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5th September 1999

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Mirror Magazine

Dreams do come true. .. at least the
phase of it for Sri Lanka's newest
hotelier Mr. Uma Kumar Sharma who
pocketed out Rs. 413 million for his
favourite hotel, the Hotel Ceylon
Intercontinental. Phase two will be a
full scale refurbishment complete
with dicotheque and all to be opened for
the millenium and the third phase will
be a 100-room addition which will e
ventually bring his hotel a six star stat
us making it the hottest hotel property in
Colombo. See Interview --->
I'm not buying any more hotels: Sharma


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Vanik to spread its wings soon

By Mel Gunasekera

Vanik Incorporation will venture into development banking activities and spin off its lucrative leasing and factoring operations, Vanik chief said.

The changes are part of Vanik's re-structuring activities, which are scheduled for end September.

"We want to separate all lending activities or fund based activities from the main company, so that Vanik can focus on the proper merchant banking operations," Vanik chief, Justin Meegoda said in an interview with The Sunday Times Business.

Meegoda says that Vanik has veered away from merchant banking operations over the past two to three years.

With market not doing too well, Meegoda admits Vanik became complacent and hoped the market would pick up.

"We went too far and got bogged down in lending activities."

Under the re-structuring process, 'the clutter', as Meegoda puts it, will be taken away from the main company. Separate companies are being formed with their own CEO's.

"It will not be just a paper company, it will have a powerful board so we don't have to get involved with their day-to-day activities."

The new CEO's would be Sisira Jayasinghe (Vanik Development Bank), Piyal Dahanayake (Vanik Leasing Ltd.), and Keerthi Wijeratne (Vanik Factoring Ltd.).

The development bank will initially operate as Vanik Development Finance pending a Central Bank licence. The bank will only do project lending activities. "We want to be unique and it will only do that and nothing else."

Initially, it will be focused on medium scale operations. Later, once credit lines are secured from international lending agencies, the bank will focus on small and medium projects.

The bank would be very conservative and not be distracted. It will strictly do project lending, term lending, or may be a little bit of equity financing. The company will not even do working capital finance.

The merchant bank will not do project lending hereafter.

Vanik has also created an internal risk management unit, which will be supported by an executive committee on risk management.

The committee will have direct board communications and can veto any projects from any subsidiary companies which fail to meet the board's risk levels. While Meegoda will head the committee, other members will include senior treasury and finance division staff.

The merchant banking operations will steer away from capital market related deals and focus on areas like re-structuring, consultancy management, mergers and acquisition type of deals.The corporate finance and mergers and acquisition department has been merged into the merchant-banking group.

In an attempt to dispel the negative publicity surrounding the company, Vanik has engaged a firm to do an opinion survey among shareholders, employees, clients, investors, media for a frank analysis and any proposals they may have for the company.

Seylan beefs up capital

By Dinali Goonewardene

Seylan Bank will issue Rs. 300 mn in unsecured, redeemable, non convertible debentures of Rs 100 each, at 13% - 15% interest, using the five-year treasury bonds as a benchmark.

Subject to CSE and SEC approval, the issue is scheduled for the end of the month.

The additional Rs. 300 million will beef up their tier two capital by 1 per cent to 8.9 per cent, Assistant General Manager, Corporate. Planning and Research, Saliya Kumara said . Most of the funds will be diverted to the housing loan sector. Seylan previously issued Rs 600 mn worth of debentures at an interest rate of 14.37 per cent. "There was an unusually large participation in the issue with an increased subscription from retail clients and lower participation from corporate clients," Mr Kumara said.

"However in addition to new participation there was a switch from time deposits to debentures," he added. The new issue will not be underwritten as the bank is confident of a similar response to their second debenture from the investing public. The bank will use its large network of branches in Colombo and the outstation to sell their debentures.

"It is not correct to say that people now do not have money. If you track the deposit growth over a period, say, before and after this government took over, there is no difference in the growth. This is just media hype," Saliya Kumar said.

