The Impact of Terminating the Simplified Value Added Tax (SVAT) Scheme on Sri Lanka’s Apparel Industry

The recent decision to terminate the long-standing Simplified Value Added Tax (SVAT) scheme has left the Joint Apparel Association Forum (JAAF) deeply concerned and disappointed. As the representative body of the apparel industry, JAAF firmly believes that abolishing SVAT for exporters will have detrimental effects on a sector already grappling with declining exports. This abrupt decision not only jeopardizes business cash flows but also hampers efforts to achieve overall growth.

They have raised the following concerns.

Negative Impacts on the Apparel Industry

The abolition of SVAT places an additional burden on an industry already under stress, especially in terms of company cash flows. Previously, funds could be reinvested in business operations, but now they will be tied up in refund systems, even those deemed efficient. JAAF highlights that this impulsive and non-consultative decision will have disastrous consequences for the long-term viability of the sector.

Revenue Neutral and VAT Refunds -Simplified Value Added Tax (SVAT)

While understanding the government’s need to meet revenue targets, JAAF points out that abolishing SVAT has no impact on the Department’s revenue. The removal of SVAT only increases cash flow between the exporter and the Inland Revenue Department (IRD). However, it is important to note that Sri Lanka has a poor track record of VAT refunds, with exporters previously waiting for over 18 months to receive their due refunds from the Department. This delay in refunds further adds to the financial strain faced by apparel exporters.

Fraud and Abuse Considerations

It is essential to consider the context in which SVAT was introduced. The refund system in place before SVAT’s introduction had significant fraud instances in the non-export sector, not among exporting companies. Exporters utilize SVAT to purchase local inputs, which are then converted into finished products for export. Consequently, their local sales are minimal, reducing the potential for system abuse. A payment and refund-based system is more susceptible to abuse compared to the voucher system employed by SVAT. Therefore, the decision to abolish SVAT without considering this aspect undermines the efforts made to ensure transparency and prevent fraud.

Impact on Raw Material Imports and Balance of Trade

Furthermore, the decision fails to consider the possibility that apparel exporters might be compelled to import raw materials instead of sourcing them from domestic manufacturers. This situation would restrict their cash flows due to the VAT refund system. The consequence would be increased imports, negatively affecting both companies and the overall balance of trade. Sri Lanka’s apparel industry has thrived due to its unique vertical integration benefits, allowing it to control the entire production process domestically. However, if the SVAT scheme is abolished, this advantage may be lost over time, raising concerns about the viability of companies and the jobs they provide.

Administrative Costs and Resource Allocation

Moreover, reintroducing a VAT refund system, even under favorable conditions, would require significant allocation of resources from the Inland Revenue Department (IRD) for constant follow-up and evaluation. This would result in increased administrative costs for all parties involved and the misallocation of valuable IRD resources and staff. The current SVAT scheme, with its voucher-based system, has been relatively efficient in minimizing administrative costs and ensuring a smooth process for exporters. Abandoning this system would lead to unnecessary complications and further strain on resources.