TANZANIA PER TAX EXEMPTIONS STUDY DRAFT … PER TAX EXEMPTIONS STUDY DRAFT FINAL REPORT Proposed to:...

TANZANIA PER TAX EXEMPTIONS STUDY

DRAFT FINAL REPORT

Proposed to:

Ministry of Finance of Tanzania

October 2013

Tanzania - PER Tax Exemptions Study - Draft Final Report (October 2013)

Table of Contents

Page

INTRODUCTION ...................................................................................................................................... I

PART I: Theory and Evidence on Tax Exemptions ...................................................................1

1. Definitions and Principles .......................................................................................................1

1.1 What is a Tax Expenditure? ..............................................................................................2 1.2 Link between Tax Expenditures and the Benchmark Tax Structure ................................2 1.3 Measuring Tax Expenditures ............................................................................................3 1.4 Limitation in the Interpretation of Tax Expenditures Values ...........................................3 1.5 Types of Tax Expenditures ...............................................................................................5

2. Pros and Cons of Using Tax Exemptions ...............................................................................6

2.1 Why Do Governments Grant Tax Exemptions? ...............................................................6 2.2 Why can Assessing the Benefits from Tax Exemptions be a Misleading Exercise? ........8 2.3 Challenges Faced by Developing Countries Using Tax Incentives ..................................9 2.4 Exemptions as a Way to Attract Investments and Improve Business Climate ....................11 2.5 The Relevance of a Coordinated Approach with EAC State Partners ............................13

3. Success Stories in Reforming Tax Exemptions ...................................................................14

3.1 The Case of Mauritius.....................................................................................................15 3.2 The Case of Senegal .......................................................................................................16

PART II: Analysis of the Tax and Duty Exemptions Regime in Tanzania ............................19

4. Quantitative Analysis ............................................................................................................19

4.1 Recent Trends in Tax Revenue in Tanzania ...................................................................19

4.1.1 Direct Taxes .................................................................................................................. 21 4.1.2 Indirect Taxes ................................................................................................................ 22

4.2 Potential Tax Revenue ....................................................................................................24 4.3 Tax Exemptions as Revenue Foregone ...........................................................................25

4.3.1 Data Limitation Issues ................................................................................................... 28 4.3.2 Benchmarking: Tax Expenditures in EAC and OECD States ....................................... 28

Table of Contents (contd) Page


4.4 Beneficiaries of Tax Exemptions ....................................................................................31

5. Analysis of Legal-Based Tax and Duty Exemptions in Tanzania .....................................35

5.1 Exemptions Inventory .....................................................................................................35 5.2 Assessment Criteria and Considerations .........................................................................36 5.3 Analysis and Recommendations .....................................................................................38

5.3.1 Income Tax Act (2004) 2006 Edition ......................................................................... 38 5.3.2 Value-Added Tax Act (1997) 2009 Edition ............................................................... 40 5.3.3 East African Community Customs Management Act (2004) 2009 Edition ............... 47 5.3.4 Export Processing Zones Act (2002) 2006 Edition .................................................... 48 5.3.5 Special Economic Zones Act (2006) ............................................................................. 50

5.4 Comments on Other Relevant Acts and Government Notices .......................................52 5.5 Summary of Recommendations ......................................................................................53 5.6 Challenges in Assessing Revenue Generated by the Proposed Recommendations ........55

6. Administrative Framework Assessment ..............................................................................55

6.1 Exemptions Monitoring and Control ..............................................................................56 6.2 Exemptions Evaluation ...................................................................................................57 6.3 Exemptions Reporting ....................................................................................................57 6.4 Exemption Information Management System ................................................................57

PART III: Implementing the Proposed Reform of the Tanzanian Exemptions Regime ......59

7. An Integrated Strategy (Roadmap) to Implement the Reform .....................................59

7.1 Purpose of the Roadmap .................................................................................................59 7.2 Conditions for the Reforms Success..............................................................................60 7.3 Implementing the Reform: A Proposed Integrated Strategy ..........................................61 7.4 Risks Mitigation Strategy ...............................................................................................70

CONCLUSION ............................................................................................................................73

REFERENCES ............................................................................................................................................ i

List of Annexes

Annex A Inventory of Legal-Based Tax and Duty Exemptions


Annex B A Review of Empirical Methods to Quantify Tax Incentives

Annex C Key Informants

Annex D Useful Websites


List of Figures and Tables

Figure 1: Most Important Factors that Impact Investment Decisions .............................................. 12

Figure 2: Total Tax Revenue and Tax Yield, 1996-97 to 2011-12 .................................................. 20

Figure 3: Direct and Indirect Taxes as a % of Total Taxes, 1996-97 to 2011-12 ............................ 20

Figure 4: Distribution of Direct Taxes, 2000-01 to 2011-12 ............................................................ 21

Figure 5: Distribution of Indirect Taxes, 1996-97 to 2011-12 ......................................................... 22

Figure 6: Breakdown of (a) Domestic Consumption Taxes and (b) International Trade Taxes: 2011-12 ............................................................................................................................. 23

Figure 7: Value of Tax Exemptions in Tanzania from 2000-01 to 2011-12 .................................... 25

Figure 8: Value of Tax Exemptions in Tanzania from 2000-01 to 2011-12 .................................... 27

Figure 9: Value of Specific Tax Exemptions as a Percentage of Total Value of Tax Exemptions: (a) 2010-11 and (b) 2011-12 ........................................................................ 33

Figure 10: Tax Yield and Tax Yield without Tax Exemptions, 2000-01 to 2011-12 ........................ 34

Figure 11: Summary of Recommended Legislative Actions Sorted by Act and by Type of Action ............................................................................................................................... 36

Figure 12: Income Tax Act (2004), 2006 Ed., Proposed Amendments to Selected Sections Dealing with Tax Exemptions - Second Schedule: Exempt Amounts ............................... 39

Figure 13: VAT Act (1997), 2009 Ed., Proposed Amendments to Selected Sections Dealing with Tax Exemptions - First Schedule: Zero-Rated Supplies ........................................... 42

Figure 14: VAT Act (1997), 2009 Ed., Proposed Amendments to Selected Sections that Provide Tax Exemptions - Second Schedule: Exempt Supplies and Imports ................... 44

Figure 15: VAT Act (1997), 2009 Ed., Proposed Amendments to Selected Sections that Provide Tax Exemptions - Third Schedule: Special Reliefs ............................................. 46

Figure 16: East African Community Customs Management Act (2004), 2009 Ed., Proposed Amendments to Selected Sections that Provide Tax Exemptions - Fifth Schedule: Exemptions Regime ........................................................................................................... 48

Figure 17: Export Processing Zones Act (2002), 2006 Ed., Proposed Amendments to Selected Sections that Provide Tax Exemptions ............................................................................. 50

Figure 18: Special Economic Zones Act (2006), Proposed Amendments to Selected Sections that Provide Tax Exemptions - Part VII of the Act: Investment Incentives ..................... 51

Figure 19: Tax Exemptions Management Process ............................................................................. 56

Figure 19: Tax and Duty Exemptions Reform in Tanzania: Proposed Integrated Strategy ............... 61

Figure 20: Reforms Decisional Structure .......................................................................................... 63

Figure 21: Four Mandates for Consulting Firm(s) ............................................................................. 64

Figure 22: Reform Implementation (2013-2018): Sequence of Key Events and Actions .................. 65

Figure 24: Modernizing Tanzanias Tax/Duty Exemptions Regime .................................................. 75


List of Figures and Tables (Contd)

Table 1: Tax Revenues and Tax Expenditures as Percentage of GDP in Mauritius ....................... 15

Table 2: Tax Expenditure in Senegal .............................................................................................. 17

Table 3: Direct Taxes: Revenues, Share of Total Taxes and Average Annual Growth .................. 22

Table 4: Indirect Taxes: Revenues, Share of Total Taxes and Average Annual Growth ............... 24

Table 5: Value of Tax Exemptions in Tanzania from 2000-01 to 2011-12 .................................... 26

Table 6: Tax Incentives in EAC Countries ..................................................................................... 29

Table 7: Value of Tax Expenditures in EAC Countries* ................................................................ 30

Table 8: Tax Expenditures as a percentage of GDP in Tanzania and Selected OECD countries ............................................................................................................................ 31

