Rethinking tax incentives

Researches, experts say there is limited evidence to show these offers attract investors

Kampala, Uganda | PATRICIA AKANKWATSA | Tax incentives are part of Uganda government’s top priorities for attracting foreign investors and new businesses. From prospective investments in agribusiness to hospitality, and from steel to textile industries, tax incentives have remained the big thing in an attempt to grow the industrial sector.

But business and tax experts say tax incentives make the government lose huge revenues that would have otherwise been collected and used in improving business environment.

Though accurate data is difficult to find, a recent study by the Southern and Eastern Africa Trade Information and Negotiations Institute (SEATINI) shows that Uganda lost Shs1.4trillion in tax incentives in the year 2017/2018.

This is enough money to run the ministries of water and environment, tourism and ICT that have been allocated a combined budget of Shs about Shs1.46trillion for the new financial year.

Now, trade experts suggest that the government should find new ways of attracting investors rather than rely on tax incentives to attract investors arguing that there is limited evidence that shows linkage between the two variables – tax incentives and new investments.

Gideon Badagawa, the executive director at the Private Sector Foundation of Uganda told The Independent in an interview that tax incentives are least on the priorities for attracting investments.

“The major investment attraction is image and reputation of the country.

This is based on peace and security of persons and their property, good governance and commitment to fight corruption and respect for the rule of law, skills and infrastructure development,” he said.

“It is after these have been fixed that we then talk about tax holidays, tax relief,” he adds.

Nicholas Musoke, the supervisor in Charge of Research and Policy Analysis at the Uganda Revenue Authority says some of the exemptions have indeed been counterproductive to the taxman’s goals.

He, however, said some of the investors have taken the advantage of tax exemptions to avoid paying taxes.

“Tax exemptions would not be harmful only that some of the provisions are abused. Investors take advantage of loopholes in the exemptions and sometimes we lose a lot of revenue more so when it comes to income tax exemptions,” he said.

Musoke says the many tax exemptions have eroded the base for URA to collect taxes, limiting its potential to raise tax to Gross Domestic Product ratio from the current around 14.7% against a five year target of 18%.

This comes as the Finance Minister, Matia Kasaija, announced a reduction in the minimum investment threshold that allows developers of free zones and industrial parks to be eligible for tax incentive from $100million to $50million.

Kasaija, who was reading the budget at the Kampala Serena Hotel on June.13, also announced a reduction in the minimum investment threshold that allows operators within industrial parks to be eligible for tax incentives to $10million for foreigners and $1million for local investors.

This reduction in the investment threshold comes amidst an increase in URA’s tax collection from Shs16trillion in the Financial Year 2018/19 to Shs 18trillion in the Financial Year 2019/20.

But supporters of the tax incentives including Moses Kaggwa, the Director of Economic Affairs at the Ministry of Finance, Planning and Economic Development says the government cannot do away with tax exemptions.

He says the initiatives are aimed at attracting investments in the country to accelerate economic growth.

Incentives vs investment

Oshani Perera, a researcher at the Canadian-based International Institute for Sustainable Development said in her study dubbed ‘Rethinking Investment Incentives’ that whereas countries offered tax incentives to attract investors in the 1960s and 1970s, with the hope that the resulting losses would be balanced by positive externalities that investors would bring including jobs, up-skilling, business linkages, this initiative did not always play out as expected.

“While many economies experienced brief Foreign Direct Investment booms, policy-makers realised that fiscal incentives did little to embed investors in the domestic economy and even less to convince them to re-invest if the wider macro-economic offering remained weak,” she said.

“Many fiscal incentives were offered in Foreign Direct Investment sectors where the investment would very likely have been made without them.”

She said the challenge is not to design incentives as blunt instruments, but to match them with the economic realities of each jurisdiction, its comparative trading advantages and its immediate and medium-term sustainable development priorities.

Similarly, a research conducted by the World Bank Group’s Investment Climate Advisory Services in 2010 shows that tax exemptions do not attract investments in countries with weak investment climate, inaccurate macro-economic data, lack of skilled labour and bureaucratic red tape for starting a business.

The World Bank Group found that lowering the effective tax rate from 40% to 20% raised Foreign Direct Investments by 1% of Gross Domestic Product for countries ranked in the bottom of its investment climate report.

Fred Muhumuza, an economic analyst and lecturer at Makerere University says tax incentives in a country like Uganda can only bring in speculative investors who come for short term gains.

“The market should be the biggest attraction for investors. Even when people look for raw materials and cheap infrastructure, they still have the market (both local and foreign) as the key driver,” he says.

He said other investment attractions include available skilled labour and research as well as political stability and governance.

Successful countries

However, Perera said countries such as Canada, Ireland, Mauritius, South Korea, Malaysia and Singapore demonstrate that investment incentives can support sustainable growth.

“These countries have stable political climates and well-developed governance and institutional capacity,” she said adding, “This may have allowed them to invest in the continued upgrading of their Foreign Direct Investment credentials.”

Going forward, Perera said in the event that the government awards generous tax incentives to attract investors, reforms should be designed as partial tax holidays for a short period of time and that they should be performance-based on selected sectors and anchor projects.

“Some governments also prefer to target performance based incentives for capital investments,” she said.

“Many European member states offered tax credits for capital investment in renewable energy projects, and on financial products engineered to deliver capital for the upgrading of student housing and retirement homes.”

She also recommend uniform low tax rate for both domestic and foreign investors to enhance levelled  playing field or eliminate the use of tax incentives altogether.

Similarly, ActionAid executives says governments should eliminate tax incentives inform of tax holidays, tax incentives in free trade zones, and stability agreements (those between investors and governments that freeze tax terms for a period of time).

The executives says that in the event of extending a tax incentive, then, it should be on the basis of a cost-benefit analysis, including an assessment of the impact on poor people and vulnerable groups.

“The analysis must be made subject to public debate, scrutiny and parliamentary oversight,” the executives said.

Some beneficiaries of tax incentives

 Bidco Oil Refineries Ltd,

Aya Investments Ltd,

Steel and Tube Industries

Cipla Quality Chemicals

Power Projects, and

Kingdom Kampala

****