1. 1

2. 2

3. 3
Residence is a material factor for a person in determining tax liability and
for the purpose of applying many provisions of any tax legislation. A person
resident in the state is liable to tax on his worldwide profits and income
while a non-resident is liable to tax on only income which arose or derived
from that particular state.
Different jurisdictions have different ways of defining tax residence, which
creates further complexity for business entities like companies, operating in
more than one jurisdiction.
Specially non-residents need to ensure that their business entity is only
subject to tax in the jurisdiction it is intends to be taxed. Failure to get this
right could result in multiple tax liabilities in multiple jurisdictions.

4. 4
The basic function of a charging section is to impose tax legislated by the
parliament. Charging section is in a nutshell, lay down a broad outline within
which the whole tax system is operated. The whole system follows after the
charging section and it is really an elaboration or an amplification of what is
stated in the charging section. Therefore more precisely, the imposition of tax
should be clear and unambiguous terms.
In the case called Cape Brandy Syndicate v Inland Revenue Commissioners
(1921) 12 TC 358, Judge Sidney Rowlatt expressed his views as;
”It is urged that in a taxing act, clear words are necessary in order to tax
the subject… It simply means that in a taxing act, one has to look merely
at what is clearly said. There is no room for any intendment… There is
no presumptions as to a tax. Nothing is to be read in, nothing to be
implied, one can look fairly at the language used”.

5. 5
Accordingly, in terms of Section 2 of Inland Revenue Act No. 10 of 2006
(Hereafter referred to as “The Act”), Income tax shall be charged on the profits
and income of every person for any year of assessment;
a) Wherever arising, in the case of a person who is resident in Sri Lanka
in that year of assessment; and
b) Arising in or derived from Sri Lanka, in the case of every other person.
“Profits and income arising in or derived from Sri Lanka” includes all profits
and income derived from services rendered in Sri Lanka or from property in
Sri Lanka, or from business transacted in Sri Lanka, whether directly or
through an agent.
“Person” includes a company or body of persons or any government.

6. 6
The charging section of The Act has introduced the concept of resident and
non-resident which are very important for determining tax liability. This is
called as the status of the person which is defined in a Section 79 as;
“Where a company or a body of persons has,
1. Its registered or principal office in Sri Lanka, or
2. Where the control and management of its business are exercised
in Sri Lanka,
such company or body of persons shall be deemed to be resident in Sri
Lanka for the purposes of The Act.”
Accordingly, if any person does not fulfill both criteria above, such person
deemed to be a non-resident for the purpose of taxation in Sri Lanka.

7. 7
Is Registered or Principal Office in Sri Lanka?
Resident
YES NO
Is Control & Management Exercise in Sri Lanka?
YES NO
Resident Non-Resident

8. 8
This definition has based on some old English cases. Originally the idea was
that a company was resident in the country where it was incorporated. But the
House of Lords came to a different conclusion in the case of De Beers
Consolidated Mines Ltd v Howe (1906) 5 TC 213.
It was held that De Beers Consolidated a diamond mining company
incorporated in South Africa was liable tax in United Kingdom on the basis of
the Board of Directors held their board meeting in UK and made some
important policy decision relating to the running of the company.
The House of Lords said that the company was resident in UK and Lord
Loreburn said;
“A company resides … where its real business is carried on … and
the real business is carried on where the central management and
control actually abides”.

9. 9
This precedent was followed by the number of cases later called;
1. New Zealand Shipping Company v Stephen (1907) 5 TC 553
2. Egyptian Delta Land & Investment Co. Ltd. v Todd (1928) 6 TC 152
3. Bullock v Unit Construction Co. Ltd. (1959) 38 TC 712
In Bullock v Unit Construction, African subsidiary company which was
incorporated and trading in Africa were held to be resident in the UK by
reason of the degree of management and control over their businesses
exercised in the UK by the parent company.
The decisions in both De Beers and Unit Construction cases make it clear that
the place of central management and control is primarily a question of fact.
Because the control is exercised by the Board of Directors in accordance with
the articles of the company.

