This chapter looks at tax incentive design and policy goals within SADC and compared to peer regions, based on an analysis of CIT incentives in the 16 SADC Member States. The analysis is based on comparable data from the OECD Investment Tax Incentive Database, covering CIT incentives across 53 developing and emerging countries.
Sustainable Investment Policy Perspectives in the Southern African Development Community
4. Assessing use and design of investment incentives
Abstract
Introduction
SADC governments offer a range of tax incentives in an effort to attract private investment and direct it toward certain sectors, locations, and activities. While tax incentives may promote investments that contribute to advancing the Sustainable Development Goals (SDGs), their benefits and costs are often not well understood. Tax incentives reduce revenue‑raising capacity, and can create economic distortions, increase administrative and compliance costs, and increase tax competition. Striking the right balance between a tax regime that supports domestic and foreign investment and securing the necessary revenues for public spending is a challenge for policy makers, particularly in developing countries, where corporate income tax (CIT) revenues are often an important source of public finances.
This chapter looks at tax incentive design and policy goals within SADC and compared to peer regions, based on an analysis of CIT incentives in the 16 SADC Member States. The analysis is based on comparable data from the OECD Investment Tax Incentive Database, covering CIT incentives across 53 developing and emerging economies (Box 4.1). Granular and comprehensive data are indispensable to improve our understanding of existing tax incentive policies and to enhance the analysis of their impacts, given that their effectiveness and costs are strongly design- and context-specific. Analysis of incentive design can inform assessments of whether incentives support positive economic, social and environmental spillovers, and at what costs.
Box 4.1. OECD Investment Tax Incentives Database
To better understand how tax incentives are used across countries, the OECD Investment Tax Incentives Database (ITID) systematically compiles quantitative and qualitative information on the design of CIT incentives, using a consistent data collection methodology. For each tax incentive, it includes information along three dimensions: instrument-specific design features, eligibility conditions and legal basis. This allows for cross-country comparisons on how countries design their tax incentives and what types of business and project characteristics they target. Celani, Dressler and Wermelinger (2022[1]) present the methodology, scope and key classifications underlying the OECD ITID.
As of October 2022, the database covered 53 developing economies in Eurasia, the Middle East and North Africa, Southeast Asia, Sub-Saharan African and includes five LAC economies. The regional groups and corresponding countries included in this report the following:
Association of Southeast Asian Nations (ASEAN): Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines, Thailand, Viet Nam.
Eastern Partnership (EaP): Armenia, Azerbaijan, Georgia, Moldova, Ukraine.
Economic Community of West African States (ECOWAS): Cote d’Ivoire, Gambia, Ghana, Liberia, Nigeria, Senegal, Sierra Leone.
Latin America and the Caribbean (LAC): Argentina, Brazil, Dominican Republic, Jamaica, and Paraguay.
Southern African Development Community (SADC): All 16 SADC Member States.
Source: Celani, Dressler and Wermelinger (2022[1]), https://doi.org/10.1787/62e075a9-en; OECD (2022[2]), www.oecd.org/investment/investment-policy/oecd-investment-tax-incentives-database-2022-update-brochure.pdf.
Investment tax incentives: opportunities and challenges
In a context of volatile foreign direct investment (FDI) to SADC Member States, most governments consider investment incentives (primarily fiscal but also financial, in-kind and regulatory) as a key tool to promote FDI. The benefits and costs of tax incentives are not always clear. In the best case, tax incentives help attract investors that would not otherwise enter the market, help correct market failures, and encourage positive spillovers of investment on the economy, society or the environment. In the worst cases, incentives result in windfall gains to projects that would have materialised without the incentive, encourage rent-seeking behaviour and distort markets, while costing the state significant resources in foregone revenues, which could be used to advance development aims. Assessing the benefits of incentives and whether they outweigh their direct and indirect costs is not always straightforward.
