‘Zero’ Tax Not Attracting Investment. Implications for OFCs

Kenya is losing the ‘race to the bottom’. According to Martin Ogindo, a member of Kenya’s parliamentary Budget Committee “the country has been part of very unhealthy competition in the region trying to out-do each other to provide better tax incentives for foreign direct investment (FDI), which has turned out to be a fallacy.”

He was speaking this month at the launch of a Christian Aid study which found that tax incentives are draining the country of revenue needed for essential public services; and that the estimated Sh100bn lost to tax incentives was twice what Kenya spent on the entire national health budget last year.

In addition the country’s debt service rose by 75% to Sh303bn for this year’s Sh1.4trillion budget which Mr. Ogindo said was a result of very low tax revenue impacted largely by the tax incentives.

Kenya’s tax incentives include generous exemptions from corporate and withholding taxes, stamp duty and investment deductions on initial investments at a rate of 100% applied over 20years.

Even so employment in the country’s Export Processing Zones (EPZ) has declined by 8,000 since 2005 which according to the report is indicative of businesses re-locating. This should not be a surprise as companies either leave or re-register under new names after the tax holidays expire thereby avoiding taxation for long periods of time.

To recoup the 3.1%of Kenya’s GDP loss through tax incentives and exemptions the study recommends the removal of tax incentives in the EPZs; an annual public review of all tax incentives; and tax coordination among states within the East African Community – like Uganda and Tanzania both of whom attract more FDI than Kenya with less tax incentives – to improve the existing draft Code of Conduct on tax competition.

Not only a problem in Africa

For the emerging countries of Central and Eastern Europe the ‘flat-tax’ revolution is over as both the Czech Republic and Slovakia are dropping their recently-introduced flat-rate corporate income tax. Further evidence of the trend away from lower taxation to attract foreign investment is Slovakia’s plan to introduce special surcharge taxes for banks and network industries.

This very specific group within the European Union (EU) is less wealthy that the rest and less able to spend on social policies, education and development. Conversely unlike the other EU states these countries also collect much less in taxes with the average rate of redistribution of income as measured against GDP at less than 30%.

In the 1990s the prevailing view was that ‘Globalisation’ would start a collective ‘race to the bottom’ in terms of tax competition. While this has not been the case in the West it has certainly been the case for the East African Community and the newer members of the EU including Hungary, Slovakia and the Czech Republic. In both cases these countries have come to rely on competitive tax rates and special tax incentives to attract FDI and fuel growth and development.

Implications for OFCs

Not only have tax rates gone up as a consequence of the abandonment of the ‘flat-rate’ regime but the EU ‘fiscal compact’ is due to be ratified at the end of this year. This Treaty on Stability, Coordination and Governance in the Economic Monetary Union will put pressure on countries to collect more taxes. Moreover, the Euro Plus Pact which was agreed in the spring of 2011 explicitly creates a framework for tax harmonisation albeit through ‘coordination’ and not binding legal obligation.

For natural resource ‘poor’ Offshore Financial Centres (OFCs) lacking the traditional inducements to attract FDI and instead rely on tax efficiency; and the provision world-class, responsible business and financial services, the retreat from tax incentives and moves towards higher corporate tax and more robust tax collection will lead to a greater emphasis in these countries on transparency and exchange of tax information.

Evidence of this is already visible in the composition of the OECD Global Forum on Transparency and Tax Cooperation (OECD GF) which last year admitted Kenya as a member of its Steering Committee. Both Ghana and Nigeria are already members and it is expected that other African states like Uganda and Tanzania will join before the next plenary of the OECD GF taking place this October in South Africa.

The Czech Republic, Slovakia and Hungary too are members of the OCED GF with Latvia, last month, becoming the most recent member from the emerging economies of the EU.

Besides swelling the membership of the OECD GF to 108 the addition of these countries rightly preoccupied with accelerating their economic development will mean more negotiating activity as they seek to codify the means of exchanging tax information either through the use of a tax information exchange agreement (TIEAs) or tax treaties.


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