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East African nations are set to continue granting tax incentives to attract foreign investors despite research showing this is costing countries in the region nearly $2 billion annually.
Countries like Rwanda are racing to demonstrate their ability to accommodate multinationals in their midst. In its 2016 budget issued in June, the country announced incentives to scrap corporate income tax for international companies headquartered in Rwanda that invest more than $10 million, and a seven-year tax holiday for investments of more than $50 million.
The government has also increased capital allowances relief, from 40 percent to 50 percent, for investments made in the capital, Kigali. A reduced income tax rate of 15 percent has also been introduced for priority sectors such as manufacturing, energy, tourism and information and communication technology.
Tax Justice Network (TJN)—a co-author with Action Aid of the June report, “Still Racing Toward the Bottom? Corporate Tax Incentives in East Africa”Tanzania also continues to provide a variety of incentives.
Companies in the Export Processing Zones are still given income tax holidays for 10 years, and are also exempt from paying withholding tax on interest in respect of foreign loans and on dividends, again for 10 years, stated the report, which broadly criticized the nations for their “unnecessary” tax exemptions that are costing the nations “colossal amounts of revenue through unnecessary tax exemptions and incentives given to corporations.”
The trend sits uncomfortably with groups like TJN and Action Aid, which have been lobbying for years to draw attention to the revenue losses for governments in the region that increasingly opt for this route to pull global investment into their countries (119 TMIN, 6/21/16).
TJN spokeswoman Michelle Mbuthia said EAC nations, comprising Rwanda, Kenya, Uganda and Tanzania, “are providing a wider range of tax incentives to corporations, in the belief that it attracts more foreign direct investment (FDI)” and that this will lead to more jobs in the economy.
“But studies indicate that such tax incentives are leading to very large revenue losses,” said Mbuthia.
The groups say that although precise figures are impossible to provide, due to a lack of transparency when it comes to numbers and vital statistics on incentives, evidence gathered suggests that collectively EAC countries could still be losing up to $2 billion a year.
Mbuthia said providing tax incentives has become part of the tax competition among EAC members, adding that “governments in East Africa have not done the cost-benefit analysis to say if these tax giveaways are worth it.”
“This harmful tax competition may lead to lower revenue base, greater inequality, greater dependence on foreign aid and weaker accountability of government,” Mbuthia said.
Further, she said the loss of revenue from granting corporate tax incentives “may lead governments to increase the tax revenue through less just means” such as increasing value-added tax rate on basic goods.
Practitioners say tax incentives should be considered from a long-term development perspective.
In a review of Rwanda's 2016 budget, KPMG described the government's latest tax incentive measures as an effort to “maintain its position as an attractive foreign investment destination” as it focuses on “implementing strategic policies aimed at addressing infrastructure needs.”
Kigali-based Stephen Ineget, a director at KPMG in Rwanda, told Bloomberg BNA that EAC members aren't necessarily losing with these tax incentives, “given the long-term contribution” made by multinationals that benefit from the incentives.
“The idea is a simple one—support an inventor during set-up phase and allow them to make more tax profits in the future,” he said.
The government has, however, removed two other incentives—a 3 percent tax discount for exporting goods or services and tax discount of between 2 percent and 7 percent for employing up to 900 Rwandans.
A PwC analysis of Kenya's incentives said companies registered under a relatively new Special Economic Zones Act benefit from a reduced corporate tax rate of 10 percent in their first 10 years of operation. The corporate rate in the succeeding 10 years then would increase to 15 percent.
The June TJN/ActionAid report acknowledges that the country has moved to “broaden” the tax base recently: By early 2015, the report said, the Kenyan government had introduced a new capital gains tax, effective from January 2015, that's expected to yield annually around 0.2 percent of GDP in additional revenues, and committed itself to abolishing VAT exemptions on oil products by August 2016, which would increase VAT revenue by about 0.3 percent of GDP per year.
And Kenya Revenue Authority Commissioner-General John Njiraini in March called for the withdrawal of tax incentives offered to attract foreign investors, in a bid to shift focus toward improving the overall business environment and enhancing the services offered by the KRA (59 TMIN, 3/27/15).
After Uganda issued its budget in June, TJN and Action Aid said Uganda, like Kenya, has “continued its commitment” to reduce tax incentives.
But it complained that many tax incentives for corporations remain, notably for oil companies. “It remains unclear how much Uganda is losing to tax incentives since government figures do not appear in full, but the amount is likely to remain large,” the report said.
