SL told to sunset all senseless tax holidays and explore tax credits as potential alternative

By Nishel Fernando 
Given the rent-seeking and corrupt elements associated with tax incentives and tax holidays granted on adhoc basis, a top investment professional urged the government should sunset all “senseless” tax holidays granted while focusing on more targeted fiscal tools such as tax credits to attract know-how and investments into the country in a much more targeted way.

“All existing tax concessions and holidays should be sunset. There are no longer any sacrosanct agreements after we have defaulted on our debt. One of the reasons why this happened to us is because this country is run for the benefit of thousand people; it’s not run for the benefit of 22 million. There’s lot of rent seeking going on,” JB Securities Limited CEO and Advocata Institute’s Chairman Murtaza Jafferjee said.

He was delivering the 24thAnnual Tax Oration of CA Sri Lanka in Colombo this week.

Jafferjee pointed out that tax incentives not only erode the tax base, but also create economic inefficiency through distortion of resource allocation while increasing administrative burden on tax authorities and opening up avenues for rent seeking and corruption without an increase in investments.

Under Strategic Development Projects Act, No. 14 of 2008, projects identified by the Board of Investment (BOI) in consultation with relevant line ministries are granted tax exemptions up to a period of 25 years.

Jafferjee pointed out that two of the recent tax holidays granted to a port-related investment project and an IT project didn’t make sense.

“The South Harbour was built over 10 years ago. There were existing terminals. There were already large amounts of container volumes coming. So, the West Container Terminal (WCT) is an almost sure thing, because ships are coming. Not only we give this without competitive bidding, but also on a 25-year tax holiday,” he said.

Over the time, he also noted that tax incentives have become less relevant for investments as other factors such as economic and political stability, costs of raw materials, local markets, transparency of legal framework, availability of skilled labour, labour costs and quality of life have become more prominent.

He stressed that tax incentives should be given judiciously– stimulating positive externalities where private returns are below the cost of capital and acquisition of tacit knowledge to increase 
economic complexity. “If you undertake a project and you have a minimum Internal Rate of Return (IRR) requirement of 15 percent and the IRR cannot get to 15 percent, you have to see that social returns (benefits to society) are much higher. Then, there’s a case for subsidy,” he added.

Jafferjee opined that tax credits are a better fiscal policy tool than tax concessions as they are capped at an absolute value or a relative value of a specified expense such as research and investment.

However, he noted that use of tax credits remains very limited in the country with hardly been mentioned in the recently passed budget. 

Further, he proposed establishing an Earned Income Tax Credit (EITC) system based on tax credits similar to the United States, which would encourage people to seek employment without solely depending on State-funded welfare programmes.  “This encourages greater employment by providing a tax rebate (negative tax) for those below a certain income. The rationale for it is, it encourages people to seek employment and is preferable to a cash transfer,” he said.