Table 9: Beneficiaries of Tax Exemptions in Tanzania, 2010-11 and 2011-12 .............................. 32

Table 10: Implementation of the Tax and Duty Exemptions Reform over a 5-Year Period (2013-2018): Proposed Sequence of Key Events and Actions ......................................... 67


List of Acronyms

BRN Big Results Now

BoT Bank of Tanzania

CAG Controller and Auditor General

CBO Congressional Budget Office

CGE Computable General Equilibrium

CIAT Inter-American Center of Tax Administration

DGID Direction des Impts et des Douanes

EAC East African Community

EPZ Export Processing Zones

EPZA Export Processing Zones Authority

FDI Foreign Direct Investments

GDP Gross Domestic Product

GN Government Notice

GOT Government of Tanzania

ICTD International Center for Tax and Development

IFC International Finance Corporation

IMF International Monetary Fund

MDA Mining Development Agreement

MEM/MOEM Ministry of Energy and Minerals

MoF Ministry of Finance

MOITM Minister of Industry Trade and Marketing

MONRT Minister of Natural Resources and Tourism

MP Member of Parliament

NBS National Bureau of Statistics

NGO Non-Governmental Organisation

OCAG Office of the Controller and Auditor General

OECD Organisation for Economic Co-operation and Development

PAYE Pay-As-You-Earn

PBO Canadas Parliamentary Budget Office

PER Public Expenditure Review

POPC President's Office Planning Commission


PWC Price Waterhouse Coopers

SEZ Special Economic Zones

Shs Shillings

TIC Tanzania Investment Center

TMAA Tanzania Minerals Audit Agency

TPDC Tanzania Petroleum Department Corporation

TRA CEO Tanzania Revenue Authority Chief Executive Officer

TRA Tanzania Revenue Authority

UN United Nations

URT United Republic of Tanzania

VAT Value-Added Tax

WAEMU West African Economic and Monetary Union

ZIPA Zanzibar Investment Promotion Authority

ZIPPA Zanzibar Investment Promotion and Protection Act


Page I

INTRODUCTION Context and Objective of the Study

Tanzania has moved in a positive direction in domestic revenue collection, attributed to wide ranging reforms, including the operationalization of the Tanzania Revenue Authority (TRA) in 1996 and the review of key tax legislations, including the Income Tax Act and Value Added Tax (VAT) Act. Tax revenue collection has increased significantly since the establishment of the TRA. Notwithstanding Tanzanias substantial progress in improving its tax-revenue collection over the last decade, significant potential for further increases remain. A potential area for further increases is linked to the high level of tax exemptions and reductions. It has been decided by the Public Expenditure Review (PER) champions group to conduct a study, which will look at the whole range of tax exemptions currently provided in Tanzania. The purpose will be for Government of Tanzania (GOT) to have a solid basis for comprehensive reforms in the area of tax exemptions. Hence, the main objective of the study is to inform policy and decisions makers in the GOT on tax exemptions provided in Tanzania and point to best practices, which can be adopted to minimize unnecessary losses of revenue as a result of the application of tax exemptions and propose reforms to reduce the use of tax exemptions, improve business climate and productivity, and thus boost economic growth and development.

Study Approach and Limitations

The study has been structured as follows:

First, an inception stage served to lay the foundation of the study and included a two- week long inception mission in Tanzania.

Following validation of an Inception report, a second phase saw the bulk of tax exemption analyses and policy recommendations-related activities undertaken by a team of experts. This phase led to the submission of a draft report and the presentation of the study findings by the team of experts at a validation workshop held on 19-20 August 2013.

The final phase of the study has focused on the completion of the study report based on feedback received from key stakeholders during the validation workshop, as well as the development of a strategy (a roadmap) to implement a reform of tax and duty exemptions in Tanzania. Study findings will be presented at the PER Annual Consultative Meeting on 4-5 October 2013, following which a final version of the study report will be produced.

A number of limitations have been encountered during the study process. Among them, the Consultant faced challenges while conducting the inventory of tax exemptions due to limited information availability. The Consultant reviewed Tanzanian and EAC legislation granting tax and customs duty exemptions, but could not consult a number of other documents which would have been required to take into consideration for a comprehensive inventory of Tanzanias exemptions. These documents include Government Notices (GNs) through which the GOT grants tax exemptions, and agreements between the government and beneficiaries such as Mining Development Agreements (MDAs), Oil and Gas Production Sharing Agreements, and


Page II

agreements between the government and Strategic investors. Accordingly, the inventory of exemptions that are not granted by legislation has not been possible. Difficulties in data availability, particularly on income tax exemptions, have also restricted the analysis. Estimation of tax expenditure in respect of income tax is problematic since tax returns do not capture exempt income, such that taxpayers files do not contain exempt income data. As a result, income tax exemptions are not taken into account in any tax expenditure estimates included in this study. Furthermore, despite the TRAs collaboration, more disaggregated data on revenue foregone by the government due to tax exemptions would have been required to conduct more specific analysis of tax expenditure values. Estimation of benefits owing to tax exemptions could not be fully addressed in this study since available data would have produced non robust estimates. Structure of the Report This report is structured as follows: Part I: Theory and Evidence on Tax Exemptions

Chapter 1 recalls definitions, principles and other factual information on tax expenditures.

Chapter 2 discusses the pros and cons of using tax expenditures, notably as a way to attract investments, and address the challenges faced in assessing the benefits one developing country can get from them.

Chapter 3 develops the cases of Mauritius and Senegal; who recently performed tax exemptions reforms and obtained a relative success.

Part II: Analysis of the Tax Exemption Regime in Tanzania

Chapter 4 proposes a quantitative analysis where a summary of recent assessments of the value of tax exemptions in Tanzania is made, and trends are identified.

Chapter 5 presents the inventory of exemptions found in five major acts of the Tanzanian legislation by the Consultant, and proposes recommendations for each.

Chapter 6 gives an overview of the administrative framework for managing tax exemptions.

Finally, Chapter 7 proposes an integrated strategy for the Government of Tanzania to successfully implement a tax exemptions reform using a gradual approach.


Page 1

PART I: Theory and Evidence on Tax Exemptions

Part I provides a definition of the main tax-related concepts used in this study and revisits some of the tax expenditures and tax exemptions principles for which a broad consensus has been observed in the literature reviewed performed by the Consultant (Chapter 1). Pros and cons in using tax exemptions are discussed (Chapter 2) and examples of successful tax exemptions reforms that took place in few other countries are analysed (Chapter 3).

The literature review has focused on the most recent publications available, although some older reference documents have been consulted on the basis of the relevance of their content.1 Only studies and analyses from credible and recognized national or international institutions have been taken into consideration for this review. Opinions and editorials not based on scientific work have been excluded.

1. Definitions and Principles2

In general, the main purpose of a countrys taxation system is to raise revenue in order to fund public goods, services and activities that will help a government achieve its policy objectives. Government leaders can choose between two approaches (or use a mix of the two) to deliver on their commitments:

The (more conventional) fiscal direct expenditures approach, where resources are allocated to (i.e., money is spent on) particular activities, individuals, businesses or governments; or

The tax expenditures approach, where tax reductions are granted to selected groups of taxpayers to generate incentives and/or promote desired behaviors.

1 The documents consulted in this literature review are listed in the References section. 2 This section is based mostly on the following publications from the International Monetary Fund, the Organisation for

Economic Co-operation and Development, the United Nations, the World Bank and the governments of Australia, Canada and Quebec on tax expenditures such as: - Australia, Department of Treasury International Comparison of Australias Taxes, Chapter 14: Tax Expenditures, 2006. - Organisation for Economic Co-operation and Development (OECD), Tax Expenditures in OECD Countries, OECD,

2010. - Villela, Luiz, Andrea Lemgruber and Michael Jorratt, Challenges for Measuring Tax Expenditure in Tax Thematic

Series, Inter-American Center of Tax Administrations, No. 9, March 2011. - Inter-American Center of Tax Administrations (CIAT), Handbook of Best Practices on Tax Expenditure Measurements,

an Ibericoamerican Experience, Inter-American Center of Tax Administrations (CIAT), 2011. - IMF, OECD, UN and World Bank, Supporting the Development of More Effective Tax Systems, Report to the G-20

Development Working Group, 2011. - Department of Finance Canada, Tax Expenditures: Notes to the Estimates/Projections 2010, 2010. - Government of Quebec, Tax Expenditures - 2010 Edition, 2011.