Whether tax incentives are effective at attracting investors or encouraging positive investor behaviour depends on the country context including the wider investment climate, the investor and project sensitivity to incentives over other location determinants, and the design of the incentive regime (Box 4.2). Investment tax incentives are one, and often not the determining, factor for firms’ investment decisions, and cannot compensate for a weak investment climate (Van Parys and James, 2010[3]; Klemm and Van Parys, 2012[4]). Yet, governments often use incentives in place of more difficult reforms, for example, as a way around inefficient tax administration burdens faced by businesses. In some SADC countries, estimates suggest that firms spend on average more than 280 hours to comply with taxes (double the time spent in OECD countries) (PwC, 2020[5]). This can incentivise firms to seek, and governments to grant, tax exemptions to avoid such long procedures, which in turn perpetuates parallel tax treatment that is neither effective nor efficient.
Box 4.2. Context matters for tax incentive effectiveness
In addition to incentive design (covered through this chapter), the effect of tax incentives on investment depends on the characteristics of the investor and country-specific context. Some investors appear to be more sensitive to incentives than others. Projects that privilege low-cost production sites, including some export-oriented manufacturing, and investors that are highly mobile can rank incentives high on factors for location decisions. Other investors, such as those interested in the domestic market or natural resources, appear less swayed by incentives (James, 2014[6]; Andersen, Kett and von Uexkull, 2018[7]).
But investor responsiveness varies by country. Several empirical studies found no effect of tax incentives on FDI attraction in many countries in sub-Saharan Africa (Klemm and Van Parys, 2012[4]; Van Parys and James, 2010[3]; Ghrara and El Morchid, 2022[8]; USAID, 2004[9]). In many developing countries, the quality of infrastructure and the regulatory framework are cited by investors as more important factors in determining their investment location decision than tax benefits (UNIDO, 2013[10]; IMF-OECD, 2017[11]). While lower effective tax rates are associated with higher FDI flows, this effect is significantly stronger in countries with good investment climates, and can have almost no effect in economies with weak investment climates, underlining the importance of wider reforms for FDI attraction (James, 2014[6]).
In general, evidence suggests that while tax benefits can play a role in some investment decisions, they are not necessarily the most effective or efficient policy instrument to stimulate investment (IMF-OECD-UN-World Bank, 2015[12]). Tax competition across countries means that many incentives are overly generous, with costs outweighing the marginal impact on investment (Chai and Goyal, 2008[13]). This underscores the importance of monitoring and evaluating incentive policies.
Across sub-Saharan Africa, the scope of CIT incentives has contributed to an overall narrowing of the corporate income tax base (Keen and Mansour, 2009[14]; Abbas and Klemm, 2013[15]). Statutory CIT rates in most SADC Member States are between 25% and 30%, with a few countries offering lower rates (Mauritius sets the lowest rate at 15%), and three countries (Comoros, DRC, Zambia) setting higher rates (35%). The average rate in the region is similar to that in other developing and emerging regions covered by the database. Yet, incentives can reduce these rates substantially, and many companies may be eligible for them. Analysis of effective average tax rates (EATRs) in five SADC Member States found that CIT incentives on average lowered EATRs by 30‑55% compared to the statutory CIT rate in the food and automotive industry, and by as much as 99% in SEZs in Eswatini (Box 4.5).1
Meanwhile, tax revenues are a key source of public finances, and are critical for delivering public goods and services (like infrastructure, education and health care), which also affect a country’s investment climate. Excessive tax relief for investment projects might limit revenue‑mobilising capacity and reduce public resources necessary for progressing towards the SDGs. Public resource mobilisation from taxation is a particular challenge in some SADC Member States; for example, Botswana, the Democratic Republic of Congo (DRC), Madagascar and Malawi all have tax-to-GDP ratios below 15%, which is considered a minimum target rate for growth and development (OECD/ATAF/AUC, 2022[16]; Gaspar, Jaramillo and Wingender, 2016[17]).
