Taxing business in bearable proportions
Is militarism creeping into Sri Lanka's business community? Shouts of
"Let's march to the Treasury" or "Let's close the factories for a day as a mark of protest" echoed at a recent meeting of associations representing garment manufacturers, exporters and buyers to discuss a controversial port and airport development tax.

The whole industry said it opposed the tax. "We have been in intensive care all this while. This new levy will send us to the mortuary," one industrialist joked. Jokes apart, the new levy is seen killing the goose that laid the golden egg in a sector that has grown from a cottage industry to an international class player.

What is all the fuss about? Industry representatives have urged the government not to impose the one-percent levy. But instead of deciding against proceeding with it, the tax was reduced to 0.75 percent.

Industrialists are furious and many gave vent to their frustrations by urging street action to make the government relent. "We may have to protest on the streets to exert pressure on the government not to levy the tax. There is no other way they would listen to our pleas," said veteran industrialist Cassian Fernando. Another industrialist suggested closing factories for a day as a protest.

Other more moderate voices cautioned against such radical measures saying one should not get emotional or act like trade unionists but suggest a temperate counter-offensive if the tax is not lifted.

The industry - particularly small and medium scale exporters - is "going through hell", in the words of one manufacturer, because of a recession in the West coupled with the attack on the Colombo airport last year which crippled exports. Any additional burden on the industry would lead to factory closures, job losses and bankruptcies. The industry also learnt with surprise that Board of Investment levies were going up.

Only about 100 from 869 garment factories are able to keep their heads above water. The rest are doing badly, the meeting was told. It's not surprising then that industrialists want firm action and not "verbose and assurances".

Verbal assurances have been given by some cabinet ministers that this tax is a temporary one to tide over a crisis and would be lifted next year. But is there any written guarantee, one industrialist asked, saying: "how do we know they won't go back on their word?"

The call for street action is a reflection of how society has come to perceive government and parliamentarians. There is a serious lack of credibility on the part of all our politicians. They cannot be trusted and the public is no longer convinced that assurances and promises will be kept however trusting a minister can be.

Accountability is lacking amongst parliamentary representatives and garment industrialists like many others know that writing letters or meeting government officials to get assurances don't work any more. The call is now for firmer action in the only language that governments understand - street protests.

Street protests in recent years by the public over a range of issues have made or broken ruling parties. Journalists have resorted to it to protect their rights; human rights groups have taken to the streets to stress a point and many other protests marches have come from the community.

Now industrialists - who have been at the receiving end of trade union action by workers - want to join the bandwagon to push the government into some action.

The message is clear - if industrialists are unhappy about the way government business is conducted then the UNP's pledge to have a clean government and to initiate speedy corrective action becomes just a hollow promise. On the other hand, the government is short of revenue and taxing business is the only way to fill empty coffers.

If what the garment sector says is true, there is a need to re-examine tax measures and make sure they are equitable and bearable.

Doing business in N-E Sri Lanka
Problems, opportunities and challenges
By Muttukrishna Sarvananthan
There are two major problems encountered in doing business in the northeast despite the Sri Lankan government unilaterally lifting economic sanctions in January: one is the infrastructural bottleneck and the other is the taxation by the LTTE. The former includes poor conditions of roads, lack of electricity and telecommunication, the absence of railways, inter alia.

The roads in the LTTE-held areas are in a deplorable condition, which increases the transport cost of goods. Even after the opening of the A9 highway from Vavuniya to Jaffna the road transport cost is expected to be high because of heavy wear and tear to vehicles plying that route. Particularly the A9 route from Mankulam to Palai is in very bad condition. The interior roads are even worse especially during the rainy season, because most of it is gravel roads. Further, the arbitrary tax imposed by the LTTE on vehicles carrying goods is another key factor that pushes up the transport cost even higher.