P&O to takes over SLPA's container handling

Inter-terminal trucking of all containers in the Colombo port is to be handed over to the South Asian Gateway Terminal (SAGT) under the P&O deal, a telegram sent by the Association of Container Transporters (ACT) said.

Industry officials said they were informed last week that the recently formed P&O Company, SAGT was going to handle all transport between the SAGT and the Jaye terminal. Unconfirmed reports say SAGT is authorised to appoint or operate its own transport system within the port under the recently signed P&O deal. SAGT officials were not available for comment.

However, reports also say that the SAGT in turn is planning to hand over transport services to only one of the existing transporters.

If this deal goes through, industry officials say at least 3000 people involved in the transport business directly and indirectly will be affected. Around 15 independent trucking companies have invested more than Rs. 140 million in equipment to service this sector in the last decade, industry officials said.

The issue came up when the SAGT failed to take over operations from the Ports Authority last Tuesday as part phase one of the Queen Elizabeth Quay (QEQ) development project. Local newspapers reported that the SAGT had refused to take over operations because several conditions were not fulfilled.

A spokesmen for the SAGT had said there were several factors to be ironed out before they took over as they did not want problems, including the lease of the land, a mortgage of the site involving a Japanese company, after the start of the project. The spokesman had also said they were ready to take over the site and had even installed a new computer system.

Inter-terminal transport, usually handled by the Ports Authority was handed over to independent transporters in the last decade due to the inefficiency of the Ports Authority. Officials said that if not for the independent transporters the port wouldn't be in the position it is in today.

ACT Organising Secretary said all they were asking for was that the transport function be left as it is, so that it will not affect those concerned. The association is urging the government to intervene to stop the handing over of inter terminal trucking of all containers in the port of Colombo to the SAGT.

Colombo stocks illiquid, says study

Nearly 50 per cent of the companies listed on the Colombo Stock Exchange are illiquid, a recent survey conducted by Merchant Bank of Sri Lanka reveals.

While statistics shown above may look alarming, Dr. Lalith Samarakone of the Sri Jayawardenepura University who conducted the study is not surprised by the results.

"Over the last five years the same sort of companies come out as illiquid stocks."

The companies are highly profitable, but closely held or they are shell companies. There are others that are being de-listed, or their trading has been suspended.

"We had problems even getting 25 companies for the mid cap index," he said.

An index needs to track companies which are investible, you need to get in and get out without much difficulty. Unless you have a strategy of very long term investment, it's not viable, he said.

Illiquidity has plagued our market for years, despite Sri Lanka being streets ahead of its neighbours in terms of technology.

"From a fund manager's point of view it's not worth investing if there is no liquidity. It has not received much attention from policymakers," Samarakone says.

Another alarming point is the poor distri bution of shareholder ownership.

A quick glance at the shareholder structure of listed companies shows less than 1% of shareholders own 86% of the company.

In other words, 99% of shareholders own only 4% of the company. In developed markets around 50% of shares are held by large institutional investors like the pension funds and the insurance funds.

The survey was based on financial performances of 1996/97.

But Dr. Samarakone argues that the figures don't really change.

"The aggregate is for the whole market. This is the average for the whole market. It could change by perhaps 1%."

                                     Trade statistics Jan. -June 1999

                                                                                No. of companies

    No trades                                                                     23
    Below 100                                                                  106
    Between 100-500                                                         70
    Between 500-1000                                                       14
    Above 1000                                                                  26
    Total 239

                                                                                        (Source: MBSL)

India and Ukraine cut duty on Ceylon tea

By Shafraz Farook

The taste of Ceylons tea seem to have finally got through to the Indian authorities who last week raised the quota for imports to 15 million kilos at half the prevailing duty. In addition to this Ukraine too decided to cut import duties on Ceylon tea by 50 per cent of the prevailing duty. Industry officials were very enthusiastic, and hoped for better prices in last week's auctions.

In the latest round of talks on the Indo-Lanka Free Trade Agreement, Indian authorities have decided to raise the quota of Ceylon teas. Earlier India's quota for Ceylon tea was five million kilos or US$ 10 million (which ever was reached first) at 10 per cent import duty and a 9.5 per cent excise duty. Under the current agreement the import duty has been brought down to five per cent.

