IMF says tax incentives not cost-effective
The tax incentives offered by the Government of Barbados have been a source of concern for the International Monetary Fund (IMF). In its report A Tax Reform Road Map For Simplicity And Revenue Buoyancy, the Washington-based institution has recommended that Government minimize some concessions and consider introducing a cap on annual costs for discretionary duty concessions.
79. The extensive use of tax incentives in the Caribbean region is well documented. Tax incentives have become increasingly pervasive, spreading over multiple taxes and resulting in substantial tax expenditures with uncertain impact on FDI and growth. But incentives regimes and policies have also diverged over the years leading to important cross-country differences in concessions offered, as well as in revenue forgone. Tax concessions may take a number of forms: exclusions, exemptions, allowances, deductions, credits, preferential tax rates, or tax deferrals.
80. The present incentives regimes are generally considered the outcome of intensive tax competition in the region. This “race to the bottom” with tax incentives targeting mobile tax bases, including FDIs, has also led to serious erosion of tax bases. In contrast, economic activities not benefiting from concessions are frequently subject to high nominal tax rates . . . .
81. Tax concessions for investment in several economic sectors are currently provided for in specific legislation. Typically, those legislations include income tax concessions, as well as import duty exemptions. Legislation guiding specific tax concessions in Barbados include the Tourism Development Act (TDA), Small Business Development Act (SBDA), Special Development Areas Act (SDAA), Shipping Incentives Act (SIA), and Fiscal Incentives Act (FIA).
The respective laws prohibit double dipping of tax concessions. The TDA aims at providing a competitive set of tax advantages for developing the tourism sector; the SBDA aims at supporting small locally owned corporations with less than $1 million in paid up capital, less than $2 million in sales, and fewer than 25 employees. The SDAA supports investments in a range of activities, including tourism, construction, and agriculture, but its scope is limited geographically. The SIA grants tax incentives to shipping companies, including commercial shipping, boating in the tourism industry, and carriage of passengers. Finally, the FIA is intended to support resident and foreign manufacturing companies. The mission has been informed that due to the apparent contravention of some of its provisions with WTO rules, the FIA would be phased out by the end of 2015.
82. Tax incentives are also provided in tax legislation, in particular corporate income tax and value added tax acts. As discussed in previous chapters, the Income Tax Act includes several provisions to encourage investment, like reduced rates for certain activities, initial and investment allowances, carrying forward of net operating losses, generous deductions, and tax credits. Also under the VAT Act, a reduced rate applies to accommodation, and a number of goods and services are either exempt or zero-rated. Table 11 summarizes the main available tax concessions under different pieces of legislation.
83. In addition, substantial discretionary powers to grant tax concessions are given under the Duties, Taxes And Other Payments (Exemptions) Act. This act, generally known as the Cap. 67B, entitles the Minister of Finance to grant by order an exemption to remit or refund any payment made by any person, business or undertaking in respect of the payment of any duty, tax or other money, including on the payment of tax arrears, interest and penalties that may apply.
84. Barbados has promulgated several stand-alone acts that provide similar tax concessions. As shown in Table 11, tax incentive legislation typically extends the scope of concessions already available under the Income Tax Act, and grant import duty exemptions on building materials, machinery, and other inputs. These several acts are, however, administered by different line ministries; that is, Tourism, Industry and Commerce, Finance. Similarly, the Minister of Finance has often used the discretionary power granted under Cap. 67B to grant waivers for import duties, VAT, and excise taxes. More recently, this discretionary power has been used to extend very generous concessions to tourism projects that go beyond the scope of the Tourism Development Act.
There appears to be scope for rationalization of the individual tax concession laws by consolidating these into one overarching concession law with individual sector chapters or schedules. It should contain, in lieu of discretionary powers, published objective criteria which would indicate whether an investor would qualify for a set of incentives.
85. By consolidating the individual incentive legislation, the authorities would have an opportunity to review the present system of tax expenditures.The relevance of some of the incentives could be reviewed. It would enable a comparison of forgone revenues against the uncertain benefits of additional investments stemming from these long-term concessions. It appears for instance, that the FIA has become obsolete since the authorities granted import duty exemptions to the entire manufacturing sector by order under Cap. 67B. It appears too that many of the income tax concessions are not effective in making investment in Barbados more attractive.
86. In general, the preparation of a periodic tax expenditure budget that takes stock of the various tax concessions and their cost in terms of revenue forgone should be considered. Tax expenditures, being Government spending through the tax system, lower tax revenues for certain categories of taxpayers (sectors, firms, or individuals) thereby deviating from the benchmark tax system. To determine whether a tax measure generates tax expenditures, it is necessary to establish the benchmark or “normal” tax structure from which concessions represent a departure and that is the most difficult part of the exercise. In essence, it constitutes preferential treatment to stimulate economic activities or attain certain social objectives. These indirect income support programmes should, therefore, be incorporated to the annual Budget process when presented to Parliament. Hence, its label of a tax expenditure Budget.
87. Some tax incentives are more cost-effective than others, which should inform future concession design in Barbados. Appropriately designed capital allowances as part of an income tax system, such as accelerated tax depreciation provisions, are critical for fostering a favourable investment climate, especially since these provide a cost-effective way to grant early cash flow benefits for major investments. Generally, depreciation can be more easily afforded as it merely defers Government’s receipts. As an aside, an income tax regime provides start-up and loss-making firms with a tax deferral benefit through provisions that allow for the carrying forward of tax losses. These tax provisions are already in place but could be further simplified to make them work more efficiently.
