24
Design and
Assessment of Tax Incentives
taxes, a reduced rate of tax or a combination of the two, for example,
two years’ exemption plus a further three years at half the standard
rate. The exemption or reduction is granted for a limited duration.
Tax holidays can vary in duration from as little as 1
year to as
long as 20 years. In determining the length of the tax holiday, a clear
trade-off exists between the attractiveness to investors and the revenue
cost to the host country’s treasury. Most
studies have concluded that
short tax holidays are of limited value or interest to most potential
investors and are rarely effective in attracting investment, other than
projects that are short-term and “footloose”,
or not tied to a particular
location and able to relocate in response to changing economic
conditions. Substantial investments often take several years before
they begin to show a profit, by which time
the tax holiday may have
expired. Short tax holidays are of the greatest value to investments that
can be expected to show a quick profit and are thus quite effective
in attracting investment in export-oriented activities such as textile
production. Since that sector is highly mobile,
it is not uncommon,
however, for a firm to enjoy a tax holiday in one country and, when it
expires, move its entire operation to another country that is willing to
give a new holiday. Consequently, the benefit of the investment to the
host country may be quite limited.
Tax holidays have the apparent advantage of simplicity for
both the enterprise and the tax authorities. The simplest tax holiday
regime,
and the most investor-friendly, provides not only that no tax is
payable during the holiday period but that taxpayers are not required
to file information or tax returns, which
results in an absence of
compliance and administrative cost. The better approach is to require
the filing of a tax return during the holiday period. For example, if the
enterprise is permitted to carry forward losses incurred during the
holiday period or claim depreciation allowances after the end of the
holiday period for expenditure incurred during the holiday, it would
need to at a minimum keep appropriate records.
In addition, tax holidays are especially prone to manipulation
and provide opportunities for tax avoidance and abuse. Another
disadvantage is that the revenue cost
of tax holidays cannot be
estimated in advance with any degree of accuracy, nor can the cost
related to the amount of the investment or to the benefits that may