The estimated costs of tax incentives are often not transparent, due in part to limited reporting. Evidence from five SADC Member States suggests that estimated foregone CIT revenues (i.e. tax expenditure from CIT incentives) as a share of GDP are low (<0.5%) compared to the OECD average (0.7%). Nevertheless, the impact on overall tax revenues may be higher since CIT revenues account for a larger share of total tax revenues in SADC compared to the OECD (Figure 4.1) (OECD, 2023[18]). For example, in the Seychelles CIT revenue makes up 18% of total tax revenues, more than double the OECD average, while CIT revenue forgone relative to GDP is similar to many OECD countries, and above that of peers. In Eswatini, Madagascar, Seychelles and DRC tax incentives on goods and services (including VAT, customs duties and excise tax) cost up to double in terms of revenue forgone than CIT incentives, showing the importance of looking at the full scope of tax benefits available to investors in considering their costs and their contribution to achieving policy goals (Redonda, von Haldenwang and Aliu, 2022[19]).2
Figure 4.1. Tax expenditure can be costly even when dependency on CIT revenues high
Note: CIT revenue as share of total tax revenue for year 2020; estimated tax expenditures from CIT incentives as a percentage of GDP for year 2020 except Madagascar (2021), Eswatini (2017), and DRC (2018).
Source: OECD Global Revenue Statistics and Global Tax Expenditures Database (2023[18]) (Redonda, von Haldenwang and Aliu, 2022[19]).
Many governments are aware of the costs and unclear benefits of incentives, but face high pressure to offer generous incentive packages, internally from firms lobbying for advantages, and externally from competition with other countries with generous regimes. Analysis of the scope, goals and design of incentives is key, as improving design can help limit redundancies and encourage positive spillovers. Conditioning incentives on specific outcomes or promoting these outcomes through other eligibility criteria, while limiting the generosity of some incentives can be an important step in this regard. It is expected that the global minimum tax, agreed by 138 jurisdictions, will also help curb harmful tax competition, and encourage better incentive design (Box 4.4).
Tax incentive design in SADC: insights from the OECD ITID
Tax incentive design is a key determinant of the effectiveness and costs of incentives. It relates to how the incentive reduces taxation (the instrument and the qualifying income or expenditures it applies to, and other features (Box 4.3)), eligibility conditions (which investors and projects qualify to receive the incentive), and governance (how the incentive is awarded to investors) (Celani, Dressler and Wermelinger, 2022[1]). These policy design choices determine incentive targeting and affect incentive uptake, the extent to which incentives contribute to stated policy goals, and at what cost. The OECD ITID provides insights into how SADC Member States use and grant incentives, which policy goals they seek to achieve, and how these practices compare with other regional groups. This analysis should be considered in conjunction with other chapters of this review, including how incentives factor into investment promotion strategies and whether incentives are prevalent in sectors already receiving FDI.
Box 4.3. Common tax incentive instruments
Investment tax incentives provide favourable deviations from the standard tax treatment for a specific group of corporate taxpayers, based on sector, activity, location or other investor- or project-related characteristics. Most countries provide preferential CIT treatment through four main instruments:
Tax exemptions provide a full or partial exemption of qualifying taxable income, which may refer to all of a business’ income or income from specific sources (e.g. export income).
Reduced rates provide CIT rates below the standard (statutory) rate for qualifying taxable income.
Tax allowances and tax credits allow firms to deduct a certain share of qualifying capital or current expenditure from taxable income (tax allowances) or directly from taxes due (tax credits). Qualifying capital expenditures are generally asset specific (e.g. machinery, buildings, equipment). Qualifying current expenditure tends to be activity specific (e.g. spending on training, R&D, exporting). Tax allowances on capital expenditure can accelerate or enhance the deduction of capital costs. Tax allowances that accelerate the deduction of capital costs allow for the faster recovery of the cost of an asset, while tax allowances that enhance deductions apply in addition to standard capital deductions (available to all taxpayers) and result in deductions that effectively exceed the initial capital cost. Tax allowances on current expenditures and tax credits can result in deductions that effectively exceed original expenses (for example, a 200% tax allowance on employee training).
The first two instruments (tax exemptions and reduced rates) are income‑based incentives; they provide tax relief based on earnings. Tax allowances and credits are expenditure‑based incentives because they lower the cost of capital or certain spending.
Source: Celani, Dressler and Wermelinger (2022[1]), https://doi.org/10.1787/62e075a9-en.
