Tax carrot won't woo quality foreign investments
Georgia Silvera-Finnikin, Guest Columnist
The Government is seeking to encourage overseas companies to establish their head offices in Jamaica through a bill that exempts officers and employees of such companies from the payment of income tax.
The bill, titled Income Tax (Amendment) Act, 2012 was passed by both Houses of Parliament and awaits the assent of the governor general to take effect. It exempts from income tax, the emoluments of a non-Jamaican holding an office or employment of profit with an approved group head office company.
The Memorandum of Objects and Reasons appended to the bill stated that "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.".
Finance Minister Peter Phillips told the House of Representatives that the Income Tax (Amendment) Act 2012 will provide incentives for multinational corporations operating in multiple jurisdictions to move their activities to Jamaica.
The minister sought to assure that the initiative will ensure some level of employment for Jamaicans. He went on further to express that it was his desire that in the short term, the employment of resident Jamaicans will exceed the minimum 30 per cent mark mandated in the legislation and even climb to attain nearly 100 per cent.
However, isn't this a conflict of the intent of the bill? The incentive is for non-citizens to be exempted. Therefore, if total employment approaches 100 per cent employment of Jamaican citizens who are residents, what would be the incentive to the multinational corporations?
The minister was keen to point out that the approved companies would still be liable to pay corporation taxes. However, it is not uncommon that in making foreign direct investments (FDIs) to Jamaica, many foreign-owned corporations set up local companies in the free zones and are given tax breaks as an incentive. Usually, these zones are set up in underdeveloped parts of the country; the rationale is that the zones will attract employers and thus reduce poverty and unemployment, and stimulate the area's economy. These zones are often used by multinational corporations to set up factories to produce goods (such as clothing or shoes).
The free zones are often used as a foreign company's hub for operations. Jamaica's Export Free Zone Act grants full relief on corporation tax on international trading, i.e., exports. Service companies are also included. So information and communications technology companies also benefit from this corporation tax relief.
Further, as in the case with companies (both local and foreign) located in downtown Kingston, the Urban Renewal (Tax Relief )Act provides a relief on taxes for capital improvements such as building renovations. This relief is 331/3 per cent of the approved capital expense. Digicel may be representative of group head office companies, and it has established its regional head office in this area. If Digicel has approval under the Urban Renewal (Tax Relief) Act, it is already benefiting from significant corporation tax incentive. Likewise, other approved companies could benefit from existing corporation tax incentives.
DRIVERS OF FDI
It is not unusual for governments to offer international companies hefty tax breaks and other incentives to set up regional headquarters or research operations. In December 2010, Japan made an unprecedented offer to foreign companies of a lower effective corporate tax rate than that paid by Japanese enterprises, which marked a "major shift in policy".
The tax breaks reflect concern that regional rivals such as Singapore and China were proving more attractive to multinationals as centres for management and research and development (R&D). Under the new policy, foreign companies were granted a 20 per cent deduction in their taxable income for five years if they set up a new regional HQ or research operations in Japan.
However, it must be noted that this was introduced within a tax-reform package which saw other benefits implemented to boost the domestic business market.
Dr Phillips maintains that this bill will encourage FDI, as it would provide business opportunities reflected in the size and growth potential of markets. Although market growth and size are the most powerful drivers of FDI, one should not undermine the significant role the country's investment climate features in attracting investments. Strong regulatory institutions and investor-friendly regulations also matter and may even boost the development impact of the investment.
Moreover, many elements of Jamaica's investment climate can be reformed in the short run and at comparatively low cost. Improving the investment climate will offer an excellent opportunity for Jamaica in its quest to attract FDI.
The investment climate can be defined by three broad sets of variables: macroeconomic policies such as fiscal, monetary and trade policies; governance and institutions; and infrastructure. The business and investment climate is made up of much more than just the tax rates and fiscal incentives available to businesses. Other critical components include: political stability, rule of law, macroeconomic conditions, perceptions of government and the regulatory environment. Political instability, inadequate security and corruption disrupt most legitimate business activity.
