Make it simpler
IMF suggests standard rate for corporate taxes
The International Monetary Fund (IMF) wants to see the corporate tax system a little less cumbersome, and investment allowances and some tax credit allowances out the door.
Following is the section of the IMF’s report A Tax Reform Road Map For Simplicity And Revenue Buoyancy that deals with business taxation, both domestic and international.
50. The Government of Barbados aims to create an attractive business climate, including through the tax system. Barbados has had considerable success in building up a substantial international “offshore” sector. This sector makes a significant contribution to tax revenues, equivalent to about 50 per cent of company tax revenue (CIT). The domestic sector is more diversified, with the service sector making an important contribution.
51. This chapter considers the various business tax provisions in place in Barbados. For convenience, domestic and international “offshore” companies are considered separately. This chapter first reviews the benchmark treatment of domestic companies and the main incentive schemes available to them with respect to corporate income tax provisions.
Domestic corporate income tax system.
52. Barbados levies a 25 per cent CIT rate on business income of corporations operating domestically. Corporate taxable income is determined by total revenue from sales and receipts minus all production expenses. Losses may be carried forward for nine years. A reduced rate of 15 per cent is levied on manufacturing, construction, residential rental income, approved small businesses, and approved developers under the Special Development Areas Act.
53. Various deductions and credits are allowed, including:
(a) interest payments in full, with an uplift (at 150 per cent) for qualified tourism projects under the Tourism Development Act (TDA) and eligible renewable energy projects;
(b) writing down (annual) allowances at multiple straight line rates, such as a four per cent annual allowance on industrial buildings. This includes also 50 per cent of expenses on intellectual property deductible over a ten-year period;
(c) an initial allowance for plant and machinery of 20 per cent (raised to 40 per cent for industrial buildings and structures);
(d) an investment allowance of 20 per cent for new plant and machinery for basic industry (40 per cent for other eligible manufacturers, including those that export outside CARICOM);
(e) a range of other expenditures on specific items (such as on export market development, the Regional Negotiating Fund), usually with an uplift (at 150 per cent in the cases just given);
(f) a qualified capital expenditure of up to $200 million can be credited in full against taxable income under the TDA over a period of 15 years; and
(g) tax credits apply to exports outside CARICOM, foreign currency earnings, qualified capital expenditures under the TDA, and expenditure incurred in respect of wages under certain conditions.
54. Withholding taxes are levied on dividends, interest, and royalties. Payments to residents are subject to final withholding at 12.5 per cent. Those paid to non-residents are taxed at 15 per cent, unless reduced by treaty. Dividends paid to residents of other CARICOM countries are exempt; tax is withheld on interest and royalties at 15 per cent. Fees and know-how payments are subject to final withholding at between 15 per cent and 25 per cent. Residents are fully taxable on dividends and interest arising abroad, except those received from CARICOM that are exempt. Dividends paid between resident companies, and to residents of other CARICOM countries, are exempt. Final withholding taxes of five per cent on life and property insurance premiums and of three per cent of other general insurance premiums are levied.
55. The statutory CIT rate in Barbados is competitive in the region and globally. Recent years have seen CIT rates tumbling around the world (Figure 1), and Barbados has adjusted accordingly. In the region some countries apply rates selectively for different sectors, but standard rates mostly range from 25 to 35 per cent (Table 7). The standard rate
at 25 per cent is also in line with those applied in OECD and Latin American countries, as well as more generally small island states around the world.
As such –– and considering the very generous capital allowances, credits, and further incentive regimes available in addition –– the reduced rate of 15 per cent applied to selective activities could be gradually phased out aiming at ultimately reaching convergence in the tax treatment of the different domestic sectors. A potential revenue gain of $25 million is estimated by considering the taxable income of the activities subjected to the lower rate for the fiscal year 2011/2012.
56. The depreciation schedule is cumbersome in the fine distinctions it attempts to make, and the annual allowances are not rapid. A system of initial and investment allowances has been introduced to accelerate depreciation, at the cost of further complexity. The combined effect of the writing down and opening allowances could be more neatly and transparently achieved by eliminating the opening allowances and allowing a more accelerated depreciation schedule. For instance, a 20 per cent investment allowance combined with writing down over ten years is roughly equivalent, at an interest rate of eight per cent, to simply writing down over five years. The system could be further simplified by reducing the number of asset categories and switching from the straight line method to that of declining balance: investors would then no longer need to keep track of each individual asset, but could pool those with the same lifetime. Table 8 summarizes the main deductions and credits as they compare to total taxable income and net tax payable.
57. The investment allowance and additional expensing of qualified capital expenditures are excessively generous. In particular, the investment allowance given to companies selling outside CARICOM is especially attractive, since there is no pro-rating to reflect the scale of these activities: that is, the smallest sale outside CARICOM entitles the company to the investment allowance in respect of all its expenditure on imported new plant and machinery. This provision may also be problematic in terms of WTO rules. In addition to the system of annual, initial and investment allowances, capital expenditure for the purpose of providing accommodation of up to $200 million can be deducted in full over a period of 15 years under the TDA, which contributes further to the erosion of the tax base.
58. Elimination of the investment allowance could generate about $5 million. This assumes that the allowance benefits mainly manufacturing activities subjected to the 15 per cent rate. Similarly, elimination of the deduction of qualified capital expenditures under the TDA and the additional 30 per cent tax credit could potentially generate $7 million in additional revenue. These estimates are based on the amount of allowances reported for 2011/2012 in Table 8.
59. There is significant scope for base broadening in streamlining allowed deductions on a range of specific items. Including in these are a number of detailed deductions — usually at 150 per cent of the actual contribution — but also unspecified “other items deductible” in aggregate amounts larger than the total resulting taxable income. Identification, better targeting, and streamlining of these deductions could generate significant revenue gains. A reduction in allowed deductions by 20 per cent could generate about $50 million in additional revenue, based on the amounts reported in Table 8 for 2011/2012, and assuming an effective tax rate of 1.5 per cent.