Use of expenditure‑based incentives growing among SADC Member States
While income‑based incentives (i.e. CIT exemptions and reduced CIT rates) are widely used across developing economies, these incentives are not always effective in attracting new investment, and have substantial costs – including forgone tax revenue, economic distortions and increased tax competition – which could outweigh their benefits (IMF-OECD-UN-World Bank, 2015[12]; James, 2014[6]; Zee, Stotsky and Ley, 2002[20]). Income‑based incentives disproportionately benefit projects that are already profitable early in the tax relief period, making projects that could materialise without the incentive even more profitable. CIT exemptions are particularly costly, and can result in race‑to-the‑bottom tax competition with other economies over mobile foreign investment, while potentially generating windfall gains for projects that would have taken place in absence of the incentives (Klemm and Van Parys, 2012[4]; James, 2014[6]). CIT exemptions and reduced CIT rates are likely to be particularly affected by the global minimum tax (Box 4.4).
Box 4.4. Tax incentives and the global minimum tax for MNEs
The recently agreed Global Minimum Tax for large MNEs places multilaterally limits to tax competition that contribute to the erosion of domestic tax bases. Pillar Two of the two-pillar solution agreed by 138 members of the Inclusive Framework on Base Erosion and Profit Shifting requires large MNEs (with revenues above USD 750 million) to pay a 15% minimum effective tax rate in all jurisdictions in which they operate. This means that if there are affiliates of an in scope MNEs with an effective tax rates (ETR) below 15%, top-up taxes may be due. In the absence of tax reform or other policy actions, governments could potentially forgo such revenues arising from low-taxed profit in their jurisdiction that would be collected by other jurisdictions.
As more countries are moving to implement the global minimum tax, it is important for ECOWAS Member States to analyse the implications of the global minimum tax on domestic tax systems. The GloBE Rules will not affect all jurisdictions, MNEs and tax incentives in the same manner. The impact of the GloBE Rules on tax incentives will depend on their design, on the jurisdiction’s tax system (its baseline tax system and its use of base narrowing provisions), and on the characteristics of MNEs and the activities they perform in the jurisdiction.
The impact of the GloBE Rules will strongly depend on the design of tax incentives. OECD analysis shows that income-based incentives for in-scope MNEs will be strongly affected, whereas expenditure-based incentives are less likely to be affected, with some incentives such as accelerated depreciation for tangible assets affected only to a limited extent. The new rules allow a carve-out for profits associated with economic substance (the substance-based income exclusion, SBIE), which allows 5% of the value of tangible assets and payroll to be subtracted from the profits to which the top-up tax applies. This means that tax incentives that are successful in attracting tangible assets and generating employment will be less affected from the minimum tax.
Governments are strongly advised to consider the implications of the minimum tax on their tax incentives. It will be important to ensure coordination across ministries on this issue given the fast pace of action of reform in this area.
Source: OECD (2022[21]), https://doi.org/10.1787/25d30b96-en.
There is evidence suggesting potential positive effects of expenditure‑based incentives on investment under certain conditions (House and Shapiro, 2008[22]; Appelt, González Cabral and Hanappi, 2022[23]). Because expenditure‑based incentives directly target investment expenses, they reduce the cost of capital, making investments more profitable at the margin (IMF, OECD, UN, World Bank, 2015[24]). The benefit for the company depends on the size of the investment it undertakes and can also be linked to spending on specific activities and policy objectives (e.g. R&D, skills development). These incentives therefore lend themselves to improving the positive impact of investment on sustainable development (OECD, 2022[25]). Additional research is required to assess impacts in different contexts. Expenditure‑based incentives typically have higher administrative costs, and if not well designed can favour existing companies over new ventures with low profits (UN-CIAT, 2018[26]; Morisset and Pirnia, 1999[27]). All incentives require comprehensive monitoring and evaluation to assess their costs and benefits.
Income-based instruments (CIT exemptions and reduced rates) are most commonly used across the region. Each SADC Member State offers at least one type of income-based CIT incentive: 15 countries offer at least one reduced CIT rate, and six countries provide at least one tax reduction to 0% rate; Out of ten countries that offer CIT exemptions to investors, eight provide at least one full CIT exemption. Most tax exemptions and reduced rates target specific sectors, primarily manufacturing, agriculture and services. Around one‑third of income‑based benefits are for firms in special economic zones (SEZs). Nevertheless, the use of these income‑based instruments is less ubiquitous than in most other regions covered by the dataset (Figure 4.2). Many countries have undertaken reforms to limit full tax exemptions and reductions. The DRC is the only SADC country that uses only income‑based incentives. All other fifteen SADC Member States use at least one tax allowances in their incentive mix to attract investors (Figure 4.2). Seven of the 16 countries offer mostly expenditure‑based incentives (tax allowances and credits), primarily targeted to initial capital expenditure. Eleven countries offer tax allowances for current expenditure, including costs related to training, R&D, and job creation. South Africa and the Seychelles use almost only expenditure‑based tax incentives. In general, expenditure‑based incentives are more commonly used by countries with higher income levels given their greater capacity requirements in terms of administration and compliance monitoring.