Officials said though duty-free exports were anticipated, something was better than nothing after so long. The Free Trade agreement, which was signed in December 1998 was in a deadlock when Indian officials pulled out from providing concessions on Ceylon tea.

However, this also means that India is either trying to develop its value added market base or trying to meet local consumer demand. Last week The Sunday Times Business published extracts of Kenyan tea export figures which showed an increase in Indian tea imports from Kenya. Sri Lanka on the other hand had reduced its imports from Kenya. Industry officials say that we should watch out, since India might be a threat to our ailing value added market.

Ukraine one hand is purely welcome. Officials decided to slash duties to 20 per cent from the prevailing 40 per cent after talks between the Sri Lankan ambassador to the Russian Federation N. Sikander and First Deputy Minister of the Ukrainian Ministry of Foreign Economic Relations and Trade Valentyn M Shevalov. Ukraine imports significant quantities of good quality high growns and some low growns, Asia Siyaka officials said. However, the agreement will have to be ratified by the Ukrainian Parliament.

"Any additional demand is welcome," Asia Siyaka officials said commenting on both agreements. Effects of the deals are said to be felt by late this year.

Has fiscal discipline been forgotten

When the government assumed power in 1994 it placed central importance on fiscal discipline. The large budget deficits of the past were considered the underlying reasons for inflation and other fundamental weaknesses in the economy.

The control of inflation was considered a primary prerequisite for economic stability and growth. The first Economic Policy Statement articulated this very clearly in these words:

"The eventual goal of policy would be to continue to reduce the overall fiscal deficit from a level of 8 per cent of GDP in 1993 to a level of 3 to 4 per cent of GDP well before the year 2000, which would both be consistent with a significant reduction in inflation, and be sufficient to absorb a reasonable amount of concessional aid.

"In order to accomplish this goal, budgetary revenue will, as mentioned, be buoyed up by rapid economic growth and tax reform. A substantial current account surplus will be generated both by the significant reduction of military expenditure and by curtailing unnecessary and wasteful current expenditures, both through improved targeting of welfare programs and reducing the role of the public sector in the economy.

"The long run objective would be to run an overall surplus in the Budget so as to enable the retirement of the high stock of public debt which is outstanding."

There were others who felt that an overemphasis on fiscal discipline could be at the expense of economic growth and long run development.

"A little bit of inflation", some would argue, was inevitable in the country's situation and necessary for economic growth. The government put its trust in the current orthodoxy of the multilateral agencies, for whom such fiscal discipline and low budget deficits are conditions for lending.

What is significant after five years of the government is not the correctness or otherwise of this policy stance, but the fact that it did not achieve it's stated objective. It has not reduced the overall fiscal deficit "to a level of 3 to 4 per cent of GDP".

The last (1998) Annual Report of the Central Bank had this to say about the budget deficit:

"The current account deficit increased by 2.4 per cent of GDP in 1998 from 2.2 per cent in 1997, while the overall deficit rose to 9.2 per cent from 7.9 per cent in 1997". This makes it very clear that the objective of a low deficit and the optimistic expectation to "run an overall surplus in the Budget" remains a dream. The Central Bank goes on to say that "the magnitude of the slippage was worrisome. It thwarted the objective of easing the high interest rates to promote investment and employment".

There are many reasons for not realising the desired objective.

The continued increases in defence expenditure, high welfare expenditures and an inability to increase revenues are among the important causes for this state of affairs.

It is also doubtful that the government has curtailed "unnecessary and wasteful current expenditure". What is more, government expenditure is likely to rise in the next year, with an election round the corner.

There is however one correction the government has made in the light of emerging conditions, for which the government should be commended. In earlier years the government reduced the outturn in the budget deficit by cutting down capital expenditure.

Last year, the government increased budgetary expenditure on capital expenditure. This is indeed an important aspect of public expenditure.