Page 2

1.1 What is a Tax Expenditure?

Simply put, a tax expenditure is a loss of revenue for a government, as for a taxpayer it is a reduction in tax liability. One of the definitions used by the Organisation for Economic Co-operation and Development (OECD) is from Kraan (2004), who describes tax expenditures as:

a transfer of public resources that is achieved by reducing tax obligations with respect to a benchmark tax, rather than by a direct

expenditure.3 Most experts agree on such a definition, which refers to two important notions, i.e., the tax reduction for taxpayers (or a reduction of revenue for a government) and the deviation from a benchmark tax structure. Therefore, to identify and estimate tax expenditures, it is necessary to establish a benchmark tax structure that applies the relevant tax rates to a broadly defined tax base e.g. personal income, business income or consumption. Tax expenditures are then defined as deviations from this benchmark. Significant differences of opinion exist about what should be considered a benchmark tax system and hence about what should be considered a tax expenditure.

1.2 Link between Tax Expenditures and the Benchmark Tax Structure

In practice, there is significant diversity in working definitions of tax expenditures across countries due to the fact that tax measures can be classified as part of the benchmark or an exception to it. There is no real common ground on what a benchmark tax might be, with the result being that each country has its own set of criteria. On that matter, the OECD concludes that no benchmark tax in any one of its member countries should serve as a model for tax expenditure analysis for all countries4 As a rule of thumb, most experts agree that structural elements of a tax system should not be recorded as tax expenditures, while programmatic or policy features should be (OECD)5. For example, a benchmark encompasses the most fundamental elements of the tax system, namely the overall tax base, the rate structure (e.g., progressive, regressive, flat tax), the taxation unit or taxpayer (e.g., individuals, households, businesses), the treatment of inflation (nominal or real figures) and the taxation period. On the other hand, preferential measures intended to provide tax relief constitute tax expenditures. Such a selection exercise implies a subjective, or even political, component that explains in part the controversy around the concept of tax expenditures since its creation.6

3 Organisation for Economic Co-operation and Development (OECD), Tax Expenditures in OECD Countries, OECD, 2010,

page 14. 4 Organisation for Economic Co-operation and Development (OECD), Tax Expenditures in OECD Countries, OECD, 2010,

page 18. 5 Organisation for Economic Co-operation and Development (OECD), Tax Expenditures in OECD Countries, OECD, 2010,

page 12. 6 The concept of tax expenditures was first identified in the late nineteen sixties in the United States by Stanley S. Surrey, a tax

lawyer and former Assistant Secretary of the US Treasury. He was the first to use this term to designate a way to represent the political use of tax breaks for means that were usually accomplished through budget.


Page 3

1.3 Measuring Tax Expenditures7

Tax expenditures can be measured in three principal ways:

The revenue forgone approach which measures how much taxation revenue is reduced (relative to a benchmark) because a tax expenditure exists. It compares the prospective treatment and the benchmark treatment, assuming taxpayer behaviour is unchanged.

The revenue gain approach which measures how much revenue could increase if a particular tax concession were removed. Accurate estimation of this cost requires estimates of the behavioural effects associated with such a change.

The outlay equivalence approach which measures how much direct expenditure would be needed to provide a benefit equivalent to the tax expenditure.

Most countries use the first method, the revenue forgone approach, to calculate the value of tax expenditures, as it is viewed as relatively simple and sufficiently reliable. With this approach, the value of a given tax expenditure equals the amount by which tax revenue is reduced as a consequence of the introduction of this very tax expenditure, based upon the assumption of unchanged behaviour and unchanged revenues from other taxes. The revenue gain approach takes into account the change in behaviour and the effects on revenue from other taxes as a consequence of the introduction of a tax expenditure. Although viewed as preferable in theory, this approach is very difficult to apply in practice, as it requires substantial information regarding behavioural responses and interactions with the rest of the tax system. This becomes quite complex (and arbitrary) as the number of tax expenditures in a system increases. For the same reason, i.e., complexity, the outlay equivalence approach is not used in practice, with the exception of Sweden which provides such estimates as supplementary information in its annual publication of tax expenditures. The value of tax expenditures is usually indicated in currency, as a percentage of the nations Gross Domestic Product (GDP), or as a percentage of its total tax collected.

1.4 Limitation in the Interpretation of Tax Expenditures Values

As previously discussed, despite the consensus of experts on the definition of tax expenditures as a function of a benchmark tax, there are no specific guidelines about what should be included in the tax expenditure basket vs. what should remain in the benchmark tax. As a result, differences in tax systems, benchmarks, classification systems and coverage of estimates across countries make international comparisons of the value of tax expenditures, in monetary or proportional

7 This section is based mostly of the following publications from the OECD and the Australian Government:

- OECD (Barry Anderson) Tax Expenditures in OECD countries, January 2008. - OECD (Joe Minarik) Tax Expenditures in OECD countries, June 2009. - Australia, Department of Treasury International Comparison of Australias Taxes, Chapter 14: Tax Expenditures, 2006. - Organisation for Economic Co-operation and Development (OECD), Tax Expenditures in OECD Countries, OECD,

2010.


Page 4

terms, unlikely to be meaningful (OECD8 and Government of Australia9). Such an exercise would come down to comparing apples with oranges, and therefore it could mislead any tax expenditure reform based on this sole indicator. Differences in benchmark structures tax between OECD countries are discussed in one of the organisations publication on tax expenditures10. For example, Canadas benchmark is articulated to a considerable level of detail. Particular decisions, such as the choice of the individual rather than the household as the unit of taxation, and the inclusion of Canadas particular method of relief for double taxation of dividends, lead to differences in the identification of tax expenditures relative to other countries. In contrast to this specificity, Japan and Korea do not yet identify any specific benchmark tax system, rather identifying tax expenditures (or in the case of Japan, what are called special tax measures) by reference to deviation from principles which are not so explicitly articulated. Other countries state their own methods with varying degrees of specificity, and with unique choices of policy standards. Moreover, there is no clear consensus on the accounting rules a country should privilege for the measurement of its benchmark tax. For instance, a country can choose between using an income approach or an expenditure approach, a nominal approach (no account taken of the impacts of inflation) or a real approach (account taken of inflation), or its base can be determined around accrued income (income is recognized as the price of assets and liabilities change) or on a realizations basis (changes in asset values recognized at the time of sale). This lack of standardization contributes to make comparisons between countries of the value of their tax expenditures an exercise for which results should be interpreted with a lot of prudence. The literature also warns to be careful in interpreting estimates of tax expenditures calculated by the revenue forgone method because the estimates are not necessarily reliable indicators of the budgetary impact of adding or removing particular tax expenditures. Furthermore, aggregated estimates of tax expenditures (i.e., the sum of the individual value of all tax expenditures of a country) are viewed as not reliable indicators of the total value of tax expenditures and should only be taken as broad indicators of trends in the value and composition of tax expenditures over time. These trends could be meaningful and interesting to analyse, assuming that no change is made to the nations benchmark tax. None of the reviewed publications provided a portrait or an analysis of the benchmark tax used by African countries in general or in Tanzania in particular. Given the lack of data in that regards, this study will assume that differences between benchmark taxes in Africa are at a level that is at least comparable to the one observed between OECD countries and for which conclusions have been well documented. Therefore, the same prudence is advised in the interpretation of African nations tax expenditures values.

8 Organisation for Economic Co-operation and Development (OECD), Tax Expenditures in OECD Countries, OECD, 2010. 9 Australia, Department of Treasury International Comparison of Australias Taxes, Chapter 14: Tax Expenditures, 2006. 10 Organisation for Economic Co-operation and Development (OECD), Tax Expenditures in OECD Countries, OECD, 2010,

page 16.


