By Irma Johanna Mosquera Valderrama
In a recent blogpost, we argued that there are differences in the measures that countries have introduced to support businesses in times of COVID19. International organizations such as the OECD, IMF and World Bank have summarized these different types of measures. However, until a recent paper from the IMF there was not a clear measure recommended by these organizations (see below).
In order to address these different perspectives, we (at GLOBTAXGOV) co-organized with the Council on Economic Policies CEP on 24th June and 1st July 2020, two seminars on tax incentives for developing economies and COVID19, one with an international (in English) and one with a regional perspective (in Spanish for Latin America and Spain). In these seminars more than 180 participants attended including representatives from international, supranational (EU) and regional (tax organizations), tax administrations, civil society, think tanks, academia, and businesses. Reports of these seminars may be found here (international in English) and here (Latin America and Spain in Spanish).
Our analysis of tax incentives in light of BEPS and in times of COVID19
In light of BEPS Action 5
In the framework of the ERC funded GLOBTAXGOV Project (2018-2023), we are analyzing one BEPS minimum standard per year. The overall aim is to find out the differences in the implementation of the standards in countries and how this affects international tax law making by the G20, OECD and the EU. In 2018-2019, we analyzed BEPS Action 6 on treaty abuse. See presentations and output (articles/book chapters/papers) on the analysis of BEPS Action 6 here.
In September 2019, we started with the discussion of BEPS Action 5 and how this Action affects developing countries. For this purpose, we focused on tax incentives, since (developing) countries were revisiting their tax incentives mainly to align them with the BEPS Action 5 and with the EU Code of Conduct group (business taxation) that publishes the list of non-cooperative jurisdictions.[i]
Even though there are differences in literature regarding the usefulness of tax incentives to attract foreign direct investment, it is clear that tax incentives are an important tool for countries to attract investment to a specific under-developed region, or to a specific sector/industry in a country. Therefore, we can safely argue that countries continue using tax incentives to attract foreign direct investment. In some cases, these tax incentives are (at the time of writing) being reformed as part of comprehensive tax reform package CTRP (Philippines) or in order to improve their efficiency (Colombia).
At first, we started asking whether BEPS Action 5 is the right framework to evaluate tax incentives in developing countries. After an analysis of the application of BEPS Action 5 to tax incentives in the form of preferential tax regimes (for mobile businesses such as income from the provision of intangibles, and financial services), we concluded that the framework of BEPS Action 5 does not improve the design and transparency of the tax incentives, and it does not provide for a systematic review of such incentives. Therefore, in our view, BEPS Action 5 and the list of factors for evaluating preferential tax regimes are not the right framework for evaluating tax incentives in developing countries. See article here.
After concluding that BEPS Action 5 is not the right framework, we developed in another publication (available here), an evaluative framework of tax incentives in developing countries This framework takes into account not only the administrative considerations and legal drafting of tax incentives, but also the link of tax incentives to the sustainable development goals (SDGs). The main elements of this framework are:
- Systematic review of tax incentives;
- Clear target and eligibility criteria for granting the incentive;
- Tax incentives should be transparent, and the granting of the tax incentive should not be discretionary;
- Tax incentives should have a fiscal budget and ceiling;
- One institution to monitor and administer the incentives. The use of one stop shop agencies should be encouraged;
- Prevent the use of excessive use of laws/regulations to regulate tax incentives.
Thereafter, we applied this evaluative framework in another publication (forthcoming) with a case study of two countries, Singapore and Philippines.[ii] Singapore has been regarded in the literature as one of the countries that has successfully attracted foreign direct investment. However, it is not yet clear whether this is the result of tax incentives or any other measure. Philippines is at the time of writing in the process of introducing a comprehensive tax reform program (CTRP) that aims to redesign the tax incentives to become more competitive in the region and to achieve social and economic growth. These countries also belong to the same region (i.e. South East Asia) and therefore, the comparison of incentives in these countries can contribute to best practices in the region. Following this comparison, the second aim of this publication was to evaluate the tax incentives granted in Singapore and Philippines taking into account a new proposed evaluative framework for tax incentives in light of the SDGs.