Figure 4.2. SADC countries offer a mix of income‑ and expenditure‑based incentives
Note: See Box 4.1 for information on countries covered in reach regional group. The total number of incentives in each region is: 168 (SADC), 69 (ECOWAS), 78 (ASEAN), 19 (EaP), 38 (LAC).
Source: OECD ITID, April 2023, based on 53 economies and 482 CIT incentive entries.
While many countries (across regions) offer permanent low CIT rates for certain sectors, these benefits are costly in terms of revenue forgone as well as potential long-term economic distortions. Stability is important to investors, but when incentive recipients gain permanent preferential treatment vis-à-vis competitors, incentives can become a tool for rent-seeking (Abramovsky et al., 2018[28]) (Lent, 1967[29]). Permanently reduced rates should be assessed for generosity compared to the statutory rate (see Box 4.5 on ETRs). Temporary incentives, and especially full CIT exemptions, also have costs and risks, including that firms will leave the jurisdiction when the incentive expires. Some firms may also use tactics to continue receiving the incentive after their benefit has lapsed, such as by incorporating a new firm that qualifies for the CIT exemption, creating de‑facto permanent incentives (IMF-OECD-UN-World Bank, 2015[12]).
The majority of income‑based incentives granted in SADC are temporary, in line with good practice. For example, Mauritius offers an eight‑year CIT exemption for manufacturers of pharmaceuticals, medical devices and high-tech products. Half of the income‑based incentives in SADC are granted for periods of five to ten years, and around a quarter are granted permanently (Figure 4.3). Duration of these incentives is similar to ECOWAS and ASEAN, though ASEAN offers relatively more short-term incentives (under five years) and very few permanent benefits, while ECOWAS offers relatively few incentives for periods over ten years. The trend at the SADC Member State level is similar: most offer predominantly income‑based incentives for ten years or less; two‑thirds of countries also offer some permanent benefits, which are primarily reduced CIT rates for certain industries, such as manufacturers with majority of turnover from exports (Zimbabwe) or farming and food processing (Zambia); there are very few examples of permanent CIT exemptions. It is noteworthy that Namibia has been phasing out all CIT exemptions (including permanent ones) available to firms in Export Processing Zones since 2020.
Figure 4.3. Most income‑based incentives are granted for 5‑10 years
Note: See Box 4.1 for information on countries covered in reach regional group. The graph reflects durations of CIT exemptions and reduced CIT rates. The number of income-based incentives reflected in each region is: 84 (SADC), 42 (ECOWAS), 52 (ASEAN), 18 (EaP).
Source: OECD ITID, April 2023, based on 53 economies and 482 CIT incentive entries.
Six SADC Member States have at least one incentive with a sunset clause. Sunset clauses stipulate an end date to an incentive policy unless legislative action is taken to extend the benefit. Most CIT incentives in South Africa have sunset clauses, including a phase out of reduced CIT rates in SEZs, and a tax allowance for industrial projects Temporary benefits could encourage monitoring and evaluation, as the merits of an incentive can be assessed after a fixed period to determine whether the incentive should be continued, reformed or left to expire, particularly if evaluation requirements are in the law. Moreover, they can also be easier to remove, as politically it is often more difficult for governments to end incentives than to introduce new ones. Lastly, there is some evidence that expenditure-based tax incentives with a sunset clause may have a greater effect on investment attraction than permanent benefits, since investors are encouraged to act quickly to enjoy the benefit (Wen, 2020[30]; US Department of the Treasury, 2010[31]). However, governments must clearly communicate if incentives are time‑bound, as sunset clauses can introduce an element of uncertainty for investors.