Page 5

1.5 Types of Tax Expenditures

Different types of tax expenditures exist and their definitions can vary slightly from one source to another. Generally speaking, common types of tax expenditures are described as follow:11

a) Tax Exemptions

Tax exemptions are incomes that are excluded from the tax base. For example, capital gains that are not subject to income tax would be considered as a tax exemption. Here, the exemption applies to a specific income (capital gains), but tax exemptions can also be granted to individuals (e.g., Aboriginal people in Canada) or businesses (e.g., NGOs). In the common language, the expression tax exemptions is often used as a substitute for tax expenditures, which is in fact a broader concept since it includes tax exemptions and other types of tax expenditures.

b) Tax Deductions (or Allowances)

Tax deductions are amounts that reduce taxable income. An example of deductions can be expenditures made to earn an investment income and which can be subtracted from this income. Other common deductions are investment losses that can be applied against gains to reduce the total amount of taxable income.

c) Tax Deferrals

Tax deferrals are amounts that are not included in the calculation of income for a given year but are included in the calculation of a future year. In many countries, this type of tax expenditure is used as an incentive for people to save money for retirement. In this example, the tax deferral benefits taxpayers who have a higher marginal tax rate when they contribute to their retirement savings plan than when they leave the workforce and withdraw the amounts saved (which is usually the case).

d) Tax Rate Reliefs (or Reductions)

In some cases, the tax system allows tax rates that are lower than the generally applicable rate. An example could be a reduced tax on fuel for businesses of a given sector (e.g., mining) or for businesses located in a specific geographic area. Unlike tax exemptions, deductions and deferrals, this form of tax expenditure does not depend on the taxpayers marginal tax rate, but only on whether or not the taxpayer can benefit from reduced tax rates on specific goods or services.

e) Tax Credits

Tax credits are amounts deducted from tax liability. In other words, tax credits reduce tax payable rather than income subject to tax, like tax deductions do. There are two categories of tax credits:

11 Based on Organisation for Economic Co-operation and Development (OECD), Tax Expenditures in OECD Countries,

OECD, 2010, page 12 and Government of Quebec, Tax Expenditures - 2010 Edition, 2011, pp. 9-11.


Page 6

i. The refundable tax credit: when the value of the credit exceeds tax liability, the difference is refunded to the taxpayer;

ii. The non-refundable tax credit: this credit can contribute to bring tax liability down to zero, but any excess of credit is lost by the taxpayer.

The five types of tax expenditures described above apply to both personal and income taxes, but only tax exemptions and tax reliefs are used on consumptions taxes (i.e., value-added tax, excise tax, other sales taxes). For instance, tax exemptions can be applied to certain goods and services (otherwise taxed) like basic groceries, medical devices, and prescription drugs. Several studies dealing with tax expenditures in Tanzania and other African countries use tax exemptions as a substitute for the broader concept of tax expenditures.12 Tax incentives is also used as a synonym for tax exemptions. Therefore, for the purpose of simplicity and consistency with publications consulted, the rest of this chapter will use the expressions tax exemptions and tax incentives in a more general (yet somewhat inexact) sense, without trying to validate (or not) the accuracy of the terminology encountered. However, it should be noted that international practice does require that an accurate identification of the types of tax expenditures forming a countrys tax arsenal be made. Such a comprehensive exercise is beyond the mandate of the present study.

2. Pros and Cons of Using Tax Exemptions

Pros and cons of using tax exemptions in developing countries are discussed in this section. The mains reasons for governments to grant exemptions and challenges generally faced by developing countries using tax incentives are reviewed, drawing from the literature on this topic. Empirical evidence on the effectiveness of tax exemptions as a way to attract investments and improve business climate is also presented.

2.1 Why Do Governments Grant Tax Exemptions?

The main reason mentioned by governments of developing countries to grant tax exemptions is the need to attract investment, and often foreign direct investment (FDI). The idea is to have the country and its population benefit from social and economic returns that are expected to be higher than the cost incurred to attract these investments. Proponents often argue that lower tax burdens give investors a higher net rate of return and therefore free up additional income for re-investment. The host country thus attracts increased FDI, raises its income and also benefits from the transfer of technology. A further argument is that it is imperative to provide incentives to investors, given the otherwise poor investment climate: the volatility in politics, dilapidated infrastructure, the high cost of doing business, the macroeconomic instability, corruption and an

12 As an example, the Annual General Report of the Office of the Controller and Auditor General (June 2012 Edition) uses the

expression tax exemptions to name what in fact are tax deductions and tax reliefs. TRA, Third Corporate Plan 2008/09 2012/2013, March 2010, page 67.


Page 7

inefficient judiciary. Tax revenue losses are rationalized by arguing that the capital and jobs created will improve the welfare of citizens and expand the economy13 In its most recent report, the Controller and Auditor General (CAG) considers that tax exemptions are necessary tool (sic) for investment promotion and economic growth14. They are granted for various reasons such as social, economic, political reasons or international agreements (bilateral or multilateral). Often, tax exemptions are granted to stimulate economic development, for example, the tax exemptions provided to mining companies and tax incentives provided to investors registered with the Tanzania Investment Center (TIC)15. The OECD considers that if tax expenditures are enacted, it is because there are perceived legitimate reasons for their use. Tax expenditures have a role to play, they are employed widely, and there are few, if any, suggestions that all tax expenditures should be repealed. Assuming in the first instance that there are valid reasons for government involvement, there are conditions under which tax expenditures are most likely to be successful, or even the best, policy tools to achieve their objectives16. Uwazi17 summarizes the reasons tax exemptions can be granted in Tanzania:

When the foreign or official nature of the item in question does not warrant a tax (e.g., diplomatic missions);

When activities of certain organizations do not earn them a profit but have a direct benefit to society which the Government may not be able to otherwise procure (e.g., charities, NGOs);

When consumption of certain goods are deemed to have direct benefits to society (e.g., VAT exemptions on drugs, fire fighting vehicles);

When the government wants to stimulate economic growth by increasing direct investments in the country. These exemptions should normally lead to increased investment, employment, output growth, and thus lead to more tax revenues in the long run. Groups of companies benefiting from reduced corporate taxes on profits or reduced import duties fall under this category. Most notable among these are companies established under the Export Processing Zones Authority (EPZA) Act, mining companies and other companies which hold certificates of incentives from TIC or Zanzibar Investment Promotion Authority (ZIPA).

13 Tax Justice Network-Africa & ActionAid International, Tax Incentives and Revenue Losses in Tanzania, June 2012, p. 20. 14 Controller and Auditor General (CAG), Annual General Report of the Controller and Auditor General on the Financial

Statements of the Central Government for the Year Ended 30th June, 2012, National Audit Office, 2013, page 64. 15 Controller and Auditor General (CAG), Annual General Report of the Controller and Auditor General on the Financial

Statements of the Central Government for the Year Ended 30th June, 2012, National Audit Office, 2013, page 65. 16 Australia, Department of Treasury International Comparison of Australias Taxes, Chapter 14: Tax Expenditures, 2006,

page 24. 17 Uwazi, Tanzanias Tax Exemptions: Are they too high and making us too dependent on foreign aid?, Policy brief

TZ.12/2010E, October 2010, page 2.


Page 8

2.2 Why can Assessing the Benefits from Tax Exemptions be a Misleading Exercise?

Assessing benefits from tax exemptions both economic and social benefits can be a very challenging exercise for a number of reasons. First and foremost, it is very difficult to determine which economic agents have really changed their behavior as a result of a particular tax incentive (for instance, which investors would have invested in the first place even if a given tax incentive had not been in place). Consequently, assessing benefits from a given tax incentives, such as those new jobs created, wage increased or extra investment flows is not straightforward. Moreover, the exact scope of benefits from tax exemptions is almost impossible to determine since direct and indirect benefits are very numerous (1st round effects, 2nd round effects, etc.). Direct and indirect benefits are also very difficult to quantify, as rigorous assessment of benefits would require a significant amount of data and the use of sophisticated analytical tools which capture the complexity of direct and indirect effects as well as the different possible economic interactions. The results from such assessments are also highly dependent on a number of key assumptions and parameters for which the empirical literature is hardly ever converging, such that results may be highly arbitrary or perceived as such. Economists have generally used several approaches to analyse the costs and benefits of a given tax measure (or a change in its parameters). For example, several cost-benefit analyses make use of highly complex models intended to capture all of the direct and indirect economic impacts of the policy being evaluated. Computable general equilibrium (CGE) models represent an example of that family of highly sophisticated models and the latter have been used in several tax impact studies. Another method, although not as widespread as CGE models, involves incidence studies that estimate individual tax burdens directly using large microdata (and sometimes longitudinal) sets. All of these approaches have become increasingly sophisticated over time, and several exhaustive surveys of the incidence literature, which examine in detail the various types of models, have appeared over the years.18

One obvious problem with this general class of detailed approaches is the immense investment required in terms of resources and data. Furthermore, the results obtained are highly dependent of the underlying theoretical model and assumptions, which always involves a great deal of arbitrariness. This explains why a wide variance of impacts can be obtained for exactly the same tax policy change. This is the reason why several economists in governments, public agencies and international organizations came to prefer to limit the scope and the analysis of a given tax exemption as the marginal gain of useful, robust and relevant information obtained from these sophisticated models was not worth the time, resources and data required to build and maintain them. A paper written for CRC Sogema19 in the very context of the present study provides a rather comprehensive survey of the literature on costs and benefits of a given tax measure. Its conclusions are that: [] costs and benefits of tax exemptions (as for any tax changes) are

18

See Mieszkowski 1969; Break 1974; McLure 1975; Kotlikoff and Summers 1987; Atkinson 1994; Fullerton and Metcalf 2002, Dixon and Jorgenson (2013) among others.