The lack of electricity, telecommunications and railways are other major impediments to doing business in the LTTE-held areas of the north and the Jaffna peninsula. The lack of electricity in the LTTE-held areas prohibits manufacturing activities. The limited number of electric generators used is totally inadequate to cater to the needs of the producers and consumers alike, and is costly. The limited supply of power in the Jaffna peninsula is far short of the requisite. The absence of telecommunication links with the rest of the country greatly increases the transaction cost of businesses in the LTTE-held areas. Even the limited telecommunication facilities available in the Jaffna peninsula are totally inadequate to fulfil the demand. Usually, it takes a long time to make a call to or from Jaffna. The absence of railways, probably the cheapest source of transport to the province, is another cause of the cost-push inflation in the province.

Free flows
The lack of storage facilities is yet another impediment to doing business in the LTTE-held areas. For example, though the free flow of petroleum products to the LTTE-held areas is ensured in the Memorandum of Understanding (MoU) there is a lack of demand for diesel and petrol in those areas. This is mainly because almost all the vehicles (two, three, and four-wheelers) in the LTTE-held areas have been converted to run on kerosene (paraffin) during several years of economic sanction. Moreover, there are no underground storage facilities for petroleum products in LTTE-held areas, and over-ground fuel tanks are wasteful due to evaporation.

Furthermore, storage facilities for agricultural and fish produce are also lacking for want of suitable buildings and ice manufacturing plants in the LTTE-held areas of the Wanni region. Therefore, the export of perishable agricultural and fish produce of the LTTE-held areas to the rest of the country is undermined. During the pre-war times, while rice was exported from the Wanni region to the Jaffna peninsula, cash crops such as onions, chillies, and tobacco were exported to the South from the Wanni region. Besides, it is claimed that about two-thirds of the total requirement of fish in Sri Lanka used to be caught along an 80-mile coastline off Mullaitivu. Hence, the Wanni region used to be a significant supplier of agricultural and fish produce to the rest of the country including the Jaffna peninsula. These past data indicate the potential out there. The lack of storage facilities for perishable agricultural and fish produce calls for the revival of the construction industry in those areas. However, due to the dearth of bank finance (loans and overdraft facilities) to fund construction activities, the construction industry is still dormant despite the lifting of sanctions on construction materials such as cement, bricks, asbestos, tiles, etc.

The realisation of the full business potential after the lifting of economic sanctions is delayed primarily because of infrastructural bottlenecks such as the poor condition of roads, lack of electricity and telecommunications, and the absence of railways. Since the lifting of sanctions on January 15, though there is a surge in the export of consumer goods such as bicycles, bicycle parts and accessories, motorcycles, plastic furniture, office machinery, stationery, radios, televisions, building materials, etc, from the rest of the country to the LTTE-held areas, there is a long way to go to exploit the full business potential.

Another critical factor inhibiting the realisation of the full business potential in the aftermath of the lifting of the economic sanction is the arbitrary taxation of goods and vehicles en route to the Wanni region and the Jaffna peninsula by the LTTE. The taxation by the LTTE, though is justified in order to run a parallel administration in the territory under its jurisdiction, extends to goods meant for personal use as well. This arbitrary taxation is debilitating to the entrepreneurial instinct of the masses, especially in the LTTE-held areas.

Due to the high transportation cost and extra-legal taxation the prices of goods in the Wanni region are still quite high though lower than during the time of economic sanctions. Similarly, though the prices in the Jaffna peninsula have fallen after the opening of the A9 highway they are still quite high compared to the prices in the rest of the country, because of high transportation costs and arbitrary taxation. In fact, the people of the Wanni region are worse off now than during the time of economic sanctions. During economic sanctions there were severe restrictions on the export of Wanni produce to the rest of the country including the Jaffna peninsula. Therefore, the local agricultural and fish produce were relatively cheaper in the Wanni region. However, in the aftermath of the lifting of economic sanctions and the opening of the A9 highway more Wanni produce is being exported to the rest of the country including the Jaffna peninsula. These exports have resulted in higher local prices for agricultural and fish produce in the Wanni region, which has made the producers better off but the consumers (who are the majority) worse off.

Therefore, the re-building of basic infrastructure such as roads, power, telecommunications, and railways are sine qua non for the full realisation of the business potential in the north-east province.