88. Until recently, Barbados has generally refrained from the practice of providing income tax holidays.With the exception of the Fiscal Incentives Act, which the mission understands has been almost unused for many years now and which the Government intends to phase out by the end of 2015. Recently, however, there has been new pressure to provide generous tax holidays. A 2013 amendment to the Income Tax Act grants an income tax holiday for a period of ten years to a developer, manufacturer or installer of renewable energy systems and energy efficient products. Also, the Minister of Finance, using discretionary powers under Cap. 67B, recently granted a 25-year tax holiday to a company in tourism.
89. Tax holidays are commonly not well targeted as they constitute only temporary exemptions to new investments from certain specified taxes. International experience suggests that tax holidays tend to attract footloose industries such as global textile manufacturers, and have minimum backward linkages to the economy. Tax holidays for hotels with a duration of decades are unprecedented and unnecessary, given that once the investment is sunk, the investor will not easily relocate. It is of least value for long-term investments (with a long gestation period). Note that for long-term investors the loss carry- forward provision and depreciation allowances as an essential element of a CIT already provides a de facto tax holiday.
Tax holidays for start-up firms are therefore ineffective. They are particularly prone to abuse such as the manipulation of transfer pricing, so as to channel profits to the untaxed affiliate. Moreover, tax holidays granted to large investors create serious distortions between new and existing firms (probably small and local), which cannot be abolished easily. The unfair competitive cash flow advantage to large foreign investors for long periods tends to erode small firm prospects for survival.
90. Waivers on VAT and excise taxes should be avoided. These waivers are problematic and very costly in terms of revenue forgone (Table 12). When properly designed and operated, the VAT is a consumption tax, not a production tax. The normal functioning of the invoice-credit system means that the tax liability rolls forward to the unregistered person (usually a final consumer but sometimes a small supplier) at the end of the production-distribution chain. The granting of VAT concessions comes from a misunderstanding of the VAT and its faulty interpretation as a production tax (like a turnover tax) as opposed to a consumption tax. In addition, it is wrongly believed that the VAT can play a significant role in setting prices. When a VAT contains numerous exclusions, as is the case of Barbados, it no longer works as a consumption tax but rather as a selective tax on some sectors with the resulting uneven and haphazardly distributed tax burden . . . .
91. Duty concessions for imports of capital or intermediary inputs, targeting new capital investments, are a standard incentive feature in Barbados. They normally operate as a duty waiver granted to registered beneficiaries of the various incentive acts (see above). More problematic, however, are duty concessions granted on a case-by-case basis. Generally, import duty waivers tend to lead to unfair competitionrelative to similar businesses not enjoying the incentiveand are especially open to abuse through leakage into the domestic economy. Duty concessions in Barbados are very costly in terms of revenue forgone. As shown in Table 12, duty exemptions cost about $150 million in 2013 (or about seven per cent of total tax revenue). Duty concessions have exceeded their actual revenue collection. As for the main beneficiaries, in 2013/2014, for example, the top five recipients of statutory waivers included industry, $63.1 million; tourism, $16.6 million; Government businesses, $10.9 million; health, $10 million; and financial industry, $4.8 million.
92. Selective duty exemptions are not the best way to support economic growth. They are inefficient because they have unpredictable and uneven effects on prices, similar to those of a gross receipts tax, because highly uneven duty rates cascade into final prices in uneven ways. They are inequitable because they can discriminate among businesses and persons. In addition, with the Government playing the role of resource allocator, opportunities for uninformed decisions and integrity problems arise. Other problems arise with the cap on the quantity or allowed frequency of purchase of certain goods that can be imported duty-exempt. Such precise quantitative controls are difficult to monitor and enforce effectively. Opportunities for leakage abound, especially given that many imports enter the domestic economy zero-rated for VAT, which obstructs the audit trail.
93. The high cost environment caused by import duties could be better addressed by reducing tariffs instead of granting waivers. The high duty structure prevailing in Barbados creates a big incentive for persons and companies to seek a waiver. The current duty rate structure varies from zero per cent for imports from CARICOM to a high of 216 per cent on selected goods. Table 13 shows that average import duties in Barbados are among the highest in the region and globally. Instead of granting waivers and special concessions that can be seen as discretionary and are very costly to administer, a rationalization of the tariff structure could be pursued. Such rationalization could be done by applying a few, simple bands with more uniform and lower nominal average rates. Duties on industrial or single purpose capital goods and intermediary inputs used in manufacturing processes should be reduced significantly or eliminated. In contrast, final consumption goods could be subject to somehow higher tariffs. The resulting tariff rate could be further lowered across the board or targeted to specific types of goods along with the strengthening of the VAT (less exempt and zero-rated goods).
1. Consolidate the various individual concession acts into a single fiscal omnibus act that can only be introduced, amended, or withdrawn by Parliament.
2. Consider the introduction of an annual tax expenditure report with an estimation of the revenue forgone to the various tax incentives. This should be an integral part of the Budget process.
3. Include income tax concessions as recommended in Chapter III only in the Income Tax Act.
4. Do not grant new tax holidays (grandfathering those already granted).
5. Use discretionary powers under Cap. 67B sparingly and then only in situations where they address market failures or generate multiplier effects such as infrastructure development.
6. Consider introducing a cap on annual costs for discretionary duty concessions.
7. Minimize VAT and excise tax concessions.
8. Convert import duties into excise duties in respect of all imports of alcoholic beverages, tobacco products, fuels, and motor vehicles that do not compete against domestic production.
9. Rationalize the tariff structure applying a few, simple bands, with more uniform and lower nominal average rates, in order to reduce economic distortions from variations in tariffs and relieve pressures for tariff concessions.