United nations of tax incentives

Part I: Theoretical Background
capital, there is no motivation in terms of compensation for investors 
to correctly state the value or for customs authorities to monitor the 
declared value. A further problem may be encountered when foreign 
investment agencies have an incentive to boost their investment figures, 
resulting in a common interest between the agency and the investor to 
inflate the amount of the investment. It is thus important for the tax 
administration to be involved in the valuation process.
Abuse of duty-free privileges
A common investment incentive is an exemption from customs duty 
on imported equipment. Once imported, however, items may be 
resold on the domestic market. A partial solution is to restrict the 
exemption to those assets that are contributed to the charter capital 
of the enterprise, but it still may be necessary to verify periodically 
that the assets remain in the enterprise. Another approach is to restrict 
the exemption to assets such as machinery, which are less likely to be 
resold, and to exclude items such as passenger vehicles and computer 
equipment.
Asset stripping and “fly-by-night” operations
Many countries have experienced problems with “fly-by-night” 
operators that take advantage of tax incentives to make a quick, 
tax-free profit and then leave to begin operations in another country 
that offers tax privileges. This problem most often arises with the use 
of tax holidays and export processing zones. Another problem occurs 
when a foreign investor acquires control of an existing local enterprise 
and, instead of contributing new capital to modernize the enterprise, 
strips it of its useful assets and leaves the country. The latter problem 
is not necessarily linked to the availability of tax incentives, although 
the ability to make a tax-free capital gain is an added attraction to the 
investor stripping the assets.
Some countries have attempted to counter the fly-by-night 
operator problem by introducing “clawback” provisions. For exam-
ple, a country can grant a tax holiday for a 5-year period only if the 
venture continues for a period of 10 years. If the venture is termi-
nated before the end of the 10-year period, any tax that was fore-
gone must be repaid. The difficulty with such a provision is that the 

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32
Design and Assessment of Tax Incentives
investor may have left the country before it is possible to claw back 
any of the forgiven tax liability.