The curtailment of capital expenditure, particularly on the development of infrastructure, could hamper long term economic growth. The government has also gone ahead with tax reforms, most of which are beneficial to the economy.

Unfortunately, a low budget deficit cannot be achieved owing to a vast committed expenditure on debt servicing, pensions and welfare. Welfare expenditure continues increasing owing to the political benefits to the government.

The Samurdhi program alone absorbs about Rs. 9 billion and can hardly be described as a better targeted welfare measure when only about one half of the families in the country receive the benefit. Fiscal discipline is not merely the achievement of deficits within certain proportions of GDP. It also means the curtailment of unproductive expenditure and direction of government funds in a non-inflationary and growth oriented manner.

The government has not only failed to achieve its own goals of reducing the budget deficit, but also failed to cut "unnecessary and wasteful current expenditures" by "targeting of welfare programs".

Draft Companies bill ignores off-shore companies

The origins of off-shore companies in Sri Lanka coincides with the establishment of an "open economy" in the post 1977 period. The legislative provisions relating to off-shore companies in Sri Lanka are set out in part VIII of the Companies Act (No. 17 of 1982). It is unfortunate that the identical legislative provisions of Part VIII of the Companies Act 1982 are reproduced in the draft Companies Act 1999 without investigating the efficacy of such legislative provisions and its importance and relevance in making Sri Lanka an off-shore financial centre in South Asia.

The registration of off-shore companies in Sri Lanka was initiated by the late Mr. Lalith Athulathmudali when he was the Minister of Trade and Shipping. In moving the Second Reading of the Companies Bill 1981 in Parliament, Mr. Athulathmudali said that one of the purposes of this Part VIII of the Bill is to attract off-shore shipping companies by providing a Sri Lankan "flag of convenience" which he aptly described as a "flag of opportunity". It was also designed to provide employment to youth as seafarers as in Greece, Panama or Liberia. It appears that his idea was to create a "niche" market for off-shore shipping companies.

However, the above idea has not succeeded due to several reasons. Firstly, the eruption of the ethnic conflict in July 1983 disturbed the prospect of Sri Lanka becoming an off-shore financial centre. Secondly, the lack of institutions, structures and processes necessary to market off-shore companies especially off-shore shipping companies with the requisite services and expertise contributed to its slow progress. Thirdly, there was also very little professional awareness among lawyers and accountants of the value of off-shore companies as a strategy for attracting investors for creating new employment opportunities, sources of revenue, income for professionals and above all as a modality to upgrade the tourism product to an up-market destination. As a result, we have only registered 64 off-shore companies for the past 17 years. In contrast off-shore companies registered in the Bahamas, British Virgin Islands (BVI) and Labuan (Malaysia) exceed 300,000. In 1993, BVI alone registered 28,618 off-shore companies.

By D.L. Mendis
Off-shore companies and international tax planning

Off-shore companies are used today as a vehicle in international tax planning since they are tax exempt or subject to low tax. These companies are registered as trading companies, insurance companies, Asset Protection Trust (APT) companies and investment companies for individual portfolio management or collective financial services. In most instances, corporate clients and high networth individuals (HNWIs) establish these off-shore companies to reduce their tax burden. This is in line with Lord Tomlin's dictum in I.R.C. vs. Westminster (1936) to the effect that "Every man is entitled if he can to order his affairs so that the tax attached under the appropriate Acts is less than it otherwise would be." However, the "US"Business Purpose Rule" and the French "Abus de Droit" do not adopt such a liberal approach in construing tax legislation.

The off-shore shipping companies registered in Sri Lanka are exempt from tax under the Inland Revenue Act of 1979. Non-shipping companies do not enjoy the same benefits since there is no special legislative authority. It is likely that the Commissioner of Inland Revenue will tax these companies although the profits generated by these companies arise outside the territory of Sri Lanka. It is indeed an area that needs complete reform. In order to achieve such reform, the tax regime applicable to the off-shore companies must be set out in an attractive manner in Part VIII of the draft Companies Act 1999 as in other off-shore companies for the benefit of discerning investors or prospective clients.

