Can You Deduct Subcontractor Payments in Sri Lanka?

You landed a project that's too big to finish alone, so you brought in someone. A backend developer for the parts you don't touch. An editor for the copy. Someone to answer email while you actually work.

Then the year ends and the question arrives: does that money you paid out count as your expense, or did you just personally fund someone else's income?

It counts. That part is straightforward. What catches freelancers is everything wrapped around it, because the moment you started paying someone for services, Sri Lankan tax law quietly handed you a second job. You became a withholding agent. And the subcontractor payment tax deduction you're counting on is legally tied to whether you do that job.

Can I deduct what I pay a subcontractor or an assistant?

Yes. The rule is Section 11(1) of the Inland Revenue Act No. 24 of 2017, and it's refreshingly plain for tax legislation:

Three words carry the weight. Incurred means you actually became liable for it during the year. In the production of income means it has to connect to the work that earns you money, which is why paying a developer to build a client's site qualifies and paying someone to reorganise your kitchen doesn't. And to the extent means a cost that's part business and part personal gets apportioned, not claimed whole.

There's one boundary worth knowing. Section 11(2) blocks a deduction for an expense of a capital nature, and Section 11(3) defines that as an expense securing a benefit capable of lasting longer than twelve months. Ordinary contract labour isn't capital. But if you paid a developer to build a system your business will run on for years, that starts to look like a different animal, and it's worth asking your accountant rather than assuming.

Beyond that, subcontracted work sits comfortably inside the same category as your other deductible freelancer expenses.

What does the deduction actually save me?

Numbers make this concrete. Meet Nishani, a freelance web developer with Sri Lankan clients, filing for the Year of Assessment 2025/2026.

Her business earns Rs. 6,000,000 for the year. She has Rs. 800,000 of other business costs: software licences, a co-working desk, internet. For one large project she subcontracts backend work to Dinuka, a software developer, at Rs. 150,000 a month for four months, so Rs. 600,000 in total.

Here's her position with and without that Rs. 600,000 claimed:

Both figures sit in the top band, where tax is Rs. 420,000 plus 36% of the amount above Rs. 2,500,000. So the Rs. 600,000 she paid Dinuka reduces her tax by Rs. 216,000, exactly 36% of the payment. If you want the full band-by-band walkthrough, we've covered how to calculate income tax in Sri Lanka separately.

That Rs. 216,000 is the thing at risk in every section below.

Do I have to withhold 5% when I pay a subcontractor?

This is where most freelancers get caught, because it feels like something only companies deal with.

Section 85(1C) requires a person paying a service fee with a source in Sri Lanka to a resident individual who is not their employee to withhold tax at 5% of the payment. It covers teaching, lecturing, examining, invigilating or supervising an examination, commission or brokerage paid to a resident insurance, sales or canvassing agent, and a long list of independent service providers.

Now, Section 85(3)(b) does carve individuals out. But read exactly what it says. The section doesn't apply to "payments made by individuals, unless made in conducting a business." Those last five words are the whole story. Paying a plumber to fix your home is a private payment and nothing applies. Paying a developer to deliver work you're billing a client for is business spending, and you're inside the rule.

Which means the same payment you want to deduct is a payment you may be required to withhold from.

The occupation list matters too, and it got much longer in 2026. The Inland Revenue (Amendment) Act No. 11 of 2026 expanded Section 85(1C)(c) to add auditors, valuers, artists, event organisers, photographers, videographers, therapists, counsellors, beauticians, cooks, electricians, dentists, veterinarians, social media specialists, brand ambassadors, information technology specialists, advertising agents, advisors, translators, writers and debt collectors, among others, alongside the doctors, engineers, accountants, lawyers, software developers, researchers and academics already there.

What about roles that aren't on it? The paragraph closes with "or any individual service provider as may be prescribed by regulation." So a general administrative or virtual assistant, which nobody named even in the 2026 expansion, isn't automatically pulled in by the statute's own wording. Prescription by regulation is the route. If the person you're paying sits squarely in the list, withhold. If they don't, check the regulations current at the time rather than deciding it yourself, because the list has already grown once and the cost of guessing wrong falls on you.