19 Delorme, Franois, A Pragmatic Roadmap of Empirical Methods to Quantify Tax Incentives, August 2013. The full version of the paper is in Annex D.


Page 9

numerous, direct and indirect as well as very difficult to quantify. [] It follows that the results

become highly dependent of a number of key assumptions and parameters for which the

empirical literature is seldom converging. Government agencies that have adopted such a pragmatic approach to assess the impact of tax changes include Canadas Parliamentary Budget Office (PBO). Created in 2006 along the lines of the US Congressional Budget Office (CBO) as an arms length and independent agency, the PBO provides independent analysis to Parliament on the state of the nation's finances, the government's estimates and trends in the Canadian economy. But more importantly, its mandate states that, upon request from a committee or parliamentarian, it has to provide estimates of the financial cost of any tax or spending proposal for matters over which Parliament has jurisdiction. In recent years, both the US CBO and the Canadian PBO have provided impacts of a wide range of specific tax changes. For example, the PBO has recently assessed individual tax deductions for travel expenses, reform to the Employment Insurance program, the tax credit for loss of retirement income, the enhancement of the tax credit for charity donations, the creation of the volunteer tax credit, changes of the taxations regime for new graduates. Each year, the PBO publishes a "ready reckoner" that provides cost estimates of corporate tax points using the pragmatic approach.20 In all cases, it has deliberately chosen to use the pragmatic partial equilibrium approach instead of more sophisticated analysis (either CGE or econometric) to focus the analysis on the public revenue impacts of the changes to the tax parameters.21

2.3 Challenges Faced by Developing Countries Using Tax Incentives

A recent report to the G-20 Development Working Group and made by the IMF, OECD, UN and the World Bank22 (2011) indicates that tax exemptions aimed at FDI largely to multinational enterprises domiciled in G-20 countries are an especially important form of tax expenditure in many developing countries, in many cases significantly undermining their tax revenue base. According to the report, developing countries sometimes believe often correctly that an attempt to hold the line against multinationals negotiating for necessary tax breaks will simply drive the investment in question into a neighbouring country. This sort of bargaining frequently results in a race to the bottom in which countries in a region are made collectively worse off, to the benefit of the multinational investors. A recent empirical study by the IMF, focusing on 50 emerging and developing economies, analyzed the impact of corporate income tax regimes on corporate tax revenues and domestic and foreign investments and concluded that a race to the bottom is evident among special regimes, most notably in the case of Africa, effectively creating a parallel tax system where rates have fallen to almost zero23. In 2001, a World Bank Paper on using tax incentives to compete for foreign investment24 was already highly critical of such a method, widely used in developing countries. The paper argued 20 See http://www.pbo-dpb.gc.ca/files/files/Ready_Reckoner_2013_EN.pdf 21 See http://www.pbo-dpb.gc.ca/en/ 22 IMF, OECD, UN and World Bank, Supporting the Development of More Effective Tax Systems, Report to the G-20

Development Working Group, 2011, page 24. 23 IMF, A Partial Race to the Bottom: Corporate Tax Developments in Emerging and Developing Economies, IMF Working

Paper No. WP/12/28, January 2012. 24 World Bank Group Private sector and Infrastructure Network: Using Tax Incentives to Attract Foreign Direct

Investment, in Public Policy for the Private Sector, Note number 253, February 2003.


Page 10

that, by providing benefits as soon as a company begins earning income, tax holidays benefited primarily short-term investments, typical of footloose industries in which companies could move quickly from one jurisdiction to another. Tax incentives were also viewed as rewarding the founding of a company rather than investment in existing companies, and discriminating against investments that rely on long-lived depreciable capital. The study, made for the G-20 Development Working Group25, also suggests that tax-driven investments do not provide a stable source of investment in the recipient country. The OECD26 (2010) recalls that tax incentives have been a serious concern for budget and tax analysts for almost half a century. In particular, many specialists are of the view that tax expenditures may have ill effects on both budget and tax policy, and that both political and policy-making considerations may make tax expenditures easier to enact, and less likely to undergo rigorous review and repeal, than equivalent but more straightforward spending programs. In a study of Kenya, Uganda and Tanzania, the IMF27 (2008) summarizes the main arguments found in the literature against the use of tax incentives28:

Tax incentives result in a loss of current and future tax revenue; Tax incentives create differences in effective tax rates and thus distortions in allocation of

investment between activities that are subsidized and those that are not; Tax incentives are hard to remove once granted, and could require large administrative

resources; Tax incentives could result in rent-seeking and other undesirable behaviours; Income tax holidays could be a particularly ineffective way of promoting investment

because companies that are not profitable in the early years of operation would not benefit from them;

Tax incentives attract mainly footloose firms; and Tax incentives can be outside the budget and nontransparent.

After reviewing several studies on the subject, the IMF concludes that these concerns are supported by available empirical evidence, which mostly confirms that investment incentives particularly tax incentives are not an important factor in attracting foreign investment. Countries that were most successful in attracting foreign investors did not have to offer tax or other incentives, and vice versa, offering such incentives has not been sufficient to attract large foreign investment if other conditions were not in place. This conclusion is confirmed both by surveys of investors and by econometric evidence. Other studies corroborate findings from the IMF literature review, including studies from the International Finance Corporation (2011)29,

25 IMF, OECD, UN and World Bank, Supporting the Development of More Effective Tax Systems, Report to the G-20

Development Working Group, 2011. 26 Organisation for Economic Co-operation and Development (OECD), Tax Expenditures in OECD Countries, OECD, 2010,

page 14. 27 IMF, Kenya, Uganda and United Republic of Tanzania: Selected Issues, 1 December 2008, pages 10-11. 28 For a more detailed discussion on the dangers of tax holidays, see also IMF, Revenue Mobilization in Developing

Countries, Fiscal Affairs Department, March 8, 2011, page 71. 29 Mwachinga, Edward, Mikra Krasniqi, and Sebastian James, Tax Incentives in the EAC Member States, Presentation to the

EABC Conference, Dar Es Salaam, Investment Climate Advisory Services, November 11-12, 2011.


Page 11

Uwazi (2010)30, Tax-Justice Network-Africa et al. (2012)31 and African Development Bank Group (2010)32. To be sure, the evidence does not disprove that under specific circumstances, well-targeted investment incentives could be a factor affecting investment decisions.33 Neither does it imply that investors would still not ask for whatever incentives they could get. But in the end, investment incentives seldom appear to be the most important factor in investment decisions.

2.4 Exemptions as a Way to Attract Investments and Improve Business Climate

According to The Investment Climate Advisory Services of the World Bank Group (2012)34 weak investment climate cannot be offset by offering lower tax rates to corporations. The paper reported empirical evidence from a study on effectiveness of tax incentives in Central and West Africa. Results shows that in countries where the investment climate is good, the effect of lowering effective tax rates on FDI was positive, while in countries with poor investment climate that includes Tanzania and other developing countries , the effect was almost non-existent. This important finding suggests that it is more efficient for developing countries to focus on improving their investment climate rather than granting tax exemptions to corporations. The study also conducted a survey showing that in Tanzania, 88.5% of business owners who have chosen to invest in the country would have done so without tax incentives. Another survey conducted in this study with investors in Tanzania, Burundi and Rwanda35, shows that tax incentives are one of the least important factors that impact investors decision. By far the most important factor mentioned by investors was the market potential (nearly 80% of respondents), followed by access to Finance (nearly 30%), access to electricity, good infrastructure, labour costs, and the like (Figure 1).