It must be noted that in the United Kingdom (UK), under the concept of controlled foreign companies, off-shore companies are taxed on their income if the central management and control is done by the UK and not in the country where it is registered. This is the practice since the De Beers (1960 ) Case.

This principle is now enshrined in Section 739 of the Income and Corporation Tax Act 1988. In Germany, the same principle is followed by reference to the "Real Seat" doctrine and in France by reference to the "Abus de droit" doctrine.

Hence, even if Sri Lanka may exempt off-shore companies from tax, they would still be liable for taxes in developed countries. Subject to the aforementioned rules, however, an off-shore company registered in Sri Lanka will pay at a lower rate in Sri Lanka in terms of the double tax agreement entered into by Sri Lanka. In this context, such companies will be liable to a reduced tax on profits, dividends and gains.

It must also be noted that the off-shore companies can avoid high taxes imposed in developed countries through transfer pricing. Transfer pricing occurs when an off-shore company engages in international trade either by purchasing or selling its goods and services for more than the arm's length prize to minimise tax liability. In such situations, the price manipulation by a parent and subsidiary company can lead to tax benefits in international trade despite anti-avoidance legislation in developed countries.

Registration of off-shore companies

The law relating to registration of off-shore companies is contained in six meagre sections (section 241-246). It is inadequate when compared with other off-shore company legislation in the Bahamas, Cyprus or Labuan (Malaysia). In these countries, off-shore company legislation contains more than 150 sections and provide for varied products and services. Undoubtedly, such legislation will be more attractive for rich corporate clients and HNWIs than what has been offered in Sri Lanka under the draft Companies Act 1999.

An examination of the draft legislative provisions reveal that it is somewhat uncertain as to what type of companies can be registered as off-shore companies in Sri Lanka. The type of companies which cannot be registered must be laid down. The uncertainties are compounded as the legislation does not spell out the tax regime applicable to such companies. There is no provision as to the fate of off-shore companies registered in fraud of creditors. It is a contentious matter and well regulated in other off-shore financial centres.

Therefore it is important to analyse the provisions of the draft Companies Act 1999 before commenting on any changes. Section 241 makes provisions to re-domicile an existing company as well as to incorporate a new off-shore company in Sri Lanka. This section contains the various documents necessary to be annexed for such incorporation or re-domiciliation. It requires the name and address of a person resident in Sri Lanka to be the Agent of such off-shore companies. It should also have a registered office and a principal place of business.

Section 242 allows the Registrar of Companies to refuse incorporation or re-domiciliation of an off-shore company in the interest of our national economy. It also requires the Registrar not to incorporate a foreign company, if such a foreign company has initiated the winding up proceedings in another state.

In Sri Lanka, an off-shore company in all respects resembles a company registered under the Companies Act 1982. The Articles of Association and the Memorandum of Association have to be notarially executed by an Attoney-at-Law. It has a separate legal personality from its directors and share holders. It has limited liability and perpetual succession. It can hold property and be liable to contracts, torts and crime. It has to file an annual report and audited accounts annually and be subjected to public scrutiny and rigid supervision of the Registrar. Hence, off-shore companies have no separate legal regime in Sri Lanka as in other off-shore financial centres.

Part VIII of the draft Companies Act 1999 is not comprehensive and thereby need radical reform in order to be attractive for registration of off-shore companies in Sri Lanka. It must specifically provide for bearer shares/warrants, one shareholder company, corporate director, one director, non-disclosure of accounts to the general public, non-disclosure of beneficiaries and some confidential provisions. It is only then such legislation can be marketed to increase the number of off-shore company registrations. Any such increase in company registrations can enhance avenues of employment and sources of income for lawyers, bankers and accountants as such off-shore companies may establish offices in Sri Lanka because of its geographic proximity to India. In some jurisdictions, even the fees charged in foreign currency for professional services by lawyers and accountants are exempt from income tax as an incentive to encourage professionals in this direction.

Fees payable by off-shore companies

In the registration of an off-shore company, several types of fees are charged in lieu of no tax or low tax. It is a source of revenue for the Government of Sri Lanka. These fees are paid on the initial registration and on an annual basis.

