ECONOMYNEXT- Domestic commercial banks which held dollar denominated bonds issued by the government of Sri Lanka will see higher profits after a tax treatment suddenly changed by a tax-oriented International Monetary Fund program, reverted to old practice.
Banks, who were among the top holders of so-called Sri Lanka Development Bonds (SLDBs) had to provide for taxes after the previously tax-free bonds were made taxable as part of the ‘revenue based fiscal consolidation’ strategy in the last IMF program with the island.
However, there had been reduced demand for new bond issues in recent months after the tax treatment was changed to make SLDBs tax liable.
Uncertainty remained over whether the tax free status only applied to sovereign bonds issued mainly outside Sri Lanka or the SLDBs which are mostly sold to resident customers who are allowed to have forex assets.
Confusion had arisen over the broader exemptions in the Sinhalese interpretation of the act, which usually takes precedence over English.
On February 12 this year Sri Lanka’s Inland Revenue Department had issued a circular, interpreting that the tax-free status applied to SLDBs with effect from April 2018.
Sampath Bank Plc was the first among banks to report their fourth quarter earnings, recording a tax reversal of over 500 million rupees on SLDB holdings of 60 billion rupees at end-2019 following the new interpretation.
SLDBs had been exempted from tax prior to April 1, 2018, Inland Revenue Department Deputy Commissioner R. M. Jayasinghe told EconomyNext.
As the government wanted to broad-base taxation, SLDBs were removed from the exempt list under the Inland Revenue Act No. 24 of 2017, he said.
“Once we made SLDBs liable to tax, as time went on, we felt that it was difficult to find investors,” he said.
DEMAND DROP: Since the new Inland Revenue Act was announced in October 2017, there has been lower demand for SLDBs, with three issuances being undersubscribed.
On three SLDB auctions in 2018 and 2019, bids were less than the announced value of bonds.
From 2016 to end 2017, there was only one auction which was not oversubscribed. During the earlier period, auctions were oversubscribed by larger margins.
Windfall for Banks
While listed banks will benefit from the tax reversal, state banks will also gain, First Capital Research Assistant Manager Atchuthan Srirangan told EconomyNext.
“Sri Lankan banks hold over 80 percent of the issued SLDBs,” he said.
At the moment, there are 3.1 billion US dollars in issued SLDBs.
Banks which have large foreign currency accounts, mainly for worker remittances, subscribe to SLDBs, Srirangan added.
Some banks also borrowed abroad, on their balance sheet at rates lower than the sovereign to invest in SLDBs.
However, with the new tax coming in, their margins reduced, leaving less on an incentive to buy SLDBs.
Bank of Ceylon, which is the largest bank in Sri Lanka, held 195 billion rupees in SLDBs at end-2018, and the bank’s annual report said said its profits fell during the year due to SLDBs coming under taxation.
Among listed private banks, Hatton National Bank Plc had invested the highest in SLDBs at end-2018 at 123 billion rupees, twice that of Sampath Bank, annual reports showed.
Commercial Bank of Ceylon Plc grew their investment to 59 billion rupees in 2018 from 40 billion rupees in 2017.
National Development Bank Plc, DFCC Bank Plc and Pan Asia Banking Corporation Plc rounded up the top six SLDB holders at end-2018, holding between 10-20 billion rupees each.
Any bank that retains the tax reversals would be able to boost their Tier I capital, analysts said. (Colombo/Feb14/2020)