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Sri Lanka, a destination for Indian investors: An assessment of legal framework

India and Sri Lanka have maintained a thriving and flourishing economic and commercial relationship for more than 2500 years. In 2021, India became the premier trading partner of Sri Lanka, and currently, India is the second largest foreign direct investor of the island nation. Importantly, India has contributed significantly to the government throughout the current unprecedented economic crisis which the country is undergoing at present. Further, it has provided significant aid to the Sri Lankan government, with approximately US$ 4 billion so far, in the form of currency swaps, loan deferments and credit lines, in addition to humanitarian aid in form of food and medication.

Particularly, questions have been raised about whether Sri Lanka could actually rely on foreign investments from India, rather than China at a time when the government is criticized for placing unwarranted faith in significant infrastructure investment projects with China, which is alleged to be the main cause of the current foreign currency deficit. In order to link East Asia with the Middle East and Europe through their Belt & Road Initiative (BRI), the contemporary version of the ancient ‘Silk Route’, China has largely acquired strategically significant foreign projects in Sri Lanka, such as the Colombo Port City project, Hambantota Harbour Project, Mattala International Airport Project, and Norochcholai Coal Power Plant are to name a few. Nonetheless, with the effects of the current financial crisis situation, Sri Lankan government has invited more Indian investors to invest in Sri Lanka in energy industry, ports, infrastructure, and manufacturing sectors, shortly after New Delhi declared a US$ 900 million loan.

Both Marubeni Corporation and Adani Group of India have now submitted their proposals to invest in the energy sector, Marubeni Corporation to set up an 800-megawatt solar and wind plant and Adani Group to set up a similar 500-megawatt project. The government changed the Ceylon Electricity Act No. 20 of 2009 in July 2022, to abolish the monopoly the Ceylon Electricity Board (CEB) enjoys in power generation, distribution, and development and to enable both foreign and domestic investors to participate in these activities. Adani Group has now received provisional approval for the construction of the energy plant in the Northern Province. The public is still unaware of the procurement process the government used to choose Adani Group.

However, Sri Lanka unilaterally terminated its previous agreement entered with India and Japan to build the Colombo East Container Terminal (CECT), which was strategically crucial for India to place a tab on the activities that are taking place in the Indian Ocean, after the agreement drew strong public outcry. India had a distinct possibility of bringing an investor-state arbitration claim against Sri Lanka on the CECT project for violating the legitimate expectations of foreign investors but, the Sri Lankan government was able to ‘politically’ compromise it by contracting the same Adani Group to build the West Container Terminal at Colombo Port (WCT). Given the increasingly close ties with India, it is crucial to evaluate the present legal system governing foreign investment in order to understand any potential consequences.

BITs and Indo-Sri Lanka BIT

The international legal framework on foreign investment is largely shaped by Bilateral Investment Treaties (BITs). BIT is an agreement created between two nations to protect and encourage foreign investment in each other’s territory. Foreign investors can directly bring a claim against the host nation relating to the interpretation and application of the investment treaty. The plethora of investor-state arbitral awards has created a pro-investor climate where nations become vulnerable in protecting their legitimate regulatory power. As a result, countries such as Bolivia, South Africa, Russia and Indonesia, have terminated their BITs, while countries such as Venezuela, Ecuador and Bolivia have decided to pull out from membership of the International Centre for the Settlement of Investment Dispute (ICSID). Nonetheless, some countries have revisited their BITs incorporating explicit reference to the regulatory power of the host state to avoid allegations of investment treaty violation. These BITs are identified as second-generation BITs.

Concerning Sri Lanka and India, both countries have entered into a BIT in 1997 to mutually protect and encourage international investments.[1] Nonetheless, consequent to bitter experiences had in ISDS claims, India unilaterally terminated 54 BITs on March 22, 2017, including India-Sri Lanka BIT. Notably, Article 15(2) of the India-Sri Lanka BIT stipulates that with regard to investments made or acquired before the date of termination, the agreement shall remain in force for a period of 15 years from the date of termination (popularly known as the ‘sunset clause’). As a result, the only investors who are qualified to obtain the protection provided by the Indian-SL BIT are those who made or acquired their investments in India (or vice versa) before March 22, 2017.

