Unit Trust Tax in Sri Lanka: How Fund Returns Are Taxed

Unit trust tax in Sri Lanka confuses people for a simple reason. You put money into one product, but the tax law may look straight through it to the dividends, interest, and bills the fund holds underneath. Or it may not. Which way it goes decides whether you owe anything more after the fund pays you.

So the first job is working out which kind of fund you hold. After that, the rest falls into place: what's already settled, what still needs declaring, and what happens when you cash your units in.

How are unit trusts and mutual funds taxed in Sri Lanka?

The Inland Revenue Act treats a unit trust or mutual fund in one of two ways.

Pass-through. If the fund carries on what the Act calls an eligible investment business, the fund is see-through for tax. Section 195 defines that as a business or investment "comprising predominately of owning, investing or trading in" capital assets, financial instruments, or other similar assets. The Act doesn't put a number on "predominately" in that definition. The IRD's own guidance on unit trusts reads it as 80% or more, calculated on gross income. Under Section 57(2), you, not the fund, are taxed on your share of its income.

Deemed company. A fund that doesn't carry on an eligible investment business is deemed to be a resident company under Section 59(1). It's taxed as a company on its own income. Your units are treated as shares, you're treated as a shareholder, and anything it distributes to you is treated as a dividend.

In practice, that certificate is your best guide. It's the document that breaks your share of the fund's income down by type and shows the tax already taken. If you're not sure which regime your fund is in, ask the fund manager. It's a fair question and they'll know the answer.

What happens to your share of a pass-through fund's income?

In a pass-through fund, the law treats the fund's income as yours. Section 57(2)(b) says each amount "shall retain its character as to type and source". A dividend the fund received is still a dividend when it reaches you. Interest is still interest.

Two timing and payment points follow from this:

• Your share counts as your income at the end of the fund's year of assessment, under Section 57(2)(c).
• The distribution itself, the cash that lands in your account, is exempt in your hands under Section 58(1)(a). That stops the same income being taxed twice.

Any tax already paid on the fund's income is passed to you as well. Section 57(2)(e) allocates it to unitholders in proportion to their share and treats it as paid by them. Here's how that plays out for each type of income.

Dividends. When a resident company pays the fund a dividend, it deducts 15% Advance Income Tax. Dividends paid by a resident company are a final withholding payment under Section 88(1A)(aa). Section 7(3)(a) excludes final withholding payments from your investment income. So your share of fund dividends is settled. Nothing more to pay, nothing to claim.

Interest. Banks deduct 10% Advance Income Tax on interest they pay the fund, the rate since April 1, 2025. But interest paid to a resident individual is not on the Section 88(1A) list of final withholding payments. So your share of it goes into your assessable income, and the 10% becomes a tax credit under Section 89. If you want the full mechanism behind that distinction, our guide to final versus creditable withholding tax walks through it.

Treasury bills and bonds. This is the one that catches people out. Section 84(3)(d) switches off withholding on interest or discount paid on Treasury bills, Treasury bonds, and securities under the Registered Stocks and Securities Ordinance, and the Advance Income Tax rule is expressly subject to it. So nothing is deducted when the fund earns that income. Your share arrives untaxed, and it's taxed at your normal progressive rates with no credit against it.

What if your fund is treated as a company?

Then the picture is simpler. Section 59(2)(d) says any distribution of the fund's income to unitholders, "in any manner whatsoever", is deemed to be a dividend paid to shareholders.

A dividend from a resident company carries 15% Advance Income Tax, deducted before you're paid, and it's a final withholding payment under Section 88(1A)(aa). So you receive 85% of the distribution and you're done with it. It doesn't go into your assessable income and there's no credit to claim. The same treatment as dividends from shares you hold directly.

Is tax deducted by the fund or left to you?

Here's the whole thing in one table.

How is redeeming units taxed differently from a distribution?

Redeeming is where most investors get unsure, because a redemption payout usually mixes two things: your share of income the fund has built up, and the change in the value of the units themselves.

The Act separates them. A unit is a membership interest in a trust, which Section 195 makes a capital asset, and held as an investment it's an investment asset. Redeeming it counts as realising it under Section 39(a), and Section 58(2) brings the gain into your income. Your gain is what you received for the units minus what they cost you.

But the income part of the payout is already taxed as income. Section 38(3) says the consideration for an asset "shall not include an exempt amount, a final withholding payment" or an amount already included in your income. So that part comes out of the sale proceeds first. Only the rest can produce a capital gain.

The capital gain is taxed on its own, separately from your other income, at a flat rate:

• 10% for realisations before June 3, 2026
• 15% from June 3, 2026, when Inland Revenue (Amendment) Act No. 11 of 2026 was certified and raised the rate

There's a small-gain exemption too. Under Third Schedule paragraph (f), a resident individual's gain on an investment asset is exempt if it's no more than Rs. 50,000 and your total investment-asset gains for the year are no more than Rs. 600,000. One condition applies: where the Commissioner-General is satisfied you realised an asset in two or more parts to take advantage of the exemption, the parts are added together.

What do you still have to declare?

Even where tax has already been deducted, some of your fund income still belongs in your return. For a pass-through fund:

1. Your interest share. It goes into your assessable income, and the 10% already deducted comes off your bill as a credit. Leave it out and you lose the credit.
2. Your Treasury bill and bond share. It goes into your assessable income in full. Nothing has been paid on it yet.
3. Any taxable redemption gain. This goes on its own Capital Gains Tax Return within the 30-day window, not your annual return.

Your share of dividends stays out, because it's final. So does any deemed dividend from a fund taxed as a company.

Your units are also a holding in their own right. Our guide to declaring assets and liabilities on your tax return covers where investment holdings go. Keep every unitholder certificate. It's your evidence for the credit you claim and for the income split on any redemption.

What does this look like in rupees?

Say Dilini holds units in a pass-through fund. Her certificate for the year shows:

The Rs. 40,000 of dividends is finished. It stays off her return.

The Rs. 300,000 of interest goes into her assessable income alongside her salary or business income, and it's taxed at her progressive rates. How much depends on her other income. You can see how the slabs work in our guide on how to calculate income tax in Sri Lanka. Whatever that tax comes to, the Rs. 20,000 already deducted comes off it.

Then, on July 10, 2026, she redeems units that cost her Rs. 1,000,000 and receives Rs. 1,250,000. The fund reports Rs. 50,000 of that as her share of income, which she already declares as income. So her sale proceeds for the capital gain are Rs. 1,200,000, and her gain is Rs. 200,000. That's well over the Rs. 50,000 exemption limit. At 15%, she owes Rs. 30,000, with the Capital Gains Tax Return and payment due by August 30, 2026.

Why does the fund type matter so much?

Because it decides whether the fund is a wrapper the law looks through or a company that pays you dividends. In a pass-through fund, you own a slice of every dividend, deposit, and bill inside it, taxed the way each one is taxed on its own. In a fund treated as a company, you get dividends, and they're final.

Check your certificate each year, declare the interest and the government securities income, and watch the 30-day window when you redeem. Do those three things and you'll pay what you owe on a fund holding, and no more.