60. Investors strip profits in Barbados by financing their operations through excessive debt. Deductible interest expenses (even at 150 per cent for qualified investments) reduce taxable profit and the only tax levied is the withholding tax on interest if paid to non-residents, at 15 per cent, unless the tax rate is reduced under some treaties. Interest deductibility should be capped to a maximum, either for related-party debt or total debt. The cap can be defined either in terms of the debt/equity ratio (for example, interest is not deductible if the debt/equity ratio exceeds a threshold of 2/1) or in terms of the interest to income ratio (for example, interest is not deductible if it exceeds 30 per cent of earnings before interest, taxes, depreciation and amortization).
61. A company providing qualified professional services outside CARICOM can receive tax credits dependent on the share of net foreign currency earnings. In 2007, this credit was extended to professional services provided to international companies, which resulted in a substantial increase in forgone revenue. The credit increases with the share of foreign exchange earnings in total profits. Table 9 presents the schedule and the resulting effective tax rate on those activities.
62. While these schemes are evidently intended to encourage foreign exchange inflows, they may cause other and less welcome distortions. A service company earning 19 per cent of its profits domestically, for example, may well find it advantageous to reduce its domestic sales so as to increase the foreign earnings share to 20 per cent, and thereby benefit from the tax credit. By the same token, taxpayers have an incentive to spin off domestic and foreign activities into separate companies. In establishing preferential treatment for income derived from the export of goods and services, these schemes have similarities to a multiple exchange rate regime offering a preferential rate for repatriation of goods and services income. For example, at a tax rate of 25 per cent, a 79 per cent credit on export earnings is equivalent to a 26 per cent overappreciation of the exchange rate by which foreign earnings are converted into domestic currency.
63. The export allowance clearly contravenes the spirit of WTO arrangements, while the foreign currency tax credit seems to go against at least the spirit of the General Agreement On Trade In Services. A strong case can thus be made for removal of these schemes, which in 2011/2012 cost about $100 million in forgone tax revenue from corporations. While the export credit is almost unused (as shown in Table 8), the foreign currency earnings credit represents a substantial share of all company tax revenue.
64. A key concern in assessing any tax system is its impact on incentives to invest. This depends on the both the rates at which tax is charged (on earnings in the corporation and distributions to investors) and on the definition of the corporate tax base (particularly in terms of depreciation allowances). A convenient way of gauging these effects is by calculating the “marginal effective tax rate” (METR) on a hypothetical investment project. This is defined as the proportion by which the pre-tax return on the underlying investment exceeds the post-tax return received by the investor. If a project yields 20 per cent before tax but only 15 per cent after all corporate taxes, for example, the METR is 25 per cent. A METR below the statutory rate signals a tax system that is more encouraging to investment.
65. Baseline METR computations suggest that, even under normal tax rules, the Barbadian tax system is supportive of investment. The baseline in Table 10 reports estimates of the current METR for hypothetical projects in manufacturing, service, and hotel sectors, under the assumption that the investor receives no benefit relative to the “normal” tax rules –– essentially the system of annual and initial allowances. No import duty exemptions or other special tax provisions are considered in the baseline scenario. The analysis also suggests that investment allowances do not contribute much in further reducing METRs, whereas the exemption from withholding on dividends for manufacturing can have a somehow larger impact. Much the same effect could be achieved, however, for the same statutory tax rates by replacing the system of initial and investment allowances with a 20 per cent accelerated depreciation (as shown under the Alternative Scenario).
66. Once all major tax incentives available in Barbados are considered, computed METRs are relatively low in international comparison. Further calculations in Appendix 2 (and discussion in Chapter IV –– Tax Incentives) suggest that import duty exemptions and exemption from withholding taxes on dividends make a significant dent in computed METRs, which are lowered to a range between 12 and 14 per cent. These are low by international standards, compared, for example, to those estimated for OECD or Latin American countries at 19.6 and 26.3 per cent, respectively. In the region, the estimated METR for Jamaica has been estimated at 15.6 per cent.
Other various tax deductions and incentives—in particular the expensing of capital expenditures or tax credits under the TDA — would, however, not contribute much to make the tax system more attractive for investment. As the piecemeal addition of such schemes erodes the integrity of the system, with the presence of some inviting the creation of more, such deductions should be removed.
67. A similar competitive tax environment could be achieved with a simplified tax system for corporations, with better targeted incentives. The mission has been informed that the government plans to expand the list of goods eligible for import duty exemptions to the tourism sector (in addition to manufacturing and other qualified enterprises that are already granted these exemptions). It is likely, therefore, that moving to a simple, 25 per cent corporate tax regime for all onshore enterprises, while eliminating investment allowances and other tax credits, and retaining the withholding on dividends could serve to largely simplify the system, and maintain the corporate tax burden, while preserving a tax system that is supportive of investment.
1. Unify the CIT rate for domestic activities towards the standard rate of 25 per cent.
2. Replace the current system of annual and initial capital allowances with a simpler onecharacterized by accelerated depreciation over five to ten years.
3. Eliminate the investment allowances.
4. Eliminate the expensing of qualified capital expenditures and the 30 per cent tax credit on capital expenditures under the Tourism Development Act.
5. Eliminate the tax credit allowances for exports and foreign currency earnings; alternatively phase them out by capping the credit schedule to up to 50 per cent.
6. Streamline the “other” deductions against Corporation Tax, and remove deductions for contributions to special funds, and so on.
7. Reduce or alternatively cap the deductibility of interest expenses, and remove the uplift of 150 per cent in all legislation.