Hidden costs of policy shifts: How Lankan SMEs are coping with rising expenses

For decades, Sri Lanka’s small and medium enterprises (SMEs) have been the backbone of the country’s manufacturing sector, driving local industry, employment, and economic growth.

- BY Bandula Fernando

However, policy shifts, particularly the abolition of the Simplified Value-Added Tax (SVAT), have placed significant strain on these businesses. With the repeal of SVAT due to happen in October this year, the long-term uncertainty surrounding these policy changes continues to pose a serious challenge for SMEs.

Transition away from SVAT

The transition away from SVAT is not just a procedural shift—it is a structural change that disrupts the entire local manufacturing ecosystem. The additional 18 percent tax on local raw materials will make exporters more competitive, disincentivizing the use of locally sourced inputs.

This shift breaks down long-standing supply chains, weakens domestic industries, and puts thousands of jobs at risk. Whilst theoretically these costs “could” be recovered at the time of export, a) there is a massive interest cost, and b) exporters have no faith in the ability of the Department to make these refunds. Given the backlog of vouchers to be cleared under the current cashless system, exporters cannot understand how the IRD would ever be able to pay cash refunds in a timely manner. Even if paid within the 45 days indicated, the SME will have this cash stuck for at least 3 days, as the IRD check only starts after the month end.

One SME manufacturer specializing in children’s apparel, which operates on a cost sensitive model, shared their experience. The business sources thread, polybags, and cartons locally, but the new tax framework will make these purchases 18 percent more expensive overnight.

With operating margins as low as 5-6 percent, the additional tax burden has made it nearly impossible to sustain profitability. The manufacturer now faces a difficult choice. That’s whether to absorb the losses, reduce local procurement, or take on expensive bank loans to cover the cash flow gap.