10. 10
Basically the question is, “where does this income arisen?” is important for a
non-resident person because, the rule in the case of a non-resident person,
only profits and income arising in or derived from Sri Lanka is liable to tax.
But occasionally where the income arises may be important even for resident
person as a result of existing of some provisions in the act to grant reliefs in
respect certain income arose outside Sri Lanka.
Example is certain profits and income derived outside for a person in Sri
Lanka is exempted from tax under Section 15
Therefore the location of income is significant not only for a non-resident but
also for resident person in Sri Lanka, in view of granting reliefs and
exemptions or some kind of special treatments such as applying reduced tax
rates.

11. 11
There are certain rules which are recognized as “Source Rules” to answer
the question “where does this income arisen?” In plain terms source rules
can be described as;
 From where income is sourced? or
 From where income is routed?
Originally these source rules were the creations of the judges who have
decided from where the particular income arose. Therefore these rules
came to know as Common Law Rules which can be described as Judge
Made Laws as distinct from Statute Law which is created by the
parliament.
These Common Law Rules are equally important as Statute Law in
determining location of income.

12. 12
1. Interest income arises in the location where the debt contract is made.
2. Rent income arises in the location where the property is situated.
3. Royalty income arises in the location where the property giving raise to
that income is registered.
4. Dividend income arises where the Fund of Profits from which the
dividend is paid, maintained or kept.
5. Annuities arise in the location where the instrument relating to the
annuity is made.
6. Capital Gains arise in the location where the property giving rights to
the capital gain is located.

13. 13
The tax liability of a non-resident on profits and income arising in or
derived from Sri Lanka consists of;
1. Profits and income under Section 2 (1) (b)
a) Service rented in Sri Lanka.
b) Property in Sri Lanka.
c) Business transacted in Sri Lanka whether directly or through
an agent.
2. Interest on certain loan under Section 93
3. Certain royalties under Section 94

14. 14
Some of Source Rules (Common Law Rules) created problems for the tax
administration in the most of countries. A concept called Statutory
Modifications have been enacted by relevant parliaments as a remedy for
such source rules which has an effect of modifying the Common Law Rules.
The following provisions have been introduced in The Act to modify these
Common Law Rule.
1. Statutory modification for business income under Section 84.
2. Statutory modification for interest income under Section 93.
3. Statutory modification for royalty income under Section 94.
The Parliament of Sri Lanka has not intervened for other common law rules
and therefore the common law rule for dividends, annuities and services
remain unchanged.

15. 15
Under Section 2 (1) (b), service income arises in the location where services
are rendered which can be treated as the source rule relating service.
An Australia case called Commissioner of Federal Taxation v Efstathakis
(1979) 38 FLR 276 where Mrs. Efsthathakis was a Greek citizen was employed
by Greek Government in media office in Australia. Tax authorities assessed
her remuneration for tax as service income arising in Australia by a non-
resident individual. The Australian Supreme Court held that she was liable
for tax as income arose within the country or service rendered in Australia.
Further court said, service income arises where the services are rendered and
not where the salary is paid or where the contract of service is made.
Efstathakis’s case is important for Sri Lanka as Section 2 (1) (b) is similar to
Australian Law.

16. 16
Profession or vocation of actor, musician, athlete or acrobat is liable for tax
under Section 96 (1) as;
“Every person or partnership who or which makes a payment to any other
person who;
a) is not a citizen of Sri Lanka; and
b) carries on or exercises the profession or vocation of an entertainer or
artiste,
in respect of services rendered by such other person in Sri Lanka in the course
of carrying on or exercising such profession or vocation, shall deduct from such
payment income tax at the rate specified in the Fifth Schedule to this Act.

17. 17
A non resident person is liable to tax on profits and income arising in or
derived from Sri Lanka whether directly or through agent. These words have
the same meaning as “trade exercised with United Kingdom” in the their
act. Therefore, the precedent of United Kingdom tax cases play a decisive role
in ascertaining a tax liability of non-resident person in Sri Lanka.
In addition to Judicial Precedents, the following important tests is very useful
to decide whether the business is transacted in Sri Lanka or trade is being
carried on within Sri Lanka.
1. Where the contract is signed.
2. Where the delivery is taken place.
3. Where the price is paid.