PwC notes that a resident taxpayer is entitled to a foreign credit for any foreign income tax paid in respect of foreign-source income included in the gross income of the taxpayer. The foreign tax credit allowed is subject to the 30 percent income tax rate in Uganda.
Conflicts around tax incentives aren't the only challenges for EAC members, as transfer pricing impacts are fast emerging as another business practice which causes tax leakage.
In its July report, “Preventing Tax Base Erosion in Africa: a Regional Study of Transfer Pricing Challenges in the Mining Sector,” the Natural Resource Governance Institute estimated annual losses documented in Tanzania at $1.2 billion, $1.1 billion for Kenya, $272 million in Uganda and $234 million in Rwanda.
The report revealed several challenges for African countries in introducing the arm's-length principle, since few have been able to match commitment to the principle, with a subsequent introduction of regulations, administrative guidance or company-specific advance pricing agreements.
Further, the NRGI noted that laws or contracts that impose taxes on industries such as the mining sector don't always refer to generally applicable transfer pricing rules, “leaving an ambiguity that could be exploited by, or lead to disputes with mining companies.”
Access to corporate taxpayer information is also difficult for tax authorities in the region.
“Consequently, they are unable to develop a full picture of a company's global operations for the purpose of investigating transfer pricing risks. At times they are also lax at enforcing domestic reporting obligations, leaving themselves ill equipped to review complex expenditure,” the report states.
Angello Musinguzi, a tax manager also at KPMG's Kigali-based firm in Rwanda, told Bloomberg in a July 22 e-mail that “tax incentives are necessary in EAC in order to attract investors in the region.”
More than 80 percent of the economy is made up of agriculture-related activity, he said, which means there is therefore a “need for value addition of agricultural produce” in the form of manufacturing.
“To attract investors in the sector, incentives have to be there. This necessity cuts across most sectors like health, energy, education, mining, etc.”
Musinguzi disagreed with the recent activist reports asserting that tax incentives are damaging to the EAC countries.
“In fact, some of the incentives have not been utilized, they are redundant in the investment code. Had there been no incentives, EAC members would have little FDIs, hence less revenue collections and unemployment, which is still a problem.
Musinguzi said that instead of condemning incentives, they should be increased since some have not directly attracted investment.
“Sitting down and computing revenue leakage without computing revenue collected, and making a comparison thereafter, is not proper,” Musinguzi said. He cited a need to question the leakages, as well as conduct research into the gains of the incentives “because everything is a give and take!”
The Action Aid/TJN report, however, noted that the Tanzanian government remains committed to limiting tax incentives and introduced a new law in 2015 that reduced VAT exemptions. However, it criticized breaks given through its Export Processing Zones and Special Economic Zones and to oil and gas investors.
The report also criticized EAC member Burundi, for which the authors found it challenging to determine revenue losses due to tax incentives because of a lack of necessary data.
Burundi President Pierre Nkurunziza reported that at least 81 billion Burundian francs ($52 million) have been lost to companies or officials given tax exemptions to import goods to build infrastructure but who instead sold the materials, it said.
Given all the leakages affecting EAC countries, Mbuthia said, the TJN intends to “reach out to East African decision-makers and influencers to end harmful tax incentives, unhealthy tax competition and the “race to the bottom” through its Tax and Investments Program.
The network also advocates for the introduction of fiscal transparency through tax expenditure policies in selected countries and supports national and regional efforts toward tax harmonization to address the competition.
If this is done, then the amount of revenue lost owing to unproductive tax incentives will be reduced and more funds can be made available to finance sustainable development,” Mbuthia added.
But Musinguzi thinks differently.
“The location of EAC, especially for countries that do not link with the sea is not attractive for investors,” he said. There should actually be harmonization of incentives at the EAC level, not country-specific incentives, he said.
To contact the reporter on this story: Francis Kokutse in Accra, Ghana, at email@example.com .
To contact the editor responsible for this story: Penny Sukhraj at firstname.lastname@example.org
The Action Aid/Tax Justice Network report is at http://src.bna.com/f4E.
The Natural Resource Governance Institute report is at http://www.resourcegovernance.org/sites/default/files/documents/nrgi_transfer-pricing-study.pdf.
Copyright © 2016 The Bureau of National Affairs, Inc. All Rights Reserved.
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