Hidden costs of policy shifts: How Sri Lankan SMEs 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 industry, employment, and economic growth. However, policy shifts, particularly the abolition of the Simplified Value-Added Tax(SVAT), have placed significant strain on these businesses. With the region of SVAT due to happen in October this year, the long-term uncertainty surrounding these policy changes continue to pose a serious challenge for SMEs.

- By Bandula Fernando

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% tax on local raw materials will make imports more competitive, dis-incentivising 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 out exporters in a timely manner. The SME will have this cash tied for at least 75 days, as the IRD clock only starts after the month end.

Nearly impossible to sustain profitability

One SME manufacturer specialising in children’s apparel, which operates on a cost-sensitive model, shared their experi-ence. The business sources thread, polybags, and cartons locally, but the new tax framework will make these purchases 18% more expensive overall, with margins already razor thin – i.e., 5-6% – the additional tax burden has made it nearly impossible to sustain profitability. The manufacturer must now face a difficult choice – either absorb the losses, reduce local procurement, or take on expensive bank loans to cover the cash flow gap. This is not just an isolated case; similar struggles are being reported across the industry.