18. 18
1. Erichsen v Last (1881) 1 TC 351
2. Grainger & Sons v Gough (1896) 3 TC 311
3. Anglo Persian Oil Company Ltd. v CIT (1935) 1 CTC 92
4. Ceylon Financial Investment Ltd. v CIT (1941) 1 CTC 234
The first 2 English Cases where the source rule relating to business income
came to be formulated and House of Loads has taken into account the place
where the contract is made. In Grainger Sons v Gough, the revenue argued
that sending price list by French wine manufacturer to UK agent is a offer. But
court clearly pointed out that offer was made by UK customers and accepted
by French wine manufacturer and therefore contact was made in France. Con..
The source rule relating to trade or business can be found in following of cases
where the facts are very clear cut.

19. 19
A judge said why they formulated the particular rule in this way saying, if
you go by any other consideration like where the goods are delivered, where
the payment is made that we make international trade is impossible.
Example, a vehicle permit holder in Sri Lanka goes to Toyota Agent in Sri
Lanka and place the order with them. The agent will transmit that order to
Toyota Corporation in Japan which send the vehicle to the permit holder.
Is Japanese Company liable to pay tax in Sri Lanka on the profit that they
made on that car?
They are not liable for tax in Sri Lanka because the contact is made in Japan. If
we try to made them liable on the basis they are doing business here Toyota
Corporation never send cars.

20. 20
But the Sri Lankan Government cannot tolerate that principle as estates are in
Sri Lanka. Therefore, the parliament in Sri Lanka enacted a rule which can be
found in Section 84 and the same section there as Section 38 in the Income
Tax Ordinance - 1932.
The source rule called “business is transacted where the contract is made”
which created a problem for Sri Lanka from very beginning due to the most of
tea estates are owned by companies in England. The practice was that time is
all tea manufactured in Sri Lanka exported to head office in England on
consignment and the sales take place at the London Tea Auction. The estate
owner non-resident company can argue that the contracts are made in UK
therefore the profits arises there is not liable to tax in Sri Lanka.

21. 21
Under Section 84, where a non-resident person carries on any agricultural,
manufacturing or other productive undertaking;
1. Sells any product of such undertaking outside Sri Lanka, or
2. Delivery outside Sri Lanka,
Whether the contract is made within or outside Sri Lanka, the full profit
arising from the sale in a wholesale market shall be deemed to be income
arising in or derived from Sri Lanka.
If such profit has been increased through treatment other than handling,
blending, sorting, packing and disposal of the product outside Sri Lanka, the
profit increased shall not be deemed to be income arising in or derived from
Sri Lanka.

22. 22
Where any such product is not sold in a wholesale market, or is not sold at
all, such person shall be deemed to derive profits from Sri Lanka within the
meaning of Section 2 of The Act.
Such profits shall be deemed to be not less than the profits which might have
been obtained, if such person had sold such product wholesale to the best
advantage.
Section 84 is a example where the parliament in Sri Lanka interfered in order
to modify the source rule relating to business income. Otherwise the profit
earned by non-resident companies in UK goes untaxed.

23. 23
Under Section 80, goods manufactures outside Sri Lanka, the liability of a
non-resident person from sales is limited to;
1. The wholesale profits, if the sale was by wholesale, which might
reasonably be expected to be made by a merchant selling the property
by wholesale.
2. The retail profits, if the sale was by retail, which might reasonably be
expected to be made by a merchant selling the property by retail.
This provision has the effect of excluding the profits attributable to
manufacture which does not arisen in Sri Lanka and restrict the profits
arising from the sale of goods in Sri Lanka.