Safeguarding civil, political and economic rights by securing human rights, preventing crime, and taming corruption should be priorities in the Government's thrust to attract investors.
One of the most destructive forces threatening economic development and a healthy society is the high crime and corruption levels.
Investors are discouraged by concerns about security and stability, and are attracted by increased transparency, good governance and simpler and fairer tax systems. Lower overall tax rates and simplified tax administration are generally more effective stimulants to economic development than complex systems of tax holidays and incentives. 'Tax competition' alone is likely to be particularly ineffective.
Although lowering effective tax rates can help boost FDI, the effect is eight times as strong for countries with a good investment climate (James 2009). Most important, the quality of the investment climate may better allow for the beneficial spillovers from FDI providing the welfare gains through technology transfer to local suppliers that many economies seek (Blalock and Gertler 2008).
In a poor investment climate, both foreign and domestic investors and businesses may not be able to benefit fully from opportunities created by market size and growth potential. An economy that has a poor investment climate is, therefore, likely to attract both less FDI and lower-quality FDI than it otherwise could. The quality of infrastructure and economic and political stability can be influenced only in the medium to long run.
In contrast, many elements of Jamaica's investment climate, such as the complexity of our tax regime and the efficiency of our bureaucracy, can be improved in the short run and at a comparatively low cost to government.
When long-term sustainability is taken into account, the use of investment promotion policies such as tax incentives or other complimentary giveaways is usually effective in the short run, but not sustainable in the long term. This is because rival countries can always offer similar tax cuts and investment promotion incentives.
ATTRACTING QUALITY INVESTMENTS
Quality investment requires that Jamaica deliver enough satisfactory rewards to make investors agree to transfer technology to Jamaican businesses and entrepreneurs. Those rewards cannot be generated by giveaways or simple incentives, but from the readiness of economic infrastructure, the quality of manufacturing factors, and the environments that are conducive to quality investment.
Increasing the incentives to attract foreign investment in R&D and technology transfer in Jamaica must be accompanied by market development and healthy competition. This can be done by adjusting the economic structure towards the target economic sectors and speeding up trade liberalisation with neighbouring countries through CARICOM to expand market size and hence increase the payback for R&D investment. Existing laws should also be improved and be better enforced to protect the rights and intellectual property of investors.
In parallel, the Government should aim to reduce investment costs in target economic sectors by developing human resource and basic infrastructure to accommodate the expansion of those target sectors, such as health tourism, sports development, and information technology.
For Jamaica to be more attractive to investors (both local and foreign), there is a need to put in place measures to ensure an enabling environment by reducing the so called hassle costs.
The present investment promotion strategy should aim to meet both short-term and long-term targets. Hence, I agree with Karl Samuda that Jamaica's White Paper on Tax Reform should have been tabled simultaneously with this bill. This would not only lend itself to transparency but supports goal congruence with the general policy direction of the government.
As a move to stimulate the economy, small and medium sized orga-nisations could have been granted similar tax incentives. It would have been ideal to have offered Jamaican businesses a comparable incentive such as a relief on employers' statutory obligations for each additional employee hired during a given period, especially by small and medium enterprises.
Dr Phillips said regulations are being drafted to address the audit and assessment methodology to be used in ensuring that such approved entities are operating in keeping with the Income Tax Act. He added that the Cabinet has also approved the introduction of transfer pricing rules to address tax-related transactions, where the arms-length principle is applicable.
It is my hope that these crucial regulations are available in the very short term, as the problems in our taxation of multinational companies stem mainly from the difficulties in determining how much of a corporation's worldwide earnings relate to its Jamaican activities, and, therefore are subject to Jamaican tax. In essence, Tax Administration Jamaica must try to scrutinise every movement of goods and services between a multinational company's domestic and foreign operations, and then attempt to assure that a fair, arm's-length transfer price was assigned (on paper) to each real or notional transaction.
The Government's role is not to manage the economy or interfere with market dynamics but rather to provide the enabling framework for enterprises to flourish.
Georgia Silvera-Finnikin is a chartered accountant and taxation consultant. Email feedback to firstname.lastname@example.org and GFinnikin@utech.edu.jm.