Tax Policy Incoherence – More Incentives For Foreigners?!

Posted on by on October 8th, 2012 | 0 Comments »

 

Tax incentives to attract foreign investments have persisted for more than 50 years in Jamaica, without an adequate assessment of their benefits to the economy. In the absence of such analysis, the Government continues to hope for benefits with a new bill that will exempt non-residents of Jamaica who perform prescribed operations here from the payment of income tax.

The memorandum of objects and reasons of the Bill to Amend the Income Tax Act clearly states: “It is hoped that, by facilitating the establishment of group head office companies in Jamaica, other companies will realise the economic benefits, including increased foreign investments, access of alternative capital providers, new markets and the creation of new jobs.”

This bill contradicts the promised tax-reform package to be implemented over a three-year period intended to achieve several objectives, including ‘Reducing distortions through drastic reductions in tax incentives and waivers’, according to the minister of finance in his 2012 Budget presentation.

Critiques of the use of tax incentives have long argued that it creates market distortions, mainly of two kinds: (1) distortion in business decisions; and (2) distortion in the competition between firms. But in our weak economy, starving for investment to drive growth, it is precisely the ‘distorted’ business decision to set up head offices in Jamaica that the Government hopes to achieve with this bill. The distortion argument, therefore, sounds superfluous.

WHERE’S THE OMNIBUS INCENTIVE LEGISLATION?

Of course, the same argument can be made for the use of incentives to attract local investments. In the absence of equivalent incentives for Jamaican business owners and their employees, the Bill to Amend the Income Tax Act appears to discriminate against hard-working Jamaican employers and employees.

This perception is fostered by the absence of the Omnibus Incentive legislation proposed in the 2011 Green Paper on Tax Reform and supported by the Private Sector Working Group on Tax Reform that provides a comprehensive and coherent approach to incentives in Jamaica. This new incentive for foreigners should be considered in the context of this Omnibus Incentive legislation after a careful analysis of the cost and benefits of such incentives.

After months of exhaustive dialogue and consultations on the 2011 Green Paper on Tax Reform, there was widespread agreement that the Omnibus Incentive legislation was the best approach to dealing with the thorny and contentious issues involved in retaining past incentives and creating new, performance-based incentives.

In these tax-reform discussions, the micro, small and medium-size enterprise (MSME) sector was asked to temper the demand for small-business tax incentives, as MSME and entrepreneurship incentives would be addressed in the Omnibus Incentive legislation and/or the promised MSME and Entrepreneurship Policy.

To date, neither incentive exists for the MSME, a sector considered to be the engine of growth in Jamaica. Instead, the engine is being weakened by the new taxes proposed in the 2012-13 Budget, creating new financial burdens that many of the MSMEs are unable to bear.

HARD QUESTIONS

Several worrying questions arise:

1. The argument presented by Finance Minister Peter Phillips is that the bill was tabled in Parliament because of commitments that were given by the previous JLP administration against which some companies acted to establish group headquarters in Jamaica.

This argument speaks volumes about the commitment and legislative priorities of our Government. What about the commitment made to the Jamaican people to table in Parliament the White Paper on Tax Reform in May 2012, at the same time as the 2012-13 Estimates of Expenditure? In addition, what level of attention, if any, was given to the cries of local businesses, especially MSMEs in the creative/cultural industries, who have been calling for tax incentives for years?

2. Has the possible unintended, negative impact of this tax exemption been weighed against the possible benefits? For example:

a. Are local entrepreneurs likely to be deterred from investing in domestic capital and increasing exports necessary for growth and development?

b. There is no provision in the bill to prevent a company selling goods and services that compete with domestic businesses from being designated a ‘group head office company’. Will this create a competitive disadvantage for local competitors or worsen existing disadvantages?

c. Will this incentive contribute to the escalation of our already grave crime problem? It has been reported that in 2000, there was a dramatic increase in smuggling in Zambia after a grant of generous tax breaks to foreigners as local traders tried to offset the competitive disadvantage that they faced.

d. Will this encourage ’round-tripping’, which occurs when local firms leave the country to return disguised as foreign investors to take advantage of tax incentives? Analysts suggest that round-tripping accounts for up to 25 per cent of foreign investment in China.

e. Will unscrupulous companies exploit the provision in the bill (s.36F(2)(c)) that enables the grant of a certificate if the minister is satisfied that the company “proposes to employ … 30 per cent or more of its employees to perform group head office activities from among citizens of Jamaica” by not employing them after reaping the benefits?

f. Will the Jamaican counterpart of those employees getting the tax exemptions and, doing the same or equivalent work, be demotivated and become less productive?

CONCLUSION

In the context of Jamaica’s feeble economy, there is some merit in seeking to attract group head office investment, which is expected to generate not only jobs, but also introduce important technical and research and development (R&D) activities which can create knowledge spillovers and other benefits for Jamaica.

Many analysts, however, question whether such tax exemptions are the best strategies to achieve this objective. This ought to be determined by a careful assessment of the past and existing tax incentives we give foreigners, as well as the experience of other countries. The conclusions of the 2012 European Commission Study on ‘Internationalisation of business investments in R&D and analysis of their economic impact’ are instructive:

1. First, policymakers should try to create a research-friendly environment. Rather than trying to attract R&D intensive foreign-owned firms, results from the econometric analysis indicate that policy should look to maintain stable economic ‘fundamentals’, increase the skills of the workforce, strengthen university research, and increase the innovative capabilities of firms.

2. Second, in order to maximise spillovers from foreign-owned firms, policy should raise the capabilities of domestic organisations to absorb knowledge and help foreign-owned firms to integrate into domestic innovation networks.

3. Third, policymakers should not be too worried about R&D activities of European Union firms outside the Union. There is no evidence that these activities substitute domestic research; in contrast, they are a means to open up new markets and may contribute to growth at home.

The proposed tax incentives should be performance-based and should be part of a comprehensive, coherent and holistic legislative framework for all incentives, with supporting policies, to enable us to achieve our development objectives.

Only in such a framework will incentives for foreigners, as well as Jamaicans, be meaningful and transparent. The promised White Paper on Tax Reform and/or the Omnibus Incentive legislation should, therefore, be tabled.

Last Friday, senators – as members in the Lower House had already done – will rubber-stamped this bill, failing to show strong and inspired leadership by breaking with tradition in this, our 50th year of Independence, and listen to the voice of local business people.

We are watching, and we will act!

Professor Rosalea Hamilton is Scotiabank chair, Entrepreneurship & Development, UTech. Email feedback to  rosaleahamilton@gmail.com

Source: Jamaica Gleaner

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