The north-east province encompasses eight districts: five in the North and three in the East. According to the Central Bank of Sri Lanka, in 2001, there were about one million people living in the North and 1.4 million in the East. This data is based on the latest census undertaken in mid-2001. However, the data for the North is questionable because the census could not be undertaken in any of the districts of the province last year. Besides, the population data for the East is also suspect because about two-thirds of the land area in the East is under LTTE-control where the census was not undertaken last year.

The present actual total population of the north-east is not known to anyone primarily because no proper census could be undertaken in that province (especially in the North) after 1981 due to the civil war. However, according to disparate data from various sources, there may be about two million people living in that combined province: divided into one million each, out of the total Sri Lankan population of around 18.7 million in 2001. Thus, nearly 11% of the total Sri Lankan population resides in the north-east. A substantial proportion of the Eastern population lives in the government-controlled areas, though about two-thirds of the land area of the East is under LTTE-control. In the North, the Jaffna peninsula has a population of about 500,000 and the government-controlled areas in Vavuniya and Mannar districts have another 100,000. The rest - 400,000 - live in the LTTE-held areas in the Wanni region.

These population figures are given in order to estimate the size of the market in the north-east. However, the population size of the north-east given above is a rough estimate, and therefore should not be construed as perfect figures. Nevertheless, the market of the north-east is quite a big one, which has a significant business potential.

Although the priority for the province (especially the North) is the infrastructural development, it is highly unlikely that private capital (whether local or foreign) would flow into this sector especially because it is still a contested territory by the government and the LTTE. The infrastructural development should be undertaken jointly by the government and bilateral and multilateral donors. The agriculture, manufacturing, construction, educational and financial (banking and insurance) services, wholesale and retail trade all have huge potential to exploit. However, due to the aforementioned infrastructural bottlenecks the realisation of this huge potential is expected to be slow.

The immediate opportunities are in the agriculture, construction, educational and financial services, and wholesale and retail trade. The manufacturing sector (medium and large scale) will take sometime to take off because the infrastructural prerequisites are very limited at the moment. The north-east, historically, was an agricultural economy. The predominance of the agriculture sector has not essentially changed during the civil war. However, in the pre-war time the region was a significant exporter of agricultural and fish produce to the rest of the island. These agricultural exports included rice, onions, chillies, tobacco, lentils, etc. But, nowadays the agriculture sector in the province has been transformed by large subsistence agriculture, especially in the Northern Province. The agriculture sector has been severely hampered by economic sanctions that had restrictions on fuel, fertiliser, and pesticide going into LTTE-held areas. Hence, there is a potential to revive the commercial agricultural sector in the province especially for exports to the rest of the country.

One of the most lucrative sectors to invest is in the construction sector of the north-east. Due to the protracted civil war, damages to homes, commercial and public buildings, roads and bridge are immense. Therefore, with the ongoing resettlement of displaced people at their original homes there would be a huge demand for construction services. Therefore, the businesses involved in construction services have a huge potential to exploit in the province.

The financial sector has a key role to play in the reconstruction and rehabilitation of the north-east. With the anticipated flow of reconstruction and rehabilitation funds from the government as well as from the bilateral and multilateral donors the need for the banking and insurance sectors is real. The lack of capital is a major constraint to investment in the province. The re-establishment of financial institutions would go a long way in bridging the gap between savings and investment in the province. The financial institutions in the province would also benefit from private remittances from abroad.

Historically, the human resources of the north-east have been one of its most valuable assets. The people of the province have been investing a lot on education. This investment continued even during times of war despite severe hardships, such as occupation of schools by the Sri Lankan armed forces, lack of electricity, transport, etc. Therefore, the opening up of educational services in the province would cater to the long felt need of the people, especially in the fields of information technology and English language teaching. Information technology and English language are the keys to success in the 21st century. Information technology and English language are absolutely essential for all academic disciplines. Therefore, good quality educational services in information technology and English language teaching would have a great demand.

There is a huge pent-up demand for consumer goods especially in the LTTE-held areas. Economic sanctions of the Sri Lankan government deprived the people (especially who live in LTTE-held areas) of even basic consumer goods including pharmaceuticals for over a decade. Therefore, the establishment of wholesale and retail trade in the north-east would facilitate access to markets for the population. However, the lack of power and local taxes imposed by the LTTE is dampening the realisation of such pent-up demand.

