The million-dollar question that is being increasingly asked is – how effective is a nation’s tax incentives in attracting investments?
In the current globalized environment, where businesses operate in multiple jurisdictions and are constantly seeking greater efficiency, effective supply chain and cost reduction, countries are compelled to continuously look at ways to attract investments to accelerate economic growth that is both sustainable and equitable. Thus, the role of tax incentives has been and will continue to be an area of focus for policymakers around the world.
The downward trend of corporate tax rates
Corporate tax rates around the world have been on a declining trend over the last two decades, as countries respond to increased corporate tax competition and turn to transaction taxes such as Value Added Tax (VAT) or Goods and Services Tax (GST) to bolster government revenue. Malaysia’s corporate tax rate has gradually been lowered from 34% in the year of assessment 1993 to the current 24%. A study by the Tax Foundation, an independent non-profit tax research group based in the US, showed that the worldwide average statutory corporate income tax rate has consistently decreased since 1980, but the rate has levelled off in recent years. Around the region, corporate tax rates have continued to be on a declining trend, with Asia having the lowest average corporate tax rate of 19.52%. This is compared to the 23.57% average rate in the Organisation for Economic Co-Operation and Development (OECD) countries and 32% rate in the Group of Seven (G7) countries.
The corporate tax rate of a country is undoubtedly a key factor when it comes to investment decisions, but it is not the only consideration. Other factors such as political stability, fiscal framework, market size, availability of skilled labor , the supply chain ecosystem and infrastructure support are among other areas influencing investment decisions. That said, as countries continue to compete to attract much-needed investments, reductions in overall tax rates as well as the availability of tax incentives will be sweeteners for investment decisions. High corporate tax rates can sometimes lead to countries being eliminated from lists of potential investment destinations, even before other factors are considered. Additionally, driving down the cost of tax compliance, simplifying the tax system and providing certainty to taxpayers will also contribute to investment decisions. A study done by the OECD showed a clear correlation between the complexity, transparency and certainty of the tax system and the investment decisions by corporates.
Tax incentives to attract investments
One key characteristic of tax incentives such as tax holidays or investment allowances is that government funds are not needed upfront. Other forms of financial incentives to attract investments such as grants, or subsidies will require an upfront outflow of funds from government coffers. Regardless of the type of incentive granted, a monitoring mechanism should be implemented to estimate and confirm the outcome of the investment, to assist governments in evaluating the performance of the said investment and the multiplier benefits to the economy, and to allow governments to react quickly if it appears that the incentives offered are not producing the intended outcomes. Common conditions such as the use of local manpower, workforce training, technology and knowledge transfer and support of the vendor supply chain are typically imposed, and positive outcomes have been observed from such conditions.
Another key feature of tax incentives is that they can be targeted to encourage investments in activities or sectors that are lagging behind others, which are important to achieve desired social or environmental outcomes, or which are key to support the overall strategic growth of the economy. For example, in recent years, to encourage the use of green technology, companies undertaking green technology activities and providing green technology services are granted a Green Investment Tax Allowance (GITA) or Green Income Tax Exemption (GITE). Such measures will encourage companies to consider the quicker adoption of green technology in their businesses.
Design of tax incentive regimes
It is important for tax incentives to be transparent, without cumbersome administration. The conditions attached should be practical and achievable by businesses, whilst at the same time bringing about the desired results for the nation. The relevant investment promotion agency should provide end-to-end support to the investor, including assisting the investor in addressing queries from the tax authorities in respect of the tax incentives claimed, where relevant. Further, governments need to consider whether tax incentives should be restricted only to new investors in the country. Failure to support existing investors may result in them looking elsewhere, and it would be logical for governments to continue to incentivize existing investors who commit to expansion projects and additional investments in the country.
