Tax Basics for U.S. Expats in Sri Lanka

Sri Lanka is a country with over 3,500 years of history. The country is home to many religions, ethnicities and languages. The country’s recent history has been marred by a thirty-year civil war, which decisively ended when Sri Lankan military crushed Liberation Tigers of Tamil Eelam in 2009. Hopefully, peace will endure in this beautiful country.

If you are planning to become a U.S. expat in Sri Lanka, or have been one for a while, it’s important to know the tax laws of the country and the potential impact on your U.S. tax return. Expat taxes can get complicated. Fortunately, the key points are outlined below.

Photo by: R Barraez D´Lucca

Taxation in Sri Lanka

Let’s start by understanding who is required to pay taxes in Sri Lanka. Residents have to report taxes on worldwide income. However, non-residents are taxed only on Sri Lanka-source income. Foreigners who are in the country for more than 183 days in a tax year are considered residents for tax purposes.

The tax rates in Sri Lanka are progressive:

• Employment income – Progressive from 4% to 24%;
• Interest income – Same as for employment income;
• Dividend income – Dividends paid by a Sri Lankan company are subject to a 10% final withholding tax.

Sri Lanka and the U.S. have an income tax treaty in-place. International tax treaties clarify tax jurisdiction. These treaties can provide U.S. citizens and residents with reductions in foreign income taxes. However, a reduction in U.S. taxes is generally not available under these treaties as a result of “tax saving” clauses that allow the U.S. government to impose taxes on U.S. expats as if there were no treaty.

Sri Lanka and the U.S. do not have a social security tax agreement in-place. Therefore, certain U.S. expats will be required to pay into both social security programs.

How Living in Sri Lanka Impacts US Taxes

As a U.S. citizen or permanent resident (Greencard), you are required to file U.S. taxes even if you live in Sri Lanka. Plus, if you have assets in foreign financial accounts (e.g., foreign banks), there are informational reports you may be required to file. For example, U.S. Expats Living in Sri Lanka with $10,000 or more in foreign banks must file the FBAR (now known as FinCen 114).

Fortunately, the U.S. government provides various forms of tax relief that can lower or eliminate U.S. tax obligations

• The Foreign Earned Income Exclusion – It allows you to exclude a certain amount of income earned outside the U.S.
• The Foreign Housing Exclusion/Deduction – This one relates to additional income that can be excluded for household-related expenses tied to living abroad.
• The Foreign Tax Credit – It allows you to offset foreign taxes paid against U.S. tax obligations.

In most cases, the foreign earned income exclusion is preferable to the foreign tax credit if you live in a country with a lower tax rate than the U.S. (assuming your income is not above the applicable threshold). However, it’s a good idea to speak with an expat tax specialist to discuss the best application of these tax reliefs.

FATCA and Sri Lanka

The U.S. government is increasingly interested in knowing about the foreign assets held by its citizens and residents. As a result, it has been busy inking deals with other countries whereby foreign financial institutions (FFIs) will be required to:

• Identify accounts of U.S. persons;
• Report certain information to the IRS regarding those accounts;
• Withhold a 30% tax on certain payments to non-participating FFIs and account holders unwilling to provide the required information

As of the publication of this article, roughly 80 countries have either signed intergovernmental agreements with the United States or are in discussions. Sri Lanka and the U.S. do not yet have a FATCA agreement in-place. However, you should be aware of the implications given that the IRS intends to expand FATCA’s reach in the upcoming years.

If you have any questions regarding your U.S. expat taxes, contact us today. We are here to help.