Lanka’s Legal Framework relating to Foreign Investment

The Constitution of Sri Lanka, the highest law of the land, has placed the BITs in a higher position. As per Article 157 of the Constitution, if a foreign investment agreement is approved as being essential for the development of the national economy by the two-thirds majority of the parliament, such an agreement should have the force of law within the country and neither a written law nor an administrative or executive action can be taken except in the interest of national security. As a result, if a BIT is approved by Parliament, such BIT becomes a part of domestic law, and no enabling legislation is required to enforce the rights and obligations before the domestic courts.

There are several other important legislations that enable the smooth establishment and maintenance of foreign investments. With the introduction of open economic policy to the country, the Board of Investment (BOI) Law No. 4 of 1978 (as amended) was enacted as the ‘central facilitation point’ providing incentives for investment in Sri Lanka. The Act has established the BOI, inter alia, to foster and generate economic development and also to encourage and promote investment within the country. The BOI, together with the Ministry of Foreign Affairs negotiates BITs with other countries.

If a local or foreign investor seeks approval for an investment project, he/she has to submit an application to the BOI. There are two kinds of approvals given by the BOI; approval given under Section 16 and approval given under Section 17. Foreign investments may operate under Section 16 without receiving any tax benefits, and they are governed by domestic law as usual (such as provisions of Island Revenue laws, Custom laws, and Exchange Control Laws and regulations). These approvals are granted to facilitate foreign investment in entry points, setting up new companies with foreign shareholdings, and issuing new shares to foreign investors in already-existing non-BOI entities. At present, the minimum investment required to qualify for the section 16 projects is US$ 250,000. This can be either a foreign investment or a joint venture investment with local collaboration.

In contrast, section 17 authorizes the BOI to enter into an agreement with any enterprise having exemptions from any law in Inland Revenue Act, Custom Ordinance, Exchange Control Act, Companies Act, Merchant Shipping Act, and Finance Act. These exemptions make the investors’ task trouble-free and smooth and also contribute in luring in more foreign capital. Under Article 17, the minimum investment threshold of a project is of US$ 3 million upwards.

The Strategic Development Projects Act No. 14 of 2008 authorizes the BOI to designate any project which is in the national interest, likely to enhance the economy and society of the nation, and likely to alter the country’s physical landscape as a strategic development project (SDP). Such identified projects require the approval of cabinet ministers to become a valid SDP and they are exempted from taxes in the prescribed legislations of the schedule to the Act for a specified period, which should not exceed 25 years.  

In order to encourage the export and import of goods and services, the Finance Act No. 3 of 2013 has granted exemptions for certain enterprises engaged in specialized trading and services. Particularly, if any enterprise engaged in entrepot trade and re-export, off-shore business, providing front-end services to clients abroad, headquarters operations of finance supply chain and billing operations, logistic services carried out in a free port or a bonded regions, such enterprises are exempted from the certain specified Acts such as Value Added Tax Act, No. 14 of 2002, Nation Building Tax Act, No. 9 of 2009, Sri Lanka Export Development Act, No. 40 of 1979, Special Commodity Levy Act, No. 48 of 2007, Ports and Airports Development Levy Act, No.18 of 2011 and Excise (Special Provisions) Act, No. 13 of 1989. They are further qualified for the exemptions granted under the Inland Revenue Act, No. 10 of 2006 and Strategic Development Projects Act, No. 14 of 2008. In other words, these areas are excluded from custom territory of the country, though they are located within the sovereign territorial limits of the country.

The Colombo Port, Hambantota Port, Mattala Airport, Katunayake Export Processing Zone, Koggala Export Processing Zone, and Mirijjawila Export Processing Zone are among the authorized free ports and bonded regions under the 2013 Commercial Hub Regulation. These special territories have smoothened the movements of products and services of the foreign investors with the least intervention from state authorities.

Moreover, the Foreign Exchange Act No. 12 of 2017 has established a flexible exchange environment that permits foreign investors to transact directly with commercial banks, unless the explicit authorization of the Central Bank is required. Besides this, a further incentive for investors has been added by the Inland Revenue Act No. 24 of 2007, which offers a 14% reduced tax rate for certain industries, including SMEs, exports of goods, education, tourism, construction services, healthcare services, and a zero corporate income tax rate applicable for agro-farming, IT and export of services.

