Sri Lanka should replace its complex vehicle taxation framework with a progressive value-based system that is fairer, more transparent, and less distortionary, according to proposals submitted by the Advocata Institute to the Finance Ministry.
According to JB Securities CEO and Advocata Institute Chairman Murtaza Jafferjee, in response to the Ministry’s recent call for public submissions on revenue enhancement strategies, the think tank argued that the existing regime, which combines ad valorem taxes with quantity-based excise duties, no longer reflects the realities of modern vehicle technology and creates unintended economic and environmental costs.
Under the current system, excise duties on internal combustion engine vehicles, including hybrids, are largely determined by engine cylinder capacity, while electric vehicles (EVs) are taxed according to motor power output. Advocata contends that these measures create inconsistencies across vehicle technologies and fail to accurately capture a vehicle’s economic value or performance characteristics.
The submission notes that engine displacement has become an increasingly unreliable measure of performance as advances in automotive engineering allow vehicles with similar engine capacities to generate significantly different levels of power, fuel efficiency, and emissions.
If policymakers wish to retain a quantity-based component, the submission suggests using engine output across all vehicle categories or gross vehicle weight as a more consistent and easily verifiable benchmark.
Advocata also criticised the extensive use of threshold-based taxes, under which crossing a specified band triggers a higher rate on the entire taxable value rather than only the incremental amount above the threshold. Such structures create abrupt jumps in tax liabilities, influencing vehicle design, pricing, and purchasing decisions in ways driven more by taxation than market preferences.
While acknowledging that the current framework has generated substantial fiscal revenue, the submission argues that high effective tax rates and complexity create incentives for under-invoicing, misclassification, and other forms of tax avoidance.
Instead, it proposes a progressive ad valorem model under which higher tax rates would apply only to the incremental value above specified thresholds, similar to marginal income tax structures. Such an approach would preserve progressivity while reducing distortions, improving transparency, and limiting opportunities for manipulation.
Advocata maintains that the reform could be structured to remain revenue-neutral while improving the efficiency and fairness of the tax system.
The submission points to hybrid vehicles as a clear example of the shortcomings of the current regime. Many hybrids utilise Atkinson-cycle engines, which are designed to maximise thermal efficiency rather than power output. Although these engines often have larger displacement capacities than conventional engines, they consume less fuel and produce lower emissions when paired with electric motors.
Modern Atkinson-cycle engines can achieve thermal efficiencies of around 40%, significantly higher than traditional Otto-cycle engines. As a result, engine size alone provides a poor indication of environmental performance or fuel consumption.
The Toyota RAV4 hybrid illustrates the anomaly. According to the submission, the vehicle’s import value is approximately Rs. 11 million, while taxes can exceed Rs. 32 million because excise duties escalate sharply once engine capacity exceeds 1,500cc. The result is a tax burden approaching 300% of the vehicle’s import value.
The think tank noted that only 16 hybrid Toyota RAV4 vehicles were registered in Sri Lanka between January 2025 and May 2026, despite the model being among the world’s best-selling vehicles.
Advocata argues that a tax framework originally designed to address Customs corruption and under-invoicing may now be generating socially undesirable outcomes. By heavily penalising larger-capacity hybrid engines without recognising their efficiency gains, the system reduces consumer welfare, discourages the adoption of cleaner and more fuel-efficient vehicles, and potentially increases environmental costs.
According to JB Securities, vehicle registrations rebounded strongly in May, rising to 62,776 units from 51,156 in April, driven primarily by a sharp recovery in three-wheeler registrations and continued strength in the two-wheeler segment.
Three-wheeler registrations increased more than fourfold to 5,669 units from 1,355 in April, while two-wheeler registrations rose to 43,842 units from 38,631. Passenger vehicle categories recorded more modest gains.
Motor car registrations climbed to 4,738 units from 3,238 in April, supported by higher volumes of both brand-new and pre-owned vehicles. Brand-new car registrations more than doubled to 1,199 units from 467, led by BYD with 468 units and BAW with 553 units, largely driven by entry-level EV models. Small cars continued to dominate the segment, accounting for more than 98% of registrations, although financing penetration eased to 43% from 47.4% in April.
Hybrid vehicle registrations increased to 2,745 units from 2,316, with Sports Utility Vehicles (SUVs) accounting for the overwhelming majority of volumes. Honda and Toyota together represented more than 80% of hybrid registrations during the month. Financing penetration in the segment stood at 43.9%.
EV registrations, however, declined to 6,248 units from 8,098 in April, largely reflecting a slowdown in electric two-wheeler registrations. While EV car and SUV registrations improved, electric two-wheelers remained the dominant category, accounting for 5,013 units. Financing penetration in the EV segment fell to 34.2%, indicating continued reliance on cash-funded purchases.