxable income for the current year to be lower than the preceding year, estimated tax must be determined according to the procedure specified by the Commissioner-General of Inland Revenue.

Final Tax Payment and Annual Return

The final income-tax payment is generally due six months after the end of the relevant year of assessment. The annual income-tax return is generally due by 30 November following the end of the year of assessment.

Therefore:

Businesses should distinguish between quarterly instalments for the current year and the final payment and annual return relating to the previous year.

Penalties and Interest

Failure to pay or file on time may result in the following:

• Late-payment interest of 1.5% per month or part of a month, calculated monthly.
• A 20% penalty is imposed when tax remains unpaid for more than 14 days after its due date.
• A 10% penalty applies where a required quarterly instalment remains unpaid for more than 14 days.
• A separate late-return penalty.

The late-return penalty is generally the greater of:

• 5% of the tax owing, plus 1% of the tax owing for each month or part of a month the failure continues; or
• Rs. 50,000, plus Rs. 10,000 for each month or part of a month the failure continues.

The late-return penalty is generally capped at Rs. 400,000. These penalties are separate statutory charges and should not all be described as “compounding”.

Enhanced Capital Allowances

From 1 April 2026, a person investing in depreciable assets for a new undertaking in Sri Lanka may qualify for a 100% enhanced capital allowance where:

• The assets are used in the new undertaking;
• The assets are depreciable assets other than intangible assets;
• The total qualifying investment exceeds USD 250,000; and
• The total qualifying investment does not exceed USD 3 million.

The Act does not impose a general BOI-approval requirement on this new undertaking concession.

Specific BOI approval is, however, required for an expansion of an existing undertaking to qualify under the relevant enhanced-capital-allowance provision.

Capital-Gains Tax Changes

From 3 June 2026, gains arising from the realisation of investment assets are generally taxed at:

• 15% for individuals;
• 15% for partnerships; and
• 30% for companies, trusts, unit trusts, mutual funds and non-governmental organisations.

Personal relief cannot be deducted against gains from the realisation of investment assets.

Large Cash Payments

Special income-tax rules apply when a person makes an aggregate payment of Rs. 500,000 or more:

• during a single day;
• for a single transaction; or
• through a series of transactions relating to the same event.

Accepted payment methods include:

• account-payee cheque;
• account-payee bank draft;
• credit or debit card;
• electronic payment through a bank account; and
• depositing cash directly into the bank account of the person entitled to receive the payment.

Where the payment is made through another method, the payer may not be permitted to deduct the payment as a business expense or include it in the cost of an asset for income-tax purposes.

Exceptions apply to specified payments made to or by the Government, government institutions, banks, financial institutions and other prescribed persons or payment categories.

SVAT Abolition

The Simplified Value Added Tax scheme was abolished from 1 October 2025 and replaced by a risk-based VAT refund scheme.

Eligible exporters and approved projects are assessed according to their compliance and risk classification when VAT refunds are processed.

Income-Tax Return Relief for Certain Employees

An individual may not be required to maintain an income-tax file or submit an annual return where:

• The individual’s only income is employment income fully subject to APIT;
• No quarterly instalments or final tax payments are due; and
• Any additional interest income does not exceed Rs. 5,000 for the year.

However, where the Commissioner-General has already opened an income-tax file, the individual must continue filing until the file is officially closed.

Common SME Tax Mistakes

Common mistakes include:

• Checking only the annual VAT threshold and ignoring the quarterly threshold;
• Failing to register for VAT as a commercial importer or exporter;
• Continuing to rely on expired BOI or historical concessionary tax rates;
• Attempting to submit an outdated Statement of Estimated Tax Payable;
• Using the previous 5% withholding rate on interest instead of 10%;
• Withholding tax only on the portion above Rs. 100,000;
• Claiming the 15% service-export rate without foreign-currency remittance evidence;
• Treating large cash payments as deductible without checking the permitted payment methods;
• Missing quarterly instalment, final payment, or return-filing deadlines; and
• Failing to issue withholding certificates.