Despite regulating both – domestic and foreign investments, the ultimate purpose of all of these legislations are to attract more and more foreign investors. Even yet, the country’s investor-friendly legal framework hasn’t been able to fulfill its intended objective due to various reasons, including political instability, the current economic meltdown, unnecessary bureaucracy and lack of infrastructure facilities. Importantly, foreign investments made in accordance with the laws and regulations of the country are primarily governed by the provisions of BIT. However, the relevant authorities do not appear to consider the BIT obligations as very serious or decisive or as a legal instrument through which it is possible to create a damaging effect.

The India-Sri Lanka BIT of 1997 contains the characteristics of first-generation BIT that more tilts towards protecting the interests of the foreign investors of capital-exporting countries. It contains only the obligations of host state to protect and promote foreign investment, and no explicit reference is made relating to the protection of legitimate regulatory rights of the host state. As a result, the hesitance to regulate public welfare concerns would create a ‘regulatory chill’ halting all public welfare state measures.

In reality, the Indian investors are likely to receive more protection from Indo-Sri Lanka BIT, than Sri Lankan investors in Indian Territory, as Indian investors are widely established in Sri Lanka. The arbitrators are also more inclined to resolve the issue within the parameters of the BIT, favouring the investors, where there is inadequate guidance in the BIT’s text for its interpretation and application.

Investment Dispute Resolution

Since India-Sri Lanka BIT has been already terminated by India, investment dispute resolution has to be explored mainly in two ways; 1) Investments established or acquired before the termination of the BIT and, 2) Investments established or acquired after the termination of the BIT.

According to the dispute resolution clause of the India-Sri Lanka BIT, if an investment dispute arises between these two countries based on an investment established or acquired before March 22, 2017, the foreign investor should first resort to amicably settle the dispute through negotiation. If any such dispute cannot be resolved amicably within a period of six months, then parties may resort such dispute to either the domestic judiciary or to international conciliation under the Conciliation Rules of the United Nations Commission on International Trade Law.

However, the exhaustion of domestic remedies is not a precondition to resorting the matter to arbitration. If parties fail to agree on the host nation’s domestic judicial mechanism or conciliation, then the dispute may be referred to the International Centre for the Settlement of Investment Disputes (ICSID).  The sunset clause would make this BIT valid for the aforementioned investment disputes until the year 2032.

But, how should investment disputes that arose after March 22, 2017 be resolved? If Adani Group or any other Indian investor finds that the state measures taken by the Sri Lankan government are in violation of the investment contract, there is no BIT that governs such a scenario. In this context, although the domestic judiciary mechanism of the host state is always available for foreign investors, it is a dilemma to decide to what extend they would be attracted by the long-delayed judicial procedure of Sri Lanka. Hence, it is obvious that the investors would rely on the dispute resolution clause of the particular investment contract, which is more likely to rely on arbitration.

What next?

In case if an investment dispute arises based on the India-Sri Lanka BIT, Sri Lanka would be in a more disadvantageous juncture, as there is no sufficient space for exercising regulatory power. Rather than maintaining neutrality in treaty negotiations, the country should demonstrate its responsibility toward the general public as well as foreign investors without making a mockery of both.  Not only countries like Canada, the United States, China, France, Norway and the United Kingdom, have followed the model of second-generation BITs. Developing countries such as Nigeria, Chile, Slovakia, Morocco and Iran have also followed the same.

When a new BIT is renegotiated, Sri Lanka has to strongly appear for reserving space for legitimate regulatory rights, rather than playing ‘politics’ over ‘geopolitics’.

Niroshika Liyana Muhandiram

(Niroshika Liyana Muhandiram is a Ph.D Candidate of the South Asian University, New Delhi, India. She has also served as a Senior Lecturer of the Department of Legal Studies of the Open University of Sri Lanka. Her research interest includes interphase between environment and investment, investment treaty arbitration, commercial arbitration and private international law)


[1] Agreement beween the Government of the Democratic Socialist Republic of Sri Lanka and the Government of the Republic of India for the Promotion and Protection of Investment < https://investmentpolicy.unctad.org/international-investment-agreements/treaties/bit/1955/india—sri-lanka-bit-1997->

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