30 Uwazi, Tanzanias Tax Exemptions: Are they too high and making us too dependent on foreign aid?, Policy brief

TZ.12/2010E, October 2010. 31 Tax Justice Network-Africa & ActionAid International, Tax Incentives and Revenue Losses in Tanzania, June 2012. 32 African Development Bank, Domestic Resource Mobilisation for Poverty Reduction in East Africa: Tanzania Case Study,

November 2010. 33 Mwachinga, Edward, Mikra Krasniqi, and Sebastian James, Tax Incentives in the EAC Member States, Presentation to the

EABC Conference, Dar Es Salaam, Investment Climate Advisory Services, November 11-12, 2011, page 24. The International Finance Corporation lists situations in which investment incentives are recommended: when investments create sustainable jobs, generate positive externalities, encourage green technologies, upgrade skills of workers, or when the new investment is an anchor investment.

34 World Bank Group, Effectiveness of Investment Incentives in Development Countries, Evidence and Policy Implications, Investment Climate Advisory Services of the World Bank Group, Presentation, Vienna, May 14, 2012.

35 World Bank Group, Investor Motivation Survey Results: Tanzania, Tax Incentives Study in the East African Community Member (EAC) States, Presentation by Global Tax Team, CIC, IFC, Washington.


Page 12

Figure 1: Most Important Factors that Impact Investment Decisions

Source: World Bank Group, Investor Motivation Survey Results: Tanzania, Tax Incentives Study in the East African Community Member (EAC) States, Presentation by Global Tax Team, CIC, IFC, Washington. According to the IMF (2008)36 investment decisions are more sensitive to the general economic prospects of the country in question and to institutional and regulatory policies. The most important conditions include:

Overall macroeconomic situation, including economic growth, wages and productivity, and macro stability;

Tax and other structural conditions, including the overall tax burden on investment projects, predictability and stability of tax regime;

Institutional conditions and availability of infrastructure, including the regulatory regime, licensing requirements, quality of bureaucracy (especially tax administration), and governance.

In the absence of these conditions, providing investment incentives would not be enough to attract investors, while if these conditions are met, most investment would come even in the absence of investment incentives. The IMF also founds that countries that were most successful in attracting FDI all displayed certain common characteristics. The Funds takes China as an example, a country where foreign investors were attracted mainly by domestic market size and growth prospects, low wage cost relative to productivity, available infrastructure, reasonable tax level, and stability of tax regimes. Similarly, Dupasquier and Osakwe (2005) in IMF37 list a number of areas where improvements could lead to a better investment climate in Africa and therefore, more FDI: 36 IMF, Kenya, Uganda and United Republic of Tanzania: Selected Issues, 1st Dec. 2008, page 12. 37 IMF, Kenya, Uganda and United Republic of Tanzania: Selected Issues, 1st Dec. 2008, page 14.


Page 13

Increased security and political stability; reduced incidence of wars and conflicts; Increased macroeconomic stability, policy transparency and GDP per capital; Improve infrastructure (telecommunication, transport, power supply) in order to increase

productivity of investment; Reduced protectionism and dependence on commodities, and accelerated integration of

Africa into the global economy.

2.5 The Relevance of a Coordinated Approach with EAC State Partners

An analysis of the literature suggests that the provision of tax incentives across the East African region in general, and in Tanzania in particular, represents a harmful tax competition where every state loses revenues without getting much in return. Under the EAC common market, firms in general, and multinationals undertaking FDIs in particular, can be located in any of the EAC countries. At the same time, however, countries are being tempted to increase tax incentives in order to attract and retain more FDIs in order to benefit from these investments in form of employment; revenues from taxes, fees, royalties and dividends among others; inter-sectorial linkages; technology transfers and other potential gains from FDIs in host economies. The main beneficiaries of tax incentives and exemptions in Tanzania remains a small group of foreign investors, while the losers due to substantial revenue losses for the government are the general population and the country as a whole38. To address this problem, the Report to the G-20 Development Working Group by the IMF, OECD, UN and the World Bank (2011)39 suggests a closer partnership between developing countries, developed countries and business. According to the report, such a dialogue could lead to a code of best practices for multinationals, and the G-20 countries should encourage and support developing countries in their efforts to resist pressure to grant such mutually damaging tax breaks. The report argues that developing countries themselves may be able to mitigate the damage to their revenue bases by stronger regional co-operation. The International Finance Corporation comes to the same conclusions and suggests a reduction as well as a harmonization of tax incentives across EAC member states to improve investment climate in the regions and stop the race to the bottom 40. Their study recalls that there is a strong demand and mandate to carry out work on tax incentives. For instance, Article 83 of the EAC Treaty requires that: Partner States undertake to harmonize their tax policies with a view to removing tax distortions in order to bring about a more efficient allocation of resources within the Community. Also, Article 80(f) calls for a rationalization and harmonization of tax incentives for industries. Finally, the paper suggests the creation of a Code of Conduct for Investment Incentives between EAC member states to limit harmful tax competition for investment. In this regard, the case of the West African Economic and Monetary Unions (WAEMU) tax coordination framework may be of interest for Tanzania and other EAC member states, as the 38 Tax Justice Network-Africa & ActionAid International, Tax Incentives and Revenue Losses in Tanzania, June 2012. 39 IMF, OECD, UN and World Bank, Supporting the Development of More Effective Tax Systems, Report to the G-20

Development Working Group, 2011, page 24. 40 Effectiveness of Investment Incentives in Development Countries, Evidence and Policy Implications, Investment Climate

Advisory Services of the World Bank Group, Presentation, Vienna, May 14, 2012.


Page 14

process of tax coordination in WAEMU is one of the most advanced in the world although some areas remain de facto ineffective. A recent review of WAEMUs tax coordination process by the IMF notes that the framework has, to some extent, succeeded in converging tax systems, particularly statutory tax rates, and may have contributed to improving revenue mobilisation41. Yet, one of the main lessons drawn from the WAEMU experience for other regions that are contemplating the coordination of their tax policies has to do with investment tax incentives. As emphasized by the IMF, WAEMUs tax coordination framework may have had the unintended effect of providing member countries with the incentive to enact special tax regimes outside their tax laws, particularly in the case of investment incentives where the framework allows unrestricted tax competition as long as it is done outside countries main tax laws. This, in turn, has made tax systems opaque, increased their complexity, and contributed to a culture of tax negotiation42, an unintended effect that EAC state partners may probably want to avoid.

3. Success Stories in Reforming Tax Exemptions

This section attempts to put tax expenditures in a broader context by presenting two cases studies of tax exemptions reforms that experienced a fair level of success at different stages of the process: Mauritius and Senegal. The choice of these two countries was dictated by the need for examples of success in reforming tax expenditures that are relevant to Tanzania's situation. To that effect, case studies of tax reforms in developed economies are less relevant as these jurisdictions generally tend to reform their tax systems in small incremental steps, yielding lessons that are difficult to adapt to a country such as Tanzania. Very few developing countries produce regular tax expenditure reports, especially in sub-Saharan Africa. Even fewer have entertained or have initiated significant tax expenditures reforms. For example, while South Africa publishes tax expenditures reports, these have yet to generate the impetus for reform, nor have they been used as a tool to reform the South African tax system in a material manner43. Thankfully, Mauritius and Senegal not only have publicly available estimates of their tax expenditures, but they both have initiated broad tax reforms stemming in great part from tax expenditures restructuring. Although examples of success stories presented in this section have to be nuanced when transposed to the Tanzanian context, some lessons can still be retained. A word of caution should however be kept in mind when transposing the lessons learned to the context of Tanzania, since the taxation regime and fiscal incentives are certainly not the only factors that impact investors decision. This is particularly relevant in the case of Mauritius, where other investment climate factors (e.g., infrastructures) must be taken into account when assessing the success of tax incentives reforms. 41 Mansour, Mario, and Grgoire Rota-Graziosi, Tax Coordination, Tax Competition, and Revenue Mobilization in the West

African Economic and Monetary Union, IMF Working Paper WP/13/163, Fiscal Affairs Department, July 2013. 42 Mansour, Mario, and Grgoire Rota-Graziosi, Tax Coordination, Tax Competition, and Revenue Mobilization in the West

African Economic and Monetary Union, IMF Working Paper WP/13/163, Fiscal Affairs Department, July 2013, page 36. 43 Somewhat similar is the case of Egypt, where tax reforms were introduced in 2005. These reforms are interesting as they

entailed using resources freed by the elimination of tax expenditures to reduce personal and corporate tax rates. These reforms and their aftermath, however, are not widely documented and their ultimate success is difficult to assess (especially given recent events in the region). For more details, see IMF, "Revenue Mobilization in Developing Countries", Fiscal Affairs Department, March 2011, page 74.


