Counting the cost of tax exemptions

Government’s desire to extend an olive branch of tax reliefs to investors, charities and a special class of government employees is proving to be a costly affair each passing financial year.Tax exemptions are viewed to be an incentive of boosting economic growth.
However, it is of concern that the cost of tax exemptions is rising, stretching a national budget laden with heavy debt.

Government registered a rise in tax exemptions in a stretch of five years from Shs947 billion as of 2017 to an estimated Shs2.4 trillion by close Financial Year 2021/22, according to a Finance Ministry expenditure report authored in the same period.

It is for this reason that when Finance Minister Matia Kasaija took to the podium to read the national budget for Financial Year 2023/2024, he proposed a cut back on tax exemptions to reduce revenue leakage and improve on their effectiveness.

Mr Kasaija said the plan is to rationalise tax exemptions through assessing the costs and benefits under the domestic revenue mobilisation strategy.
“Madam Speaker, no major changes in taxes rates have been proposed for next financial year, apart from measures to improve the governance of tax exemptions. The focus will be to expand the tax base without increasing the burden on the same taxpayers,” Mr Kasaija said.

The Tax rationalisation plan was mooted by the International Monetary Fund (IMF) suggesting that the rationalisation of tax expenditures will help maintain the debt-to-GDP ratio on a declining path, and allow for an increase in social spending over the medium term.

“The Ministry of Finance should identify areas for repealing tax exemptions, outline the intended yields, and establish a clear timeline for implementation,” a recommendation reads in part from the IMF.  
Ramathan Ggoobi, the Permanent Secretary in the Finance Ministry toed the same line while speaking to journalists after the budget speech on June 14th.  

Ggoobi noted that a full plan had been instituted to analyse tax exemptions and the Finance Ministry was working with one of the Bretton Woods institutions to establish the merits and demerits [of such exemptions].
“Those which don’t work, we are going to stop them; those which work, definitely we are going to support them. In this very budget that the minister has read, we are beginning the implementation of our tax exemption rationalisation agenda next financial year, effective 1st July,” Ggoobi said.  

Government has many tax incentives embedded within tax laws such as the Income Tax [Amendment] Act, Value Added Tax Act, Excise Duty Act, Stamp Duty Act and East African Community Customs Management Act.

It is within these tax laws that certain individuals, such as armed forces’ personnel, employees of the Judiciary and the East African Development Bank, are eligible for tax exemptions on their employment income.
Members of Parliament are also exempt from tax on their non-wage income.
In addition, exemptions are provided for on non-business capital gains and the business, investment, and rental income of specific firms, such as those in the aircraft sector.

Tax holidays are also an option for investors who meet certain criteria. Interest earned on infrastructure bonds and dividends paid by listed companies are both exempt from withholding tax.
Ibrahim Bossa, the Uganda Revenue Authority (URA) Assistant Commissioner on public and corporate affairs, provides an illustration of developers of an Industrial Park or Free Zone that benefit from Income Tax Exemptions.

For instance, a ten-year income tax exemption is granted to developers who derive income from leasing or letting facilities, starting from the commencement of construction or upon making an additional investment.

To qualify, a foreigner must have a minimum investment capital of $50m, while a citizen must have at least $10m.
For the next financial year, the size of investment capital required for an investor to benefit from excise duty exemption on construction materials, has been reduced to $5 million (Sh18.3b) from $50 million (Shs183.7b) for Uganda nationals.

Foreign investors will be required to have investment capital of at least $50 million (Shs183.7b) in order to benefit from this exemption.

Operators located within or outside of an industrial park or free zone are eligible for a ten-year income tax exemption on their earnings.
In order to qualify, foreign investors must have a minimum investment capital of $10m (Shs36.7b), while EAC citizens must have an investment capital of $300,000 (Shs1.1b) or $150,000 (Shs551b) for upcountry investments.
Some of the economic activities that qualify for consideration for tax exemptions include; processing agricultural goods, manufacturing or assembling medical appliances, medical sundries, or pharmaceuticals; building materials, automobiles, and household appliances; manufacturing furniture, pulp, paper, and instructional materials; and printing and publishing among others.