Eligibility conditions suggest focus on manufacturing and other key sectors
Incentive eligibility conditions are criteria that businesses or investment projects must meet to receive a tax benefit. Incentive policies often tie tax support to investment in specific sectors or locations, or certain investor or project characteristics (e.g. majority foreign-owned, minimum investment value, new entrant). Incentives are also often conditional on certain investor activities (e.g. training, R&D) or outcomes (e.g. job creation, energy efficiency) (Celani, Dressler and Wermelinger, 2022[1]). In SADC, sector-related criteria are by far the most commonly used (in all 16 countries), followed be SEZ criteria (used by 12 countries) which is similar to practices observed in other economies (Figure 4.4, Panel A.). Over half of the incentives granted by SADC Member States require investors to meet only one eligibility condition to benefit (Figure 4.4). When multiple eligibility conditions are used, sector conditions are often combined with requirements to invest in a certain region or SEZ, or meet a certain outcome.
Figure 4.4. Most incentives target certain sectors, often as the only eligibility condition
Note: Panel B reflects 144 CIT incentives registered in the OECD ITID with at least one eligibility condition. The number of incentives that have specific eligibility criteria is 144 (SADC) and 302 (Other developing economies). Shares do not add up to 100% because incentives can have multiple eligibility criteria.
Source: OECD ITID, April 2023, based on 53 economies and 482 CIT incentive entries.
All 16 SADC Member States offer incentives conditional on sector of activity. Most of these define eligible sectors in a positive list (the focus of this section). Sector targeting can be broad (e.g. if the incentive is available to investors active in the entire manufacturing or agricultural sector) or narrow (only available to projects in a set of sub-sectors, e.g. temporary reduced CIT rate for production of pharmaceuticals and leather industry in Tanzania). Broad sector categories are agriculture, mining and quarrying, manufacturing, electricity/water/waste, and services.
More than one third of incentives in SADC support investors in manufacturing (36%), followed by agriculture (29%) and services (23%) (Figure 4.5). This means that incentives are available to investors operating in these broad sector categories or in a subset of industries. For manufacturing, two‑thirds of SADC Member States have incentives that support the entire manufacturing sector; ten countries target food and beverage manufacturing; a third of SADC countries targets a range of other industries, and including textiles, chemicals and plastics, and electrical equipment. While only 23% of all incentives target services, which is a much lower share than in ASEAN but in line with ECOWAS, these incentives are offered by over two‑thirds of SADC countries. Angola, Mozambique and Madagascar target the most diverse set of services. The service sub-sector most frequently targeted (by 9 countries) is tourism, followed by infrastructure (5 countries). Just 9% of incentives in SADC target mining and quarrying industries (including coal, oil and gas, metal ore and other mining), less than other comparator regions. In line with best practice, most of these incentives are accelerated allowances to support high initial capital costs, while there are few examples of CIT exemptions for extractive industries, which can be both ineffective at attracting additional investment and inefficient (i.e. costs are greater than benefits) (IGF-OECD, 2018[32]; James, 2014[6]). Four SADC Member States offer incentives for investments in renewable energy.
Figure 4.5. Sector-based incentives primarily support manufacturing
Note: See Box 4.1 for information on countries covered in reach regional group. The number of registered incentives in each region is: 168 (SADC), 69 (ECOWAS), 78 (ASEAN), 38 (LAC). Incentives can be specific to one or more sub-sectors within these five sector categories, or are available to any investor that falls under the broad category. Shares do not add up to 100% as incentives can target multiple sectors.
Source: OECD ITID, April 2023, based on 53 economies and 482 CIT incentive entries.
Overall, sector-based incentives in SADC are more targeted than in other regions like ECOWAS and ASEAN. Just over a third of sector-based incentives target multiple broad sector categories (e.g. agriculture and manufacturing) at once; these incentives are usually for investors in SEZs that seek to support, for example, manufacturing and some services industries. By comparison, countries in ASEAN and ECOWAS offer a greater share of incentives to investors across multiple broad sectors. This reflects a difference in the mode and extent of targeting. Other regions tend to target beneficiaries by location or minimum investment value, whereas SADC appears to have a stronger focus on supporting specific industries. Industry targeting can be a means of containing costs of incentives by focusing only on priority activities, which are expected to create the greatest economic, social and environmental benefits (Celani, Dressler and Wermelinger, 2022[1]). However, the benefits and costs of narrow versus broad sector targeting are not thoroughly assessed in the literature.