Our full breakdown of the 5% withholding tax on professional fees covers this from the recipient's side, which is useful reading if you're on both ends of it.

What happens if I don't withhold the tax?

Your deduction is suspended. Not reduced. Suspended, until you fix it.

And you don't escape the tax by having failed to deduct it. Section 86(3) says a withholding agent who fails to withhold "shall however pay the tax that should have been withheld in the same manner and at the same time as tax that is withheld." You already paid Dinuka in full. Now you owe the IRD 5% on top, out of your own money.

There are two mercies in the same section. Under Section 86(4) the recipient is jointly and severally liable, and under Section 86(6) a withholding agent who pays tax that should have been withheld "shall be entitled to recover an equal amount from the withholdee." Legally you can go and get it back. Practically, asking a subcontractor from eighteen months ago for money is a conversation nobody enjoys.

So the mechanics, in order:

1. Deduct 5% at the time you pay. Nishani pays Dinuka Rs. 142,500 and keeps Rs. 7,500.
2. Remit it within 15 days after the month ends. That's Section 86(1). A payment made in June is remitted by 15 July.
3. Give them a certificate. Section 87(1) and (3) require a withholding certificate covering each calendar month, served within thirty days after the end of that month, and since the 2026 amendment added Section 87(6) it must be provided free of charge. Dinuka needs it to claim the 5% back on his own return.
4. File the annual statement. Section 86(2) requires a statement within thirty days after 31 March listing the payments, the tax withheld, and the name, address and tax identification number of each person you paid.

Your total cost is unchanged by any of this. Nishani still spent Rs. 600,000 and still deducts Rs. 600,000. The 5% doesn't shrink her expense, it just changes who receives part of it.

Does it matter if I pay a registered company instead of an individual?

For the withholding, yes. Considerably.

Section 85(1C) applies to a service fee paid to a resident individual. The Act defines an "entity" as a company, partnership or trust, but explicitly "excludes an individual." So a resident company or partnership falls outside the subsection, and you pay their invoice in full with nothing withheld.

That's a genuine practical difference. The same Rs. 150,000 of work triggers a monthly withholding obligation, a monthly certificate and an annual statement if you hire Dinuka personally, and none of it if you hire a registered studio. It isn't a reason to prefer one over the other, but it is a reason to know which you're dealing with before the first invoice lands.

What doesn't change is the deduction. Individual or company, the payment is deductible under the same Section 11(1) test, and you need the same evidence that the work was real and the money moved.

What if my subcontractor is based overseas?

Different section, much higher rate, and a threshold question first.

Section 85(1B) requires 14% to be withheld from a service fee with a source in Sri Lanka paid to a non-resident person. Note "person" rather than "individual" this time, so unlike the resident rule, it catches overseas companies as well as overseas freelancers.

The pivot is whether the fee has a Sri Lankan source, and the Act gives two different tests:

• Managerial, technical or consultancy fees are "technical service fees" under Section 73(2), and Section 73(1)(c) sources them by who pays. A resident person paying such a fee gives it a Sri Lankan source, regardless of where the work happened.
• Other service fees fall under Section 73(1)(j), which sources them by where the service was rendered: "in Sri Lanka, regardless of the place of payment." Section 74 then treats an amount as foreign sourced to the extent it doesn't have a Sri Lankan source.

So an overseas consultant advising your business can be Sri Lankan sourced through you as the payer, while a different service performed entirely abroad may not be. The classification is doing real work here and it isn't always obvious which box a given engagement lands in, so this is a reasonable point to get a second opinion rather than a rate to apply on instinct.

Can I pay a subcontractor in cash?

Under Rs. 500,000, yes. At or above it, cash can cost you the entire deduction.

Section 10(2A) disallows a deduction where you pay another person Rs. 500,000 or more in aggregate, in a day or for a single transaction or for a series of transactions relating to one event, other than by account payee cheque, account payee bank draft, credit or debit card, an electronic payment system through a bank account, or by depositing cash into that person's bank account. The amount also can't be treated as the cost of an asset.