Due to the long drawn out civil war a large proportion of the entrepreneurial class of the north-east has migrated to other parts of the country or abroad. Thus, there may be a dearth of entrepreneurs in the province, especially in the LTTE-held areas. The involuntary displacement of the Muslim community (who formed a vibrant trading community) from the North (particularly from Jaffna and Mannar) also contributed to this situation. The re-visiting of such entrepreneurs, as well as newer ones, to the north-east would help shore up the fledgling markets there.

There are two major challenges awaiting businesspersons who would like to do business in the north-east. One is the infrastructural bottleneck enunciated above. The other is the arbitrary (strictly speaking illegal) tax regime of the LTTE. It is well known that the LTTE imposes its own taxes on traders, producers, and households in the north-east including in the government-controlled areas. The entrepreneurs and households in the government-controlled areas of the northeast are paying taxes both to the government as well as the LTTE.

In the aftermath of the signing of the MoU the LTTE has spread its tax net to the people living in the government-controlled areas as well, such as the Jaffna peninsula, Batticaloa, Trincomalee and Vavuniya towns. This has resulted in the slow exodus of people from these government-controlled areas in the north-east to the rest of the island, particularly to Colombo and the suburbs.

The Tiger taxes create a moral hazard and an ethical dilemma for entrepreneurs planning to establish manufacturing, trading, or service-oriented business in the province. Should we pay or should we not, is the question often asked. The situation is delicate. There is a huge unemployment problem in the region due to the civil war. Therefore, the business community has a social responsibility to establish businesses in order to create employment opportunities and draw the vast army of unemployed into the national mainstream, and prevent them falling into the wrong hands.

Social taxes?
On the other hand, how does the business community handle the issue of Tiger taxes? There are two options - one is to refuse to pay and the other is to pay up. The former is the ethically most correct thing to do. Having said that I am not sure how far this is practically possible. Therefore, some business people may decide to pay up the Tiger tax and continue to do business in the region. If this is the option left to any businessperson then I would suggest a mechanism by which they could mitigate the effects of such unethical taxes. That is, no one should pay the Tiger tax directly to the LTTE. Instead they may ask the LTTE to suggest some social welfare programmes, or community services they would like to do for the local community and finance such programmes or services. By this mechanism the taxpayers do not pay cash to the LTTE, but fund community welfare-oriented projects identified by the LTTE. Thus, the taxpayer would be providing a social service and at the same time ensuring that their tax payments are not utilised for military purposes. This mechanism, I believe, would mitigate the moral hazard of doing business in the north-east at this critical juncture in the history of this country.

If you opt to keep away from doing business in the north-east the consequences could be fatal to the entire country. Therefore, I would strongly urge the business community to take up this moral and ethical challenge and fulfil their enormous social responsibility to the north-east and to the country at large. However, please try your best to avoid paying the unethical taxes of the LTTE, if not at least try your best to minimise the consequences of such taxes.

It is not only important to establish businesses in the government-controlled areas of the region. Please remember that it is absolutely vital to open businesses in the LTTE-controlled areas as well, in order to provide employment opportunities and revive the dormant economy of those areas. Historically, the Eastern Province has been relatively less developed than the Northern Province prior to the eruption of the civil war. Therefore, please invest in the Eastern Province as well when you plan to expand your businesses to the northeast.

Finally, the Government of Sri Lanka also could help the business community in mitigating the moral hazard of doing business by handing over the interim administration of the province to the LTTE as soon as possible. Once the LTTE takes over the interim administration there would be no justification to impose its own taxes, because official funds would flow for the development of the province. If the LTTE continues to impose its own taxes even after the establishment of the interim administration, what does the business community do? I would strongly urge non-payment and non-compliance.

The business community of Sri Lanka is faced with an unprecedented moral hazard and ethical dilemma in the north-east. I sincerely hope it has the tenacity to mitigate this challenge.

(The author is an economist and the above observations were made from study tours to LTTE-held areas in the Wanni region during March and April 2002. However, he says he is yet to travel to the Jaffna peninsula and the Eastern province and therefore these observations are somewhat limited.)

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