COLOMBO, June 16 (Reuters) - Sri Lankan shares fell 1 percent on Thursday to hit their lowest closing level in more than seven weeks as concerns over a government decision to reintroduce capital gains tax kept investors on the sidelines.

Investor sentiment also took a hit on continued foreign fund outflows and rising interest rates, dealers said.

Sri Lanka's cabinet approved a proposal to reintroduce a capital gains tax on Wednesday, especially on land sales, with a cabinet spokesman saying no decision had been taken on whether the tax would apply to capital gains in the share market.

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"Market is falling on low volumes with the high interest rates and the news of reintroduction of the capital gains tax," said Dimantha Mathew, head of research at First Capital Equities (Pvt) Ltd.

The benchmark Colombo stock index ended 1 percent, or 64.87 points lower, at 6,435.77, its lowest close since April 27.

Treasury bill yields rose between 1 and 4 basis points at a weekly auction on Wednesday. They have risen between 6 and 40 basis points since the central bank left key policy rates steady for on May 20.

The average prime lending rate edged up 24 basis points to 10.47 percent in the week ended June 10. Stockbrokers have said rising interest rates could be detrimental to risk assets if they jump beyond 12 percent.

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Overseas funds offloaded a net 5.84 million rupees worth of equities on Thursday, extending the year to date net foreign outflow to 5.59 billion rupees worth shares.

Turnover stood at 325.6 million rupees ($2.25 million), well below this year's daily average of around 764.8 million rupees.

Shares in conglomerate John Keells Holdings Plc fell 1.94 percent, while the biggest listed lender Commercial Bank of Ceylon Plc lost 2 percent and Carson Cumberbatch Plc dropped 5.44 percent. ($1 = 144.9000 Sri Lankan rupees) (Reporting by Ranga Sirilal and Shihar Aneez; Editing by Biju Dwarakanath)