Sri Lanka’s remarkable recovery in tax revenue, which saw government revenue almost double from 7.3% of Gross Domestic Product (GDP) in 2021 to 15.4% in 2026, is facing a serious institutional challenge, with the International Monetary Fund (IMF) warning that persistent tax evasion, widespread non-filing, weak enforcement and outdated administrative systems could undermine the gains achieved through successive tax reforms.
In its Fiscal Affairs Department’s Revenue Administration Diagnostic, published by the Ministry of Finance on October 30, the IMF has cautioned that Sri Lanka cannot sustain its revenue recovery simply by imposing additional taxes or increasing existing rates. Instead, the country must overhaul its revenue administration, strengthen compliance and establish a modern, digitally driven system capable of identifying and pursuing taxpayers who fail to meet their obligations.
The report reveals that although VAT revenue increased from 1.8% to 5.3% of GDP and income tax from 1.9% to 3.5%, the improvement has not been accompanied by corresponding institutional improvements. The IMF describes the existing compliance system as fragmented, with risk-based enforcement still not consistently integrated into the daily operations of the Inland Revenue Department (IRD), Sri Lanka Customs and the Excise Department.
Particularly disturbing is the scale of income tax non-compliance. During 2025, non-filing reached 52.7% among corporate income taxpayers, 45.6% among personal income taxpayers and 67.8% among individual income taxpayers. In all three categories, more registered taxpayers failed to submit returns than those who filed on time.
VAT compliance also exposes significant weaknesses. Although timely filing improved among both large and smaller taxpayers during 2025 and the first quarter of 2026, non-filing among non-large taxpayers increased from 12.3% to 19.1%. Even among large taxpayers, the non-filing rate increased from 0.3% to 4%.
The employer withholding system presents another worrying picture. Of 47,662 employers required to submit returns for 2025/26, timely compliance stood at 81% among large taxpayers, compared with just 38% among medium corporate employers and 13% among employers managed by regional and metropolitan offices.
More alarming is the accumulation of outstanding tax liabilities. Total tax arrears reached approximately Rs. 2.1 trillion by December 31, 2025, compared with Rs. 1.1 trillion a year earlier. Around Rs. 1.6 trillion remains under dispute, raising questions about the Government’s ability to convert assessed tax liabilities into actual Treasury revenue.
The IMF attributes the problem to inadequate staffing, weak prioritisation, inconsistent penalties and the absence of effective systems to distinguish collectible debts from disputed or economically unrecoverable amounts.
The diagnostic also identifies an immediate technological threat. The maintenance contract for RAMIS, the IRD’s principal revenue administration system, expires on January 31, 2027, while the planned transition to locally based technical support has not begun.
The potential economic benefits of reform are substantial. The IMF estimates that improving Sri Lanka’s revenue administration capability score from 0.39 to 0.55 over five years could generate additional domestic revenue equivalent to 1.9 percentage points of GDP.
The challenge, therefore, is no longer simply collecting more taxes from compliant citizens and businesses. It is ensuring that those already legally required to pay taxes actually do so. Without credible enforcement and institutional modernisation, the country’s revenue recovery could remain vulnerable despite the heavier tax burden already borne by households and businesses.
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