24. 24
Under Common Law Rule, interest income arises in the location where the
debt contract is made. The statutory modification has been enacted for this
rule under Section 93 in The Act which stipulates;
“Where interest is payable to a non-resident person on a loan obtained from
such person and the interest on such loan is borne;
a) directly or indirectly by a person resident in Sri Lanka; or
b) by a non-resident person, where the amount of such loan or part
thereof has been brought to or used in Sri Lanka,
Such interest shall be deemed to be profits and income arising in or derived
from Sri Lanka.”

25. 25
Example: If a Sri Lankan person goes abroad and takes a loan from a person
outside Sri Lanka after signing the agreement outside the country. Then he
comes to Sri Lanka and pay interest for that foreign person in terms of the
agreement.
With regard to interest income, the Common Law Rule is interest income
arises in the location where the debt contract is made. The outcome is the
foreign person is not liable to tax in Sri Lanka under Common Law Rule. This
rule has been modified by Section 93 in the present act. Now even though the
debt contract is made outside Sri Lanka, the interest income liable for income
tax if the interest is borne by a person resident in Sri Lanka.

26. 26
The Common Law Rule relating to royalty income is the income arises in the
location where the property giving raise to that income is registered. Similarly
as above, Section 94 enacted to cover royalty income received by a non-
resident person. The particular section stipulates as;
“Where royalties are;
a) borne directly or indirectly by a person resident in Sri Lanka; or
b) deductible under Section 32,
Such royalties shall be deemed to be profits and income arising in or derived
from Sri Lanka.”

27. 27
Under Section 95 (1) in The Act;
Where any person or partnership in Sri Lanka pays or credits to any person
or partnership out of Sri Lanka, any sum falling due as;
a) Interest on debentures, mortgages, loans, deposits or advances; or
b) Rent, ground rent, royalty or annuity which is payable either in respect
of property in Sri Lanka or out of income arising in Sri Lanka,
Whether such sum is due from him or from another person or from a
partnership, he shall be entitled to deduct income tax at the appropriate rate
specified in the Fourth Schedule to The Act.

28. 28
Under Section 62 (1), a non-resident company shall be liable to pay income
tax for any year of assessment is consist of;
a) A sum equal to the amount calculated at the rate specified in the
Second Schedules in The Act.
b) Where there are remittances of such company in that year of
assessment, a sum equal to 10% of the aggregate amount of such
remittances by such company.
Note: Normally a resident company is required to pay Dividend Tax on their
gross dividend declared. But this Dividend Tax is replaced by Remittance Tax
at the same rate 10% for a non-resident company on their gross remittances.
Deemed Dividend Tax is not applicable for non-resident companies.

29. 29
1. Any sums remitted abroad or retained abroad out of the profits which is
chargeable with income tax.
2. Any sum retained broad out of sale proceeds of any product exported.
3. Any product exported and not sold in the wholesale market or not sold
at all, the deemed profit of sale of such product in wholesale.
Under Section 62 (2) remittances means;
The remittances do not include;
1. Any dividend paid by a resident company to another non-resident
company.
2. Any remittance of expenses or expenses incurred abroad which are
claimable in arriving at the profits and income.

30. 30
But a sum equal to the lower amount can be deducted as head office
expenses in terms of Section 27 (1) as;
a) Amount of actual expenses, or
b) Amount equal to 10% of profits or income.
In the case of a non-resident company, head office expenses are not allowed
as a deduction in terms of Section 26 (1) (w) in The Act.
But again, the effect of Section 27 (1) is overruled by Section 97 (Effect of
Agreements for Double Taxation Relief) by which head office expenses are
allowed to deduct if such expenses are attributable to agencies, branches or
establishments in Sri Lanka.
Note: Above deductions should be made, subject to other provision of The
Act. Examples are restriction of advertising and capital nature expenditure.

31. 31
Instrumentality rule is recognized as a principle of corporate law which
permits a court to disregard the corporate existence of a subsidiary
company when it is operated solely for the benefit of the parent company
which controls and directs the activities of the subsidiary. According to this
rule, a company is treated as a subsidiary if it is controlled to a great extent
by another company.
Accordingly, a non-resident person is liable to tax on the profits and income
arising in or derived from Sri Lanka, if such profit arose through the
Instrumentality of a person in Sri Lanka although the actual sales and the
legal transactions were finalized outside Sri Lanka.

