African countries too often use tax incentives to attract investment to sectors like manufacturing when in fact other factors bear more weight

Philip Smith, journalist

Calls are growing to unify tax policy and legislation in West Africa in a bid to avoid a ‘race to the bottom’ in tax incentives for foreign investors.

The rallying cry comes as nations in the region and throughout the African continent seek to increase tax revenue to meet their domestic resource mobilisation targets in the aftermath of the Covid-19 pandemic.

Speaking at a recent council meeting of the West African Tax Administration Forum, former Sierra Leone National Revenue Authority deputy commissioner Alfred Akibo-Betts FCCA said: ‘A West African regional approach and even a continental approach through the African Union can be pursued to harmonise policy and legislation regarding granting tax incentives to foreign investors.

‘At the moment, each country has its own tax incentives structure and policy, which leads to a “race to the bottom” as countries compete with each other in reducing tax rates in the belief that this will shift the investment from another country to theirs.’

Akibo-Betts also warned that countries should be aware that once a global consensus is reached on new international tax rules through the OECD’s Inclusive Framework on Base Erosion and Profit Shifting (BEPS), under Pillar 2 a minimum corporate income tax rate will limit countries’ ability to reduce their tax rates as part of any incentive for foreign companies.

Public revenue drop

The calls come as the OECD releases its latest tax revenue statistics for Africa, which show that the ongoing Covid-19 crisis is expected to significantly reduce public revenues across the region.

The OECD said: ‘With countries facing high levels of uncertainty due to the ongoing pandemic, African governments will need to carefully sequence their efforts to secure fiscal space for a strong and inclusive recovery and, once the health and economic crises are under control, mobilise additional domestic revenues to meet longer-term objectives.’

Tax incentives are bad in theory because they distort investment decisions, and they are bad in practice because they are often ineffective, inefficient and prone to abuse and corruption

While not ruling out the use of incentives to encourage inward investment, Akibo-Betts urged governments in the region to carry out cost/benefit analyses, which would weigh up the loss of tax revenue against potential benefits to the local economy and decide whether such a move would be good for the country in the long term.

Co-ordinated approach

Akibo-Betts also argued for governments to have a clear policy and a more co-ordinated approach, rather than looking at incentives on a case-by-case basis. ‘This would reduce discretionary powers,’ he said.

In addition, a legislative approach would promote tax certainty for the tax administration on the one hand and fiscal certainty for investors on the other as they would be fully aware of what they would be required to pay.

Such an approach would discourage future governments from scrapping what they see as ‘bad’ tax deals.

Local benefits

Delegates at the meeting recognised the importance of creating incentives for local investors. They noted that, for most countries in the region, tax incentives are structured to attract foreign direct investments, as high investment thresholds are set to access incentives, which local investors do not usually meet.

At the same time, they noted that some tax administrations do not monitor the administration of tax incentives as they do not expect any revenues. There was a fear that non-monitoring led to abuse as companies could use tax incentives for non-qualifying activities. Countries were urged to put mechanisms in place to monitor the use of tax incentives to reduce abuse.

Akibo-Betts told the session: ‘Generally, tax incentives are bad in theory because they distort investment decisions, and they are bad in practice because they are often ineffective, inefficient and prone to abuse and corruption.

‘However, many West African countries that are resource-rich offer tax incentives to stimulate investment in mining, and to boost other sectors like manufacturing and agriculture, with the hope of attracting foreign direct investment. But research has shown that other factors – such as consistent and stable macroeconomic and fiscal policy, political stability, the rule of law, a skilled labour force and flexible labour laws, and an effective dispute resolution process – are the key considerations that influence investment decisions.’

Lack of measurement

The session included representatives from Ghana, Nigeria and Burkina Faso, as well as Akibo-Betts from Sierra Leone. It was noted that there was a lack of measurement of lost tax revenue, and therefore accountability. As a result, countries were urged to publish yearly tax expenditure statistics that included tax incentives. At the moment, Nigeria is preparing to publish such information.

At a regional level, delegates discussed how regional economic commissions – such as the Economic Community of West African States (ECOWAS) and the African Union Commission – should work with member states in harmonising tax incentive policies on the continent.

As Akibo-Betts says: ‘As we seek to increase tax revenue to meet our domestic resource mobilisation targets post-Covid-19, the West African region through ECOWAS must seek to agree on a tax incentives policy that discourages trading tax revenue for additional investment, as this “race to the bottom” makes all countries worse off.’