Costly exemptions
Besides government’s rationalisation plan, government is letting out a substantial amount of revenue in tax exemptions.
In January this year, URA Commissioner General John Rujoki Musinguzi estimated that the tax man was bound to lose Shs2.8 trillion in tax exemptions, credits and deferrals for the financial year 2022/2023.

Musinguzi was presenting to parliament a list of new companies that were requesting for a tax waiver in the Finance Ministry’s Budget Framework Paper for the financial year 2023/ 2024.

Some of the entities that requested for tax exemptions included; Zenitaka-Hyundai Joint Venture for Pay as You Earn (PAYE) of Shs725 million and withholding tax (WHT) of Shs11 billion, Brookside Limited Shs8 billion in corporation tax, and St Mary’s Hospital withholding tax of Shs282 million.

Others were FINASI-International Specialised Hospital Uganda (Lubowa), Uganda Broadcasting Corporation (UBC), and China Nanjing International Limited among others.

Over the past six financial years, tax expenditures in Uganda have grown both in number and in terms of the value of revenue foregone.

Data obtained from the Finance Ministry indicates that the largest share of revenue foregone came from the Value Added Tax (VAT), representing Shs1.15 trillion.
Other estimates of revenue foregone by tax head include; Customs at Shs411b, Income tax worth Shs 416b, and Excise Duty at Shs498b.

Beneficial or not?
Some tax experts argue that there is a real return of investment from tax incentives.
URA’s Bossa says the provision of tax incentives serves to entice investors and promote investment in various sectors of the economy.

Bossa says this is evident in the PAYE returns, paying employee salaries, supporting local purchases, making sales, and investing capital within the country.
URA records show that revenue from beneficiaries of tax incentives increased from Shs1.2 trillion in FY2018/19 to Shs1.5 trillion in FY2021/22 with the highest revenue contributions generated from PAYE, followed by VAT.

Ms Jane Nalunga, SEATINI executive director says, tax exemptions are not bad but it depends on which investor is receiving the exemptions.

“If a company is going to build up a factory in Luweero where they add value to pineapples, then the  incentives shouldn’t be about taxes, but can government decide to extend free electricity and water?,” Nalunga says.

“Tax holidays is one of the ways of convincing investors to come and invest in the country. We need them because if a condition is set by someone with the money, and is ready to put up a factory in my constituency, I will tell local authorities not to charge him because the factory will be remaining here for years and years,” Tom Bright Amooti, the Kyaaka Central Member of Parliament in Kyegwegwa district, says.

Some tax experts argue that tax exemptions are benefiting a select few, leaving out others in the cold. 
A broader look into exemptions offered to the power sector shows some revenue leakages.

The second schedule of the VAT Act stipulates a VAT exemption for the supply of goods and services to contractors and subcontractors involved in hydroelectric power, solar power, geothermal power, biogas, and wind energy projects are exempt from VAT.

Bossa paints a scenario in which he says that such an exemption is not limited to project-related goods and services, but rather applies to all goods and services. These broad exemptions can result in revenue leakage.
Ausi Kimbowa, an economist with the Initiative for Social and Economic Rights, assesses this trend through a policy brief noting that tax exemptions only benefit Uganda’s wealthy.

The brief titled, ‘Leveraging Progressive Taxation to fund public services’ shows that government has, over time, foregone significant revenue collections from the [wealthy] individuals and corporations which presents major implications for the country’s resource envelope.

“When the wealthy can engage in tax avoidance or tax evasion, or enjoy excessive and redundant tax incentives, resulting in low effective income tax rates, the progressivity of the tax is distorted, as contributions start falling disproportionately on smaller businesses and poorer households,” the brief reads in part. 
Kimbowa is of the view that government is then left with little to spend for critical social sectors such as education and health.