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VOL 22 NO 78 REGD NO DA 1589 | Dhaka, Wednesday, January 28 2015

Proper taxation policy key to attracting FDI

M S Siddiqui
Business enterprises are expected to compete internationally for markets with competitive
products/services and quality. Competitiveness in respect of price, quality and service is
precondition to survive in the globalised market. An economy's competitiveness and its ability to
achieve high and growing productivity and economic prosperity are likely to be driven primarily
by domestic factors.
'Competitiveness' is a relative concept. When applied to a business, it would mean that the firm
in question is able to produce its output at the same or lower cost than others in the same line of
business, or that it has some other advantages over them such as better quality of its product.
Foreign and local investments are closely related to competitiveness of the particular industry,
sector and the country as a whole. The enterprise and the environment in which it operates
remain the key to the issue of competitiveness.
At country level, the notion of competitiveness becomes less clear. Countries and enterprises
compete in a different manner. Different countries do compete with each other in order to attract
investments. As a response to global processes, they lay specific emphasis to retain economic
activities within their business environment. In this respect, attracting foreign direct investment
(FDI) is one of the most effective ways for economies to become integrated and competitive in
global markets. The level of FDI depends on a country's business environment.
The income and other taxes are not a principal factor determining FDI flows. A low burden of tax
of the host country cannot compensate for a generally weak or unattractive FDI environment. In
practice, the range of empirical estimates of the responsiveness of FDI to corporate tax rates is
quite wide and this makes clear-cut conclusions difficult. FDI increased across the world,
including emerging countries, due to international competitiveness and improvements in business
environment of many countries. Companies search for better locations of lower cost, new
markets, competitively high skills in order to maximise the returns of their investment strategies
i.e. efficiency, strategic asset seeking, market and/or resource seeking (UNCTAD, 2006).
The World Economic Forum, in its Global Competitiveness Report, defines 'competitiveness' as
'a set of institutions, policies and factors that determines the level of productivity of a country'.
The Report weighs together data pertinent to 12 'pillars of competitiveness': institutions,
infrastructure, macroeconomic environment, health and primary education, higher education and

training, goods market efficiency, labour market efficiency, financial market development,
technological readiness, market size, business sophistication and innovation.
The impact of tax on 'competitiveness' is dependent on how tax policy and administration impact
various 'pillars' and hence productivity. In practice, most taxes, including corporate income tax,
can have an impact on competitiveness. Proper tax policy and administration can contribute to a
competitive economy in a number of ways.
Bangladesh and other least developed countries are hungry for FDI for accelerated growth of
their economies. But to attract FDI, location advantages must be offered with low trade, labour
or energy costs and low tax burden. These indicators can make local investment more profitable.
The actual tax burden on FDI is related to tax planning and administrative discretion in deciding
tax liabilities and other taxes. Globalisation integrates the economies of neighbouring and other
trading states on the basis of common tax, tariff and trade regime. The main consideration is
about statutory tax parameters influencing capital costs and establishing the statutory tax burden
on investment returns. Investors give much attention to corporate income tax. The potential
importance of other taxes must also be recognised. Taxes such as energy taxes and payroll taxes
are important and according to some officials, are becoming much more important.
Again, tax administration that is not open to corruption and that implements tax law consistently
and impartially make the tax regime predictable and reduce the extent to which it might
discourage investment. Inefficiency in tax administration reduces an economy's resources in
terms of revenue collection. Raising tax revenues with an efficient administration is broadly
accepted. Low compliance costs and burdens on business reduce the time that taxpayers have to
spend on tax compliance - time and effort that could otherwise be spent on creating income and
wealth.
Tax policies have had significant implications as cross-border investors will generally be looking
to maximise their post-tax, not their pre-tax returns. Countries may feel that they are increasingly
in a position of competing as a location for FDI and, as a result, may be under pressure to reduce
taxes on returns on investment, particularly their corporate income tax rate.
There may be tax incentives which would include reduced tax rates on profits, tax holidays, easy
accounting rules that allow accelerated depreciation and loss carry forwards for tax purposes, and
reduced tariffs on imported equipment, components, and raw materials, or increased tariffs to
protect the domestic market for import substituting investment projects.
EXAMPLES FROM CHINA AND INDIA: China offers foreign-invested firms a tax refund of
40 per cent on profits that are reinvested to increase the capital of the firm or launch another
firm. The profits must be reinvested for at least five years. If the reinvested amounts are
withdrawn within five years, the firm has to pay the taxes.
India, similarly, offers a tax exemption on profits of firms engaged in tourism or travel, provided
their earnings are received in convertible foreign currency.