32. 32
This Rule of Instrumentality has been recognized in Section 80 as where a
person in Sri Lanka, acting on behalf of a non-resident person;
1. Effects or is instrumental in effecting any insurance,
2. Sells or disposes of or is instrumental in selling or disposing of any
property,
the profit arisen from the insurance, sales or disposals are deemed to be
derived by the non-resident person from business transacted by him in Sri
Lanka. The person who acts on his behalf is deemed to be his agent.
The purpose of Section 80 is to ascertain non-residents who is acting
through agent in Sri Lanka in selling or disposing insurances or properties,
although legally contacts and transaction are made outside Sri Lanka

33. 33
In the case of Chivers Sons Ltd v CIT (1937) 1 CTC 124, the court held that
non-resident company was liable to tax on the profits arose from Sri Lanka
as a result of local company F. X. Perera & Sons brought about the
transaction.
But in the case of Anglo Persian Oil Company Ltd. v Commissioner of
Income Tax (1935) 1 CTC 92, the court held that;
1. The company in UK not doing any business in Sri Lanka.
2. Local company was not instrumental in bringing about the transactions.
The following factors must be satisfied to make a non-resident liable.
1. The sale must be to a person in Sri Lanka.
2. The goods must be brought to or property must be in Sri Lanka.
3. The goods must be the property of the non-resident person.

34. 34
In Anglo Asian Oil Company case, Justice Akbar expressed his views as;
“ The sale or dispose when it refer to the person in Sri Lanka,
means… a definite legal act and does not include a mere delivery by
an agent in Sri Lanka of goods sold in pursuance of a contract made
outside Sri Lanka”.
Note: The sale or dispose has to be brought about through the
instrumentality of a person in Sri Lanka acting on behalf of a person outside
Sri Lanka.
If a non-resident person sells his property directly to buyer in Sri Lanka
and not through the instrumentality of an agent, then no tax liability will be
arisen on the profits made by that non-resident person.

35. 35
A broad definition has been provided for the term “agent” under Section 217
which reads as;
“Agent, in relation to a non-resident person or to a partnership in which
any partner is a non-resident person, includes;
a) The agent, attorney, factor, receiver or manager in Sri Lanka
of such person or partnership; and
b) Any person in Sri Lanka through whom such person or
partnership is in receipt of any profits or income, arising in or
derived from Sri Lanka.”

36. 36
Under Section 81, a non-resident person shall be assessable either directly or
in the name of his agent in respect of all his profits and income arising in or
derived from Sri Lanka, whether such agent has the receipt of the profits or
income or not.
The income tax so assessed whether directly or in the name of the agent shall
be recoverable in the manner provided for in The Act, out of the assets of the
non-resident person or from the agent.
Where there are more agents than one, for they may be assessed jointly or
severally in respect of the profits and income of the non-resident person and
shall be jointly and severally liable for income tax thereon.

37. 37
Transaction Remarks
Consignment
Account
Goods are sent on consignment basis then the contract of sales
takes place in Sri Lanka. Profits are clearly liable.
Tenders
Where tenders are made by a non-resident to the government
through an agent, the non-resident is liable to tax. If the
tenders are made directly to principal, no tax liability.
Transshipment Goods in transshipment are not liable to tax.
Indenting
Agent
Commissions received by indenting agents are liable to tax.
Also profits of non-resident person is liable to tax.
Buying House
or Shippers
Commissions received are liable to tax. No liability to non-
resident manufacturer or merchant. However, if the Buying
House or Shipper acts as an agent of non-resident, the profits
will be liable to tax in Sri Lanka.

