By: Staff Writer
March 09, Colombo (LNW): After a period of steady growth, Sri Lanka’s Information Technology (IT) sector encountered significant challenges in 2025, primarily due to increased taxation, talent migration, and financial burdens on IT services. The introduction of a 15% tax on IT services for international clients and an 18% Value Added Tax (VAT) on locally-developed software and electronic equipment has put the industry under considerable strain.
Impact of Taxation on IT Growth
The imposition of income taxes has triggered a substantial brain drain, particularly among mid-level employees crucial for business operations. With the removal of VAT exemptions and the subsequent 18% VAT increase, there is growing concern that IT companies may relocate abroad to mitigate tax-related expenses.
A report by the Information and Communication Technology Agency (ICTA) of Sri Lanka, in collaboration with the United Nations Conference on Trade and Development (UNCTAD), estimates that Sri Lanka’s digital economy is valued at $3.47 billion, contributing 4.37% to the country’s GDP. The ICT and Business Process Management (BPM) workforce is projected to reach 300,000, supporting a $3 billion industry by 2025, compared to its current $1 billion valuation.
Government Initiatives and Industry Concerns
The previous government earmarked Rs. 3 billion to establish a digital authority, tasked with spearheading the public sector’s digital transformation. Additionally, a Technological Innovation Council was proposed to foster collaboration among government bodies, research institutions, and the private sector. Another notable initiative involves creating a National Centre for Artificial Intelligence to drive economic and social transformation through emerging digital technologies.
Despite these measures, industry leaders warn of potential setbacks. PickMe Founder and CEO Jiffry Zulfer criticized the VAT policy, arguing that it could drive startups abroad and deter Foreign Direct Investments (FDIs). He highlighted that, since foreign software providers remain exempt from VAT, local businesses might opt to move operations overseas while still serving the Sri Lankan market. This shift, he stressed, would make investors wary of investing in Sri Lankan startups.
Cybersecurity expert Asela Waidyalankara pointed out that taxation is only one of many challenges facing the industry. Structural and policy inefficiencies also need to be addressed to attract foreign investments.
He warned that increased VAT would drive up operational costs, particularly for startups, and called for a more business-friendly regulatory environment. He noted that Sri Lankan startups are already considering relocating to Singapore due to the lack of a conducive business climate.
The IT Sector’s Future Amid Economic Policies
Federation of Information Technology Industry Sri Lanka (FITIS) Chairman Indika de Zoysa voiced concerns about rising costs for hardware and locally-produced software, which could affect competitive pricing and slow down digital adoption. He warned that the new VAT policy might encourage black market transactions, exposing consumers to risks like poor product warranties and counterfeit goods.
FITIS has been in active discussions with the Ministry of Finance and the Ministry of Technology to reconsider VAT exemptions. De Zoysa emphasized that before 2005, Sri Lanka’s IT sector was subject to 15% VAT but was later exempted to promote digital expansion. He stressed the need for continued exemptions, citing policies in regional countries such as Malaysia, Singapore, Thailand, and Bangladesh, where IT-related services enjoy tax incentives to stimulate growth.
A major concern is that startups might relocate abroad due to tax burdens, especially since shifting IT operations requires minimal physical infrastructure. This could result in an immediate decline in foreign investments and economic contributions.
The Path to a Digital Economy
FITIS remains committed to the DIGIECON 2030 policy framework, which aims to expand the digital economy’s contribution to GDP from 4% to 15% by 2030. The framework focuses on advancing Industry 4.0 and Industry 5.0, fostering a sustainable, export-oriented tech hub, and creating a business-friendly investment climate. It seeks to leverage technology to enhance productivity, integrate into global value chains, and navigate the current economic crisis.
To achieve these goals, Sri Lanka must prioritize fostering a stable and encouraging environment for IT businesses. This includes tax policies that support growth while ensuring a competitive edge in the regional and global digital economy. Without such measures, the country risks losing valuable talent, investments, and its position in the rapidly evolving tech landscape.