Page 15

3.1 The Case of Mauritius

It is fitting to begin our section on success stories with Mauritius, as this small island nation is a forerunner in the estimation of tax expenditures and in their use as a vector for broad, revenue-enhancing tax reforms. The first formal estimation of tax expenditures in Mauritius (unpublished) was done in 2005 and Mauritius has published a report on tax expenditures in its Annual Budget every year since the 2007-08 Budget. The report details the various expenditures, provides an estimate of their costs, as well as methodological notes. Tax expenditure estimates for Mauritius are presented in Table 1. We see that after falling dramatically following the 2006 tax reforms, tax expenditures in Mauritius have been hovering around 1.3% of GDP in recent years. Expenditures related to the corporate income tax system and the VAT make up the bulk of the figure, with excise and customs duties accounting for a small proportion (personal income tax expenditures made a comeback in the report following a 5-year hiatus as the government introduced interest-relief on secured housing loans as well as an exemption for dependents pursuing post-secondary education in its 2012 Budget).

Table 1: Tax Revenues and Tax Expenditures as Percentage of GDP in Mauritius

2006-07 2007-08 2008-09

July -

Dec. 09* 2010 2011 2012 2013**

Total tax

revenues

(Rs million)

38,508 46,440 50,236 27,641 55,209 59,180 64,654 71,086

Total tax

expenditures

(% of GDP)

3.23 1.64 1.48 0.14 1.44 1.34 1.30 1.35

PIT 0.69 - - - - - 0.04 0.04

CIT 1.49 0.56 0.55 0.64 0.74 0.50 0.47 0.52

VAT 0.69 0.69 0.68 0.58 0.46 0.56 0.58 0.58

Customs Duty 0.21 0.20 0.06 0.06 0.07 0.10 0.05 0.05

Excise Duty 0.15 0.19 0.19 0.16 0.16 0.18 0.17 0.17

Totals may not add up due to rounding. * The Mauritian Government moved from fiscal year to calendar year accounting in 2009. ** Figures for 2013 are projections.

Source: Mauritius Department of Finance and Economic Development.

By putting a figure on the cost of the tax incentives, tax expenditures estimates in Mauritius were instrumental in bringing about the sweeping changes to the country's tax structure that took place beginning in 200644. As part of those reforms, virtually all tax incentives were eliminated, with the exception of those already granted (i.e., previous exemptions were grandfathered) and a four-year tax holiday for income derived from small businesses45. The reforms of tax incentives were 44 Sudhamo Lal, "Tax Expenditure Analysis: The Mauritian Experience", Africa Tax Spotlight, First Quarter, Volume 3, 2012. 45 IMF, "Revenue Mobilization in Developing Countries", Fiscal Affairs Department, March 2011.


Page 16

targeted to personal and corporate income taxes which comprised about two thirds of the value of total tax expenditures in Mauritius. On the personal income tax side, the tax authorities eliminated over 20 different types of allowances or deductions, and all but eliminated the tax code's complex system of exemptions, introducing a single enhanced income tax exemption threshold. Other simplifications measures included the replacement of the various tax bands and rates (15%, 20%, 25% and 30%) with a single rate of 15%.

On the corporate income tax side, tax authorities streamlined the deduction system, removing all deductions not directly linked to the production of income. Investment allowances on capital expenditures as well as tax holidays and tax credits (e.g., for investments and exports) were also eliminated, and the carry forward of corporate losses was limited to five years instead of being unlimited. Similar to the changes to personal income tax system, the dual rate tax structure (15% and 25%) was replaced with a flat corporate income tax rate of 15%. Finally, Mauritian authorities also amended the Customs Tariff Act to eliminate the power of the Minister of Finance to remit, exempt or refund custom, excise and registration duties (including land duties).

As illustrated in Table 1, these reforms rapidly paid dividends, resulting in an increase in tax revenues while reducing tax expenditures as a per cent of GDP by more than half. Mauritius' reforms of tax incentives is considered an overwhelming success, resulting in a tax system that is simpler, less costly to administer and comply with, less arbitrary, and where avenues for rent seeking behavior are limited46. By using foregone revenues in tax expenditures to fund business and investment-improving measures (such as low rates of taxation), Mauritius was able to establish a solid foundation for economic growth and stimulate investment. Far from having a negative impact on foreign direct investment, the reforms, which were coupled with new business facilitation measures, helped increase foreign direct investment in Mauritius by 44% between 2006 and 2009. This is reflected in the fact that Mauritius ranked 19th in the latest Doing Business survey, higher than countries such as Germany, Japan, and France47.

3.2 The Case of Senegal

Senegal is also a country whose use of tax incentives as a vector for tax reform is worth noting. Senegal has published two reports on Tax Expenditures (for fiscal years 2008 and 2009), the only country in Western Africa to have done so. These reports are quite complete and include a thorough discussion of the methodology used (including a description of the reference, or benchmark tax system), estimates of the various tax expenditures, and recommendations and analysis regarding tax incentives. It is worth noting that, notwithstanding the Senegalese tax authorities best efforts, only 133 out of 308 tax expenditures were estimated for FY2008 (or 43%) and 171 out of 326 were estimated for FY2009 (or 52%)48. This illustrates that tax expenditure estimation is a continuous process which authorities should aim to improve every year. Senegal's interest in tax expenditures was triggered by three main factors: 1) the need for greater effectiveness in domestic revenue mobilization to fund poverty reduction efforts as well as public investment programs; 2) the desire for tax authorities to create a culture of evaluation

46 Presentation by Sudhamo Lal, Director General, Mauritius Tax Authority, IMF Seminar on Revenue Mobilization in Sub-

Saharan Africa, Nairobi, Kenya, March 21-22, 2011. 47 World Bank, "Doing Business 2013", 10th Edition, 2013. 48 All figures quoted in reference to Senegal's tax expenditures are taken from: Rpublique du Sngal, Ministre des Finances

et de l'conomie, "Rapport sur l'tude portant sur l'valuation des dpenses fiscales", March 2010 and "Rapport sur l'tude portant sur les dpenses fiscales de l'anne 2009", November 2011.


Page 17

and transparency, and 3) a series of recommendations from organizations such as the IMF, the World Bank and the West African Economic and Monetary Union49. Tax expenditure estimates from Senegal's Tax Expenditures Reports are presented in Table 2. The reports show a slight decline in the weight of tax expenditures in the Senegalese economy between 2008 and 2009, dropping from about 5.0 % of GDP to 3.7%. Tax expenditures in Senegal in those years also appear to be concentrated in the country's VAT, with income taxes following suit, albeit accounting for less than a third of total tax expenditures in 2009.

Table 2: Tax Expenditure in Senegal

2008 2009 Total tax expenditures (FCFA,

billions) 296 223

Tax expenditures as % of GDP 5.0 3.7

VAT

Domestic 1.14 1.48

On imports 2.27 0.92

Duties 0.95 0.41

Income taxes 0.51 0.68

Payroll taxes 0.01 0.01

Insurance tax 0.03 0.02

Taxes on banking operations 0.01 0.13

Other taxes 0.09 0.05

Source: Rpublique du Sngal, Ministre des Finances et de l'conomie, "Rapport sur l'tude portant sur les dpenses fiscales de l'anne 2009", November 2011 and CRC Sogema calculations. Since 2010 discussions on tax reforms in Senegal have been centered on making the tax system more effective and simpler, including rationalizing tax expenditures. Plans for tax expenditures reform crystallized around a vision aimed at consolidating all tax incentives in the main tax code, while eliminating certain exemptions and reforming others. Indeed, many tax incentives in Senegal, as is the case in most other African countries including Tanzania, are enclosed in special conventions or codes aimed at a particular type of investment or taxpayers (e.g., Investment Code, Mining Code, Petroleum Code, Small Business Code, Microcredit Institutions Code, etc.). Eligible taxpayers can apply to obtain an accreditation in accordance with one (or sometimes more than one) of these codes and automatically benefit from the tax incentives contained in each separate legislation or Code. This effectively creates different categories of taxpayers, scattering taxpayer information, and more often than not leads to a lack of control from tax authorities on who benefits from which set of tax incentives. Hence, the thinking went, a consolidation of all incentives in the actual Tax Act (Code Gnral des Impts) would enable tax authorities to have a better grasp on incentives. In doing so, authorities could also rationalize incentives, keeping those that are perceived to be effective while eliminating others.