However, the fees do not include the charges for services provided by lawyers, accountants and bankers to off-shore companies and such charges vary from one individual or bank to another.

In Sri Lanka, the prescribed fee for registration of an off-shore company is determined by Regulations. In terms of the existing Regulations, fees payable to the Government of Sri Lanka can be classified by reference to:-

(1) an off-shore shipping company and
(2) an off-shore non-shipping company .

In 1997, the prescribed fees for shipping and non-shipping companies were upgraded. A shipping company pays an annual fee of US$250, while a non-shipping company pays an annual fee of Rs 15,000/- irrespective of the share capital. A shipping company has to deposit US$250 to defray any office expenses while a non-shipping company has to deposit US$33,000/- in a bank to defray any expenses. The whole fee structure is flawed and a more realistic fee structure must be established in line with other off-shore jurisdictions. The need to deposit US$33,000/- to defray any office expenses is an anomaly since it does not serve any purpose.


The draft off-shore company legislation in Sri Lanka has serious inadequacies. These inadequacies are dealt with in the following paragraphs and need to be addressed legislatively in a separate Parliamentary Act if Sri Lanka is keen to establish an attractive legal regime for registration of off-shore companies. It is opportune to do so as there is room for an active player in the South Asian Region. Unless action is taken speedily, it is likely that Sri Lanka will "miss" the boat and Mauritius will become the off-shore financial centre for the South Asian Region with special links with India.

The major inadequacies in Sri Lanka in regard to off-shore products and services are associated with legislation. The draft legislation does not spell out an attractive tax regime relating to off-shore companies. It does not incorporate recent legal innovations introduced in reputed off-shore financial centres. It does not attempt to secure an element of confidentiality which is essential for off-shore companies. It is not clear whether an off-shore investment company, insurance company and an asset protection trust company or non-banking financial services company can be registered under the draft legislation. It is a matter left to the discretion of the Registrar in terms of national interest and national economy. Therefore these inadequacies will certainly discourage a prospective client or an investor in registering off-shore companies in Sri Lanka.

The registration of off-shore companies is limited to Attorneys with a Notarial licence and not extended to an "Agent" as defined in other off-shore financial centres. In many jurisdictions off-shore companies are incorporated by non-lawyers such as accountants and they come within the definition of an "Agent"

The fee structure and the requirement to deposit a sum of US$33,000/- is certainly an anachronism associated with the registration of off-shore companies in Sri Lanka. This kind of requirement is not seen in any off-shore company incorporations. It is unproductive and also difficult to enforce effectively and even if deposited, can be withdrawn. A more competitive fee structure and an up-graded legislation are paramount to enhancing the volume of off-shore company registrations in Sri Lanka.

The very poor performance in regard to registration of off-shore companies is due to many other reasons. There is no office in Sri Lanka to market this product abroad and to provide information and services in the form of attractive brochures and explanatory notes. There are no law firms and accounting firms engaged in this exercise although our professionals are capable of delivering the services cheaply and effectively. There is much to be done through Sri Lankan Embassies and High Commissions, if Sri Lanka were to enhance the volume of incorporations of off-shore companies and emerge as an off-shore financial centre.

However, nothing is possible unless part VIII of the draft Companies Act 1999 is deleted and replaced by a modern Parliamentary Act relating to Off-shore Companies. It is appropriate to draft such an Act on the lines of the International Business Companies Act of BVI, Barbados, St. Kitts-Nevis, Bahamas or Labuan (Malaysia). Hence the reproduction of Part VIII of the Companies Act 1982 (No. 17 of 1982) in the draft Companies Act 1999 is a retrograde step undertaken by the draftsman of the IBRD without fully understanding the inadequacies, deficiencies and defects of the existing legislation applicable to off-shore companies.

( The writer was formerly UN legal expert and adviser to the off- shore financial centre in the Caribbean state of St. Kitts and Nevis. He was instrumental in drafting legislation in this field in close conjunction with a well known Washington based legal firm- Smith and Wayne.)

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