A related challenge for tax policy from globalisation is the greater ease with which businesses,
especially multinational enterprises (MNEs), can evade tax moving ('stripping') earnings from
higher tax country to lower tax one through internal group leverage such as financing
subsidiaries in high-tax countries, primarily with debt. They have the option of profit shifting
through transfer mis-pricing, i.e. by setting prices for intra-group transactions and the local
investors cannot take such an opportunity. The tax base of a MNE's home country and that of
host countries can be at risk. Especially if the home country is a relatively high-tax country, its
taxable profits may be reduced dramatically through aggressive tax planning techniques,
particularly in the area of intangibles.
Business decisions are not only influenced by tax policy parameters (e.g. tax bases and rates) but
also by the way in which a tax system is administered. A MNE considers whether the tax
administration has a good understanding of business models and provides good 'service' to
business. Do they provide certainty and predictability in the application of the rules and are the
rules applied in a consistent and coherent manner? Investors also assess the cost of complying
with the letter and spirit of the law and whether there is a level playing field in terms of tax
compliance for local and overseas investors and also future plan and forecast of tax policy
incentives.
Tax policy-making is evidence-based and transparent with publication of the revenue forgone
from tax expenditures and periodic reviews of their cost-effectiveness, estimates of the revenue
effects of tax measures proposed in the budget, etc. There are numerous examples of poor
infrastructure and other weak investment conditions having deterred FDI. Tax is but one element
and cannot compensate for weak non-tax conditions.
Again, higher corporate tax rates are matched by well-developed infrastructure, public services,
etc. Tax competition from low-tax countries not offering these advantages is not regarded by a
number of policy-makers as seriously undermining the tax base.
According to the Organisation for Economic Co-operation and Development OECD, corporate
and income tax reforms are crucial to maintaining inward investment in an era of capital mobility
and globalisation. The government must lower taxes to attract capital investment, ensure job
creation and attract human capital. This assumption has underpinned the tax reforms of the
United States since the 1980s and the European Union since the 1990s. It is a policy discourse
that is particularly strong in liberal market economies such as Ireland, the UK, the US, New
Zealand and Eastern and Central Europe. Many countries have given increased attention to 'tax
competition' for inbound FDI, linked to the increasing mobility of capital and pressures to offer a
competitive tax system. Countries such as Ireland, the Netherlands and the UK have used tax
competition as a strategy to increase foreign direct investment (FDI), which has become a
lynchpin of their economic development models.
Bangladesh's corporate tax and other taxes are high in comparison to competitor countries and
there are complexities of tax assessment too. The tax administration is not updated with
technology and highly skilled manpower and is suffering from colonial mentality. The local
enterprises have option to evade taxes in collusion with tax officials and auditors. The tax law
has anomalies resulting in cascading effects (tax on tax) on sincere taxpayers and opportunity of

evading taxes. The level playing field does not exist. These are responsible for unhealthy
competition among the local as well as overseas investors.
Capital is highly mobile internationally and the economies of countries like Bangladesh are small
in relation to international capital markets. Any taxation on capital income could mean investors
would choose to invest in another country where taxes are lower than those of the host country.
In a world with high levels of capital mobility, Bangladesh cannot ignore the potential effects of
their tax rates on investment as compared with other countries.

The writer is a legal economist. shah@banglachemical.com