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Sri Lanka’s tea exporters are now paying 18% value added tax (VAT) on exports after the government decided to widen the tax net.
Although the tax money is later reimbursed to exporters through a system called SVAT (Simplified Value Added Tax), the move has brought with it a host of other issues on top of administrative woes, according to industry experts.
Primarily, making the tea industry pay a hefty tax and then have it refunded is “quite meaningless,” Tea Exporters Association (TEA) of Sri Lanka Chairman Ganesh Deivanayagam told World Tea News.
He called the government decision a “first of its kind in the sector’s history” because Sri Lanka’s tea products, where 85% is exported, have always enjoyed tax-exempt status.
Acting on International Monetary Fund (IMF) recommendations to help the ailing Sri Lankan economy, the government hiked the existing 15% VAT on businesses to 18% from January 1 this year. The government insisted that every single industry in the country should come under a uniform tax regime.
Even previously tax-exempt sectors like tea were not spared.
As a result, the industry is now having to deal with a “ton of paperwork,” said Deivanayagam. There may not be a massive financial loss—apart from added administrative cost—as taxes paid to the government are refunded. But it has taken its toll on the sector’s efficiency, he said.
Unlike other counterparts such as India and Kenya, Sri Lanka’s tea sector is in a unique position in terms of how it operates locally: Over 95% of the country’s tea is sold in weekly auctions making the whole process transparent, he said. Weekly tea auctions sell nearly 6 million kilos of tea separated into almost 10,000 different types. Tea smallholder farmers can observe how prices are set during auctions, ensuring greater transparency, he said. Weekly tea auction sales reports are posted on the association website.
Not every country has a transparent system of selling tea. In contrast, Kenya sells only 60%-70% of its tea via auctions, and in India, the amount sold via auction is only 30%.
But now weekly auction sales means there is a “paper trail” due to VAT invoices, Deivanayagam said.
Tea smallholder farmers face similar issues: until January 1 this year, all agriculture producing organizations and individuals in Sri Lanka were exempt from VAT, but now they too have come under the 18% VAT bracket. Following talks with the government, tea producers have “managed to obtain a VAT exemption,” said Madhuri Nanda, director, South Asia, at the Rainforest Alliance in India.
The exemption works in the same way it applies to exporters, where producers initially pay VAT and have it refunded later via SVAT.
Growers, even though not direct tea exporters, play a key role in the tea industry; they are Sri Lanka’s second largest export sector next to apparel and textiles. The imposition of VAT in the first place has caused “cash flow hindrance” to smallholders because it takes about two months for the government’s Inland Revenue Department to refund the tax.
Moreover, the current exemption for farmers is only for 18 months (from January 2024), but it is still a “relief for tea producers to some extent,” Ms Nanda said.
Afterall, the country’s current economic outlook is not helping: Inflation rose to 6.4% last month (January) from 4% in December 2023, according to data from the central bank of Sri Lanka. Sri Lanka’s economic growth in the third quarter in 2023 recorded 1.6% after months of negative growth.
In May 2022, Sri Lanka’s foreign reserves plunged to a dismal USD50 million after years of economic mismanagement and corruption. Since then, an IMF bailout package has recommended a wider tax net, among other measures.
As a result, the cost of day-to-day operations have surged, affecting “sustainability efforts of tea producers, particularly smallholders who are vulnerable to changing climate, extreme weather, low productivity, and poor price realization of the tea in the market for plantation companies and smallholders,” said Nanda.
Indeed, the “rising cost of production and labor shortage” are issues in the sector, according to Sri Lanka-based bought leaf processing company Tea Smallholder Factories PLC Assistant Manager of Marketing Dilumi Samarakoon. So the company is looking to automate and invest in state-of-the art machinery, which will require less labor. In doing so, “smallholder, next generation family members of the company will be given internship programs” to obtain the operational and administrative skills needed to use machinery. Such training will include visits to tea broking offices and warehouses as well as meetings with top exporters and tea buyers, helping them secure jobs in the long run.
Going forward, global tea producing countries need to offset high input costs by increasing production efficiencies via technology and improve labor shortages by improving mechanisation, TEA said in a report quoting analysts.
In January, Sri Lanka’s tea production was at 18.73 million kilos, down from 19.4 million kilos in December 2023, according to TEA data. And the global tea output is forecast to increase by 1.5% -3% between 2024 to 2025, and the predicted growth is well below the historic average annual gain of 4.4%, it said.
As for Sri Lanka, its strength lies in Ceylon orthodox black tea: The country already claims an impressive “45% of the global orthodox black tea exports,” said Deivanayagam. Of Sri Lanka’s produce, over 90% of the tea is orthodox black tea as opposed to Kenya where over 90% of the tea produced is CTC (crush, tear and curl); in India, 80-85% of the tea produced is CTC.
Amidst growing health benefits of orthodox black tea, on top of the quality of Ceylon tea, there is a way to go: “This serves to appeal to growing demands from higher income consumers in export markets,” London-based market intelligence company Euromonitor Insights Manager Nathanael Lim said, adding that many tea companies in Sri Lanka have moved beyond mass production and focused on premium tea products.
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