VAT on supply of Residential property back on agenda in Sri Lanka

A brief analysis of policy intent and likely market impact in Sri Lanka

After the amendments to the Value Added Tax Act, No.14 of 2002, (Amendment Act No. 25 of 2018) and the termination of the exemption of VAT on the supply of residential accommodation, it would appear that all sales of condominium properties in Sri Lanka, over LKR 15 million, now attract VAT at 15% of the sale price, in addition to stamp duty and NBT, effective 16August 2018.

Rumorhas it that, further government announcements may clarify the effective date of imposition as1 April 2019, but this only adds to confusion over government policy and fuelsindustry wide gloom, compounded by a lack of clarity and consistency from policy makers. While it is difficult to find anyone who welcomes the removal of the exemption, and, therefore imposition of VAT on residential sales, with immediate effect, equally,history tells us that a fake ‘gold rush’ of sales, to beat the deadline, if 1 April 2019is confirmed, followed by adramatic fall off, afterwards is just as unwelcome.

This stop/start‘is it?/isn’t it?’approach to the imposition of property taxation also raises the issue of the agenda of policy makers, what they are trying to achieve and what has been the impact of lobbying from various stakeholders? Is the VAT levy purely a revenue gathering exercise or an attempt to manipulate the market by dampening demand, in the higher reaches of the condominium market and, if so, why? This confusion undermines confidence, and confidence is the key to any market, be that real estate, or any other product, so, if theintention is to raise revenue, the VAT measure is counter-productive, andif it is intended to dampen demand, when absorption rates, for luxury condominiumscurrently averages 50% in Colombo, why would the government want to see stalled development projects and vacant development plots littering the Colombo environment? Of course, the other possibility is that the government may wish to concentrate developer focus on low cost and social housing, for social policy reasons, but land price speculation, publictransport infrastructure issues and a lack of clear government policy, remain significant barriers to commercial activity in these sectors.

Other governments in south east Asian countries have recently imposed rafts of real estate taxes, for a variety of reasons, mostly to rein in rampant market growth, but also to promote socio economic policy, with mixed results, but, as interested parties begin to weigh up the impact of VAT on condominium sales in Sri Lanka, it might be a good time to take a look at early indicators of market responses to property taxation in other geographies.

The Indonesian government, at the end of 2015, introduced a revised luxury tax of 20% on units over IDR10 billion, which has resulted in weak sales and subdued market conditions in the luxury sector, impacting both new unit launches and resulting sales. In Jakarta, in 2016, 11,000 units were released for sale and sales numbered 10,500. In 2017, only 3500 new units were launched and sales slumped to some 4,000 transactions, a fall of 68% and 62% respectively. Industry commentators predict sentiment to remain subdued, with flat, or falling, prices, on both primary and secondary markets, especially as the market is heavily skewed to local demand. Although the population of the urban municipality of Jakarta exceeds 10 million and the market dynamics differ to Colombo, these statistics may correlate closely to condominium sales in the commercial capital, as 95% of demand originates from Sri Lankan residents and ex pats.

In Malaysia,the introduction of 6% Goods and Services tax on land sales and construction materials/services has filtered through to a 3.5% rise in unit prices in the luxury sector, resulting in a subdued high-end condominium market, with developers scaling back on new property launches amid continued weak demand. The full impact of Hong Kong’s new Vacancy tax has yet to be witnessed, but, as developers have 12 months to sell, or lease, newly constructed apartments, if a tax equivalent of 5% of the property value is to be avoided, they are adopting conservative pricing policies, to shift unsold inventory, and prices are predicted to fall in the range of 10 -15% from present levels. In the Philippines, the government has a different agenda, shifting policy away from direct to indirect taxation, in an effort to reduce poverty and increase middle income status. A 12% VAT levy has been imposed on luxury condominiums, together with significant incentives for the development of low cost housing projects, which has seen a shift towards affordable projects, to the cost of luxury developments, although it should be remembered that this was clear policy at the outset of the measures taken, which differs somewhat from the Sri Lankan case.

It remains to be seen how the market in Sri Lanka reacts to the new announcement, and subsequent imposition of VAT on condominium sales, whether in August 2018, or April 2019, but, even when making allowances for differing agendas and demographics, the above examples demonstrate that, changes in property taxation regimes, when not linked to clear policy goals, result in confusion and a steep decline in activity, which makes identifying any particular beneficiaries, under any new regime, something of a challenge. A robust property sector, underpinned by local and international demand, makes significant contribution to an expanding and open economy, with trickle down effects, such as employment prospects, increased personal spending, tourist arrivals and improved infrastructure/utility provision, to thebenefit of the entire population. New removals of exemptions in Act No. 25 include such diverse goods as helicopters and sunglasses, but none are as important to the overall economy of Sri Lanka as the real estate sector. By, in effect, targeting the sector, in isolation, when a multi-faceted approach is called for, risks missing the opportunity to foster controlled property sector growth, and increased FDI, as Sri Lanka emerges on to the global investment stage as one of the last remaining prospects for genuine growth in the entire region.