49 Presentation by Ismala Diallo and Wilson Pritchard, Annual Meeting of the International Center for Tax and Development,

Cape Town, 11-13 December 2012.


Page 18

The push for reform came to fruition in December 2012 as a new Code Gnral des Impts was adopted, coming into force on January 2013. Senegal's new tax code takes on the issue of tax expenditures head on, eliminating almost all separate codes (with the notable exception of the Petroleum Code and the Mining Code) and enclosing tax incentives inside the general provisions of the tax code. For corporate income taxes, tax holidays and exemptions included in the various codes were replaced with an investment tax credit during a business' investment and operation phase50 as well as a tax reduction of 50% of taxable income to corporations exporting at least 80% of their turnover and providing proof that the proceeds of these sales are repatriated. These measures are coupled with other measures aimed at streamlining the tax system, such as the replacement of the Tax on Banking Operations by a broader Financial Activities Tax and the streamlining of various registration and stamp fees (Droits d'enregistrement and Droits de Timbre). On the corporate tax rate itself, Senegal went in a different direction than Mauritius, increasing the regular rate to 30% from 25%. Instead, Senegalese authorities have decided to lessen the tax burden on households by reducing the number of tax brackets and capping the statutory tax rate on the highest levels of income to 40%. Reforms to VAT exemptions, the largest source of tax expenditures, were somewhat more timid; however, as the exemption for eligible corporations investing in Senegal was maintained. This exemption of the VAT on imported products (and in certain cases on the VAT on the domestic market as well) destined to eligible companies that have obtained a special status due to their high investments in Senegal was brought in the general tax code from the investment code but remains intact. It is intended to complement the CIT investment tax credit. And while Senegal is putting in place certain measures intent on making the VAT easier to remit, the list of products exempted from the VAT does not appear to have been modified. Nonetheless, exemptions destined to aid-funded projects and to certain export-oriented corporations were repealed.

The new Tax Code having been in place for less than a year, it is too early to tell whether Senegal's efforts will bear fruit or whether tax revenues will be positively affected by the reform. While the new Tax Code represents a significant improvement from the previous patchwork of tax incentives, significant tax expenditures remain. Nevertheless, the reform appears to have been well received by international organizations and should position Senegal favorably vis--vis other Western African economies51.

Although examples of success stories presented in this section have to be nuanced when transposed to the Tanzanian context, some lessons can still be retained when put in the perspective of the considered reforms in Tanzania. While Senegal's reforms were not as profound as those of Mauritius, reforms undertaken in both those countries do illustrate how tax expenditures, and the realization of the vast sums that can be at play, can be a powerful catalyst for tax reform and revenue mobilization. From this point of view publishing regular tax expenditure reports should certainly become a priority for the GoT. More generally, the reforms in Senegal and Mauritius can be viewed as success stories primarily because they illustrate the way these countries have managed to achieve more transparency with respect to tax incentives, not necessarily because they have generated more revenue for the government and attracted investment to these countries.

50 Articles 249 to 252 set out a precise set of conditions under which companies can benefit from this credit, which is set at 40%

for new investments and 30% for extensions to existing investment (capped at 50% of taxable income). 51 For example, the IMF in its June 2013 fifth review of Senegal under the Policy Support Instrument notes that "The new Tax

Code which took effect in January 2013 represents a major step forward but also that it is not the last word in tax reform".


Page 19

PART II: Analysis of the Tax and Duty Exemptions Regime

in Tanzania

Building on important principles and factual information collected in the literature and covered in Part I, Part II proposes an quantitative analysis where a summary of recent assessments of the value of tax exemptions in Tanzania is made, and trends are identified (Chapter 4). Then, the inventory of exemptions found in the Tanzanian legislation and compiled by the Consultant is presented, and recommendations are proposed for each section on whether GOT should consider amending or removing them from legislation (Chapter 5). The administrative framework for managing tax exemptions is examined in Chapter 6.

4. Quantitative Analysis

4.1 Recent Trends in Tax Revenue in Tanzania

The evolution of tax revenue in Tanzania in the past two decades has been characterized by strong growth. As shown in Figure 2 total tax revenue52 has grown in an almost exponential fashion, reaching 6,668,642 million of Shs in 2011-12 from 506,630 million Shs in 1996-97. In fact, total revenue collected by TRA has grown by about 20% on average each year since the establishment of the TRA. Following some growing pains after the significant tax reforms that established the TRA in the mid-1990s53, tax revenue growth soon outpaced the growth of the Tanzanian economy, resulting in an increase in the tax yield (the ratio of total taxes to GDP). From 12% in 1996-97, the tax yield decreased slightly in the late 1990s, resuming an upward trend in 2000-01 and reaching 15.8% in 2011-12.54

52 All data referred to in this section has been obtained from the Tanzania Revenue Authority (TRA). Tax revenue includes

Treasury vouchers, less refunds. 53 The causes of the decline in tax yield in those early years are diverse but well documented in IMF, Fiscal Adjustment in

IMF-Supported Programs, IMF Evaluation Report, 2003. 54 The retreat to 14.6% in 2009-10 was partly due to a two-point cut in the VAT rate in response to the financial crisis.

Source

Tax revenue in Tanzania hataxes (e.g., income taxes, withholding taxes) and indirect taxes (i.e., consumption and taxes related to international trade) as seen quarter of total taxes when the TRA began operating, they now account for about two thirds of revenues.

Source

Source:


Source:

1 000 000

2 000 000

3 000 000

4 000 000

5 000 000

6 000 000

7 000 000

8 000 000

: Tanzania Revenue Authority


Figure

: Tanzania Revenue Authority

1 000 000

2 000 000

3 000 000

4 000 000

5 000 000

6 000 000

7 000 000

8 000 000

20%

40%

60%

80%

100%

Tanzania Revenue Authority


Figure


1 000 000

2 000 000

3 000 000

4 000 000

5 000 000

6 000 000

7 000 000

8 000 000

0%

20%

40%

60%

80%

100%


Tax revenue in Tanzania hataxes (e.g., income taxes, withholding taxes) and indirect taxes (i.e., consumption and taxes related to international trade) as seen quarter of total taxes when the TRA began operating, they now account for about two thirds of

Figure


0

1 000 000

2 000 000

3 000 000

4 000 000

5 000 000

6 000 000

7 000 000

8 000 000

25%

75%

Figure



Figure 3: Direct and Indirect Taxes as a % of Total Taxes


25%

75%

Tanzania

Figure



Direct and Indirect Taxes as a % of Total Taxes


25% 27%

75% 73%

Tanzania

Figure 2





27% 26%

73% 74%

Tanzania

2: Total Tax Revenue and Tax Yield





26%

74%

Tanzania - PER Tax Exemptions Study

Total Tax Revenue and Tax Yield

Tanzania Revenue Authority.

Tax revenue in Tanzania has also been characterized by a fairly stable distribution between direct taxes (e.g., income taxes, withholding taxes) and indirect taxes (i.e., consumption and taxes related to international trade) as seen quarter of total taxes when the TRA began operating, they now account for about two thirds of


Tanzania Revenue Authority.

26% 30%

74% 70%

PER Tax Exemptions Study

Total Tax Revenue and Tax Yield

also been characterized by a fairly stable distribution between direct taxes (e.g., income taxes, withholding taxes) and indirect taxes (i.e., consumption and taxes related to international trade) as seen quarter of total taxes when the TRA began operating, they now accou

TANZANIA PER TAX EXEMPTIONS STUDY DRAFT … PER TAX EXEMPTIONS STUDY DRAFT FINAL REPORT Proposed to:...

Documents

Transcript of TANZANIA PER TAX EXEMPTIONS STUDY DRAFT … PER TAX EXEMPTIONS STUDY DRAFT FINAL REPORT Proposed to:...