The bank-deposit option is the newest of those. The Inland Revenue (Amendment) Act No. 11 of 2026, certified on 3 June 2026, added it and backdated it to 8 May 2023, which was the original commencement of the subsection. Handing over an envelope of notes is still fatal. Walking into a branch and depositing the same notes into your subcontractor's account is fine.

What documents do I need to keep?

A deduction survives a query on evidence, and the Act is specific about what evidence means.

Section 120(1) requires records and accounts sufficient to record all transactions and to work out the profit or loss on them. Section 120(5) goes further and requires you to retain the source documents underneath those accounts. Section 120(10) spells out what counts: "sales and purchase invoices, costing documents, bookings, diaries, purchase orders, delivery notes, bank statements, contracts, and other documents which relate to an element of a transaction."

For a subcontractor payment, that translates into four things worth having:

• A written agreement or engagement email describing the work and the fee
• An invoice from the subcontractor carrying their name, address and TIN
• The bank transfer record showing the money leaving your account and reaching theirs
• The withholding certificate you issued, where 5% applied

Keep them for five years from the date of the transaction under Section 120(6), and longer where an assessment or appeal for that year is still running.

There's also a running penalty attached to poor records. For years of assessment commencing on or after 1 April 2023, Section 182(1A) and (2) set it at Rs. 1,000 per day for each day the failure continues. Section 182(3) requires a warning notice first, and no penalty is due if you comply within the time that notice gives you. Our guide on tax record keeping in Sri Lanka covers the wider filing system.

What if I hire my spouse or a family member?

Two separate rules, and the one for spouses is stricter than most people expect.

Section 33(1) requires associated persons to calculate their income "according to the arm's length standard," and Section 33(2) defines that as quantifying and allocating amounts "to reflect arrangements that would have been made between independent persons." Section 196(3) defines a relative broadly: child, spouse, parent, grandparent, grandchild, sibling, aunt, uncle, nephew, niece or first cousin, including by marriage or adoption.

In practice, paying your cousin a market rate to do real work is a deductible business expense like any other. Paying them four times a market rate to shift income out of your top band is the thing Section 33 exists to unwind.

Spouses are different. Section 34(4) provides that where a spouse receives income for services rendered in a business carried on by the other spouse, or by a partnership that other spouse is a partner in, "the income shall be included in the income of the spouse who carries on the business." The income comes straight back to you. Paying your husband or wife for helping with the business doesn't move that income into their hands for tax purposes, so it can't do the job people usually hope it will. If you're weighing this, our article on how married couples are taxed in Sri Lanka has the wider picture.

Is the person helping me actually an employee?

Worth stopping on, because it changes which rules apply to everything above.

Section 85(1C) covers a resident individual who is not an employee of the payer. If the person you're paying is genuinely an employee, you're not in the 5% withholding regime at all. You're in the employment one, and Section 83A(1A) requires an employer to deduct Advance Personal Income Tax on payments to an employee with effect from 1 January 2023. That deduction is compulsory. The employee's consent, which mattered under the older version of the section, no longer does.

Someone who works set hours, uses your equipment, takes direction on how the work is done and depends on you as their sole source of income starts to look like an employee whatever the contract calls them. Someone who invoices you, works for other clients and controls their own method looks like a contractor. If your "assistant" has drifted from the second description towards the first, the APIT rules for employees are the ones you need, not this article.

What should I do before the next invoice?

Paying someone to help you is deductible. It's the plumbing around the payment that decides whether the deduction actually lands.

Pay through a bank. Get an invoice with a TIN on it. Check whether the 5% applies before you transfer rather than after, and if it does, remit it by the 15th of the following month and issue the certificate. Do that, and the Rs. 216,000 in Nishani's example is simply hers. Skip it, and Section 10(2) holds the deduction back until you've paid the IRD the money you should have withheld in the first place.

None of it is difficult. It's just unforgiving about order.