There have been several reports/studies dealing with tax incentives from the Platform for Collaboration on Tax, the World Bank, the United Nations-CIAT report. These reports have been addressed in all contributions mentioned above. More recently, on 31 May 2020, the United Nations Committee in its 20th Session approved a chapter to improve the design and use of tax incentives in the extractive sector. These recommendations are also useful to other sectors and therefore, the contributions mentioned above as well as the reports of international organization may help countries to create their own framework to evaluate their tax incentives in light of the SDGs.
In times of COVID19
Due to COVID19, countries are introducing (or modifying) their tax incentives as fiscal stimuli for businesses and as a tool to continue attracting foreign direct investment into the country despite the uncertainty of COVID19. However, one of the problems is that these tax incentives have been introduced, or modified, without having a clear framework to design and evaluate these incentives. This framework is even in times of COVID19 still important so that incentives are transparent and targeted to the country’s needs.
In the seminars co-organized by GLOBTAXGOV and CEP in June and July 2020, the speakers mentioned the importance to have clear objectives for tax incentives in COVID19 and the importance to continue enhancing transparency and accountability of the tax incentives.
The case of the Philippines is an example. In the Philippines, the (proposed) comprehensive tax reform package (CTRP) 2 addressing tax incentives (CITIRA) has been recalibrated recently in light of the COVID19 Pandemic. The new Package 2 is referred to as the Corporate Recovery and Tax Incentives for Enterprises Act (CREATE). According to the Philippines Department of Finance website, the recalibration was necessary “to make it more relevant and responsive to the needs of businesses, especially those facing financial difficulties, and increase the ability of the Philippines to attract investments that will benefit the public interest”.
The new measures proposed by the CTRP Package in its CREATE form are mainly the introduction of fiscal stimuli for business. These measures include an immediate 5% corporate income tax reduction starting July 2020, extension of the applicability of carryover for losses incurred in 2020 from 3 to 5 years for non-large taxpayers, companies benefiting from the 5% gross income earned (GIE) incentives will benefit from a sunset clause from 4 to 9 years (in the CITIRA reform, it was 2 to 7 years); and more flexibility for the President in granting fiscal and non-fiscal incentives, which according to the Philippines Department of Finance, “will be critical as the country competes internationally for high-value investments”.
In our view, to ensure fair and accountable tax incentives regime, incentives need to be (1) performance based, (2) targeted, (3) time bound and (4) transparent. However, the discretionary power to the President to grant fiscal and non-fiscal tax incentives in CREATE may reduce the effectiveness of the transparency goal of the CTRP reform. [iii] This is also in light with the evaluative framework of tax incentives addressed above.
On 11 May 2020, the IMF published a paper in the special series on COVID19 addressing temporary investment incentives. According to the author of this paper (Jean-François Wen) “temporary investment incentives can provide investment demand stimulus to support economic recovery from the COVID19 pandemic”. In this paper, the author calls for incentives to be limited in duration and to target investment spending as directly as possible, to expire for all qualifying firms on the same dates and encourages countries to enhance cross-border coordination. The paper concludes that “well-designed, temporary provisions of accelerated depreciation provide the most cost-effective forms of investment stimulus in recessions”.
To sum up, countries use tax incentives to attract foreign direct investment, and to keep the economy going in times of COVID19. However, whether in times of COVID or not, there should be a clear framework to evaluate the usefulness of these tax incentives. Therefore, policy makers, governments and tax administrations should be careful when granting any type of tax incentive without a clear policy of what the incentive wants to achieve, and how to do so in the most efficient and (less costly) way.
[i] See on the EU Code of Conduct. Mosquera Valderrama, I.J. the EU Standard of Good Governance in Tax Matters for third (non-EU) countries. Intertax 47(5): 454-467. Available here.
[ii] See Mosquera Valderrama I.J. and Balharová M. Tax Incentives in Developing Countries: A Case Study: Singapore and Philippines in Taxation, International Cooperation and the 2030 SDG Agenda”, United Nations University Series on regionalism. Eds. (Mosquera Valderrama I.J, Lesage, D. and Lips W.) Springer Publications Forthcoming.
[iii] Ibid.