38. 38
Where the Commissioner General is of the opinion that the correct amount of
the profits of a non-resident person arising in or derived from Sri Lanka cannot
be readily ascertained for the reason that such person is unable to furnish;
1. The fuller or further returns or fuller or further information referred to
in Section 106 (12), or
2. The documents or the other documents referred to in Section 106 (13),
relating to his trade or business,
If such non-resident person makes a declaration of that inability, the
Commissioner General shall ascertain such profits on the basis of fair
percentage of the turnover at minimum 6%.
Note: Section 106 (12) & (13) - An Assessor or Assistant Commissioner give
notice in writing to any person asking for further information and documents.

39. 39
Under Section 82 (1) (a), a person is closely connected with another person,
where the Commissioner General is satisfied that such persons are;
1. Substantially identical or
2. Ultimate controlling interest of each is owned or deemed to be owned
by the same person or persons.
Under Section 82 (1) (b) , the controlling interest of a company is deemed to
be owned by the beneficial owners of its shares, whether held directly or
through nominees. Shares in one company held by or on behalf of another
company deemed to be held by the shareholders of the last-mentioned
company.

40. 40
Example: A person in Sri Lanka and another non-resident person arrange
their affairs in a way where the person in Sri Lanka receives little or nothing
of the profit of the business and pay minimum tax or no tax at all.
Section 82 (2) and 82 (3) of The Act intended to catch them and seek to make
liable the profit of the non-resident who is doing business with a resident
person deemed closely connected.
In a situation where the Commissioner General is of the opinion that such
persons are closely connected, the business is deemed to be carried on Sri
Lanka and the non-resident is chargeable and the resident person in Sri
Lanka is considered as his agent. In that case, all the provisions of The Act
shall be applied accordingly under Section 82 (2).

41. 41
Under Section 97 (1) (a), where the Parliament of Sri Lanka approves any
Double Taxation Avoidance Agreement (DTAA) with a government of
any other territory for the purpose of affording relief from double taxation
in relation to income tax under Sri Lanka Law and any taxes of a similar
character imposed by the laws of other territory, such agreement shall
provide for;
1. Relief from income tax.
2. Determining the profits or income attributable to non-resident
persons and their agencies, branches or establishments in Sri Lanka.
3. Determining the profits or income attributable to resident persons in
Sri Lanka.
4. Exchange of information.
5. Assistance in the recovery of tax payable.

42. 42
The reliefs will be granted under “Credit Method” and the credit so granted
on profits or income arising from any source, shall not exceed the amount of
Sri Lanka tax payable in respect of that profits or income.
Income shall be calculated in accordance with the provisions of The Act
relating to the ascertainment of assessable income, but shall not include any
sum payable by way of interest, annuity, ground rent or royalty.
“Sri Lanka Tax” means the amount of income tax payable under The Act
before deducting any reliefs under Section 97. But does not include tax on
any sum payable, by way of interest, annuity, ground rent, or royalty out of
the income in respect of which the tax is charged.

43. 43
Liability to Tax Rate
The Profits or income arising in or derived from Sri Lanka to any
person who is not a citizen of Sri Lanka carrying on the profession
or vocation of an entertainer or artiste. Section 96
12%
Interest arising in or derived from Sri Lanka to a non-resident
person or partnership outside Sri Lanka on loan granted to a
person in Sri Lanka. Section 38
15%
Royalties received by a non-resident person or partnership from
any person in Sri Lanka and is deemed to be arisen or derived
from Sri Lanka. Section 39
15%
The profits and income derived from outside Sri Lanka by any
individual who has been a non-resident of Sri Lanka and who
arrives and stays in Sri Lanka. Section 15
Exempt

44. 44
Liability to Tax Rate
Any royalty received by a non-resident person from a company
with which an agreement has been entered into before April 1,
2004 by the Board of Investment of Sri Lanka. Section 13 (y)
Exempt
Interest, annuity, ground rent or royalty received by a non-
resident person from outside Sri Lanka.
Exempt
Any dividend received by a non-resident company from a
resident company which has deducted Tax under Section 65 (1).
The non-resident company is not entitled to a refund of tax so
deducted.
Exempt
Note: A non-resident person or partnership will be liable to tax as resident
persons and partnerships in all other cases as stipulated in The Act.

45. 45

46. 46