Investment location is a common condition
Investment location is the second most frequently used eligibility criterion for incentives offered in SADC, as is the case in other developing regions (Figure 4.4, Panel A). At the Member State level, all but two SADC countries (Lesotho and Seychelles, both geographically smaller countries) offer at least one incentive for investors that locate in a specific region or economic zone. Investing in an economic zone is required for at least one CIT incentive in 12 out of 16 countries, while investing in a specific (non-zone) subnational location is required in 9 SADC Member States. Location-based incentives generally give greater benefits to investments outside of capital cities, and often in less developed areas. For example, Mozambique provides an enhanced allowance for costs related to infrastructure, utilities, or other investments considered public goods outside Maputo. Angola and DRC divide their countries into different zones, with preferential benefits in more remote areas. Three‑quarters of SADC Member States use SEZs, including industrial zones, free ports, and export processing zones. According to an assessment of EATRs in a sample of SADC Member States, incentives in SEZs typically offer the most generous tax treatment (Box 4.5).
Box 4.5. Estimated EATRs in Sub-Saharan Africa suggest generous benefits in SEZs
Forward-looking corporate effective average tax rates (EATRs) are a way of measuring the extent to which tax incentives affect tax costs and influence business investment and location decisions. Using the OECD’s forward-looking corporate EATR framework, a comparison was made on how CIT incentives affect EATRs in seven Sub-Saharan African countries (Angola, Botswana, Eswatini, Kenya, Mauritius, Senegal and South Africa) in two sectors – food and automotive industries – and in Special Economic Zones (SEZs).
Across the seven Sub-Saharan African countries, tax incentives reduce EATRs by 30% on average in the sectors considered. The most generous tax treatment is typically offered within SEZs, where ETRs are reduced on average by 65% compared to the standard tax treatment. In some specific cases, including in Eswatini and Mauritius, tax incentives can reduce EATRs to nearly zero.
A range of different EATRs is applicable within each country, depending on the sectors, locations and projects targeted by the incentives. Even within sectors, different EATRs often apply due to varying investor or project characteristics (e.g. project size, profitability, the taxable income position over the lifetime of the project), specific incentive design provisions (e.g. benefit ceilings, treatment of carry-forwards, etc.) and interactions of incentives with standard capital allowances. These features can substantially affect the size of the tax benefit from incentives. Depending on their design and context, expenditure‑based incentives can deliver tax benefits that are as generous as income‑based ones.
The findings reveal several – potentially unintended – effects of tax incentive policies on the tax costs of investment and on revenue forgone across the different periods of an investment’s lifecycle. This highlights the importance of careful design, including of interactions between incentives.
Source: Celani, Dressler and Hanappi (2022[33])
Outcome conditions focus on domestic value added and export promotion
Outcome conditions require companies to achieve certain performance results to be eligible for a tax incentive. They are linked to the outcome of the investment, rather than the characteristics of the qualifying investor (Celani, Dressler and Wermelinger, 2022[1]). Nine out of 16 SADC countries offer at least one incentive with a specific outcome or performance requirement. The most common performance criteria relate to domestic value added, exports, and jobs created for country nationals. For example, Zimbabwe offers reduced CIT rates for manufacturers that export over 41% of turnover. In Comoros, reduced CIT rates are conditional on number of jobs created per year.
Outcome conditions can be designed to promote positive economic, social and environmental spillovers. For example, in Eswatini, investors in SEZs are required to pay wages that are 90% above the minimum wage to receive a tax exemption. South Africa grants a tax allowance on machinery and training costs if the project meets a combination of (mostly) quantifiable criteria related to energy efficiency, innovation, SME procurement and local linkages. Outcome conditions are, however, often vague or based on non-quantifiable criteria (e.g. contributes to job creation or beneficial to the national economy), leaving ample room for discretionary approval of incentives by awarding authorities. Outcome conditions also require monitoring to ensure that the outcome has been met, which requires public resources, administrative capacity, and often co‑ordination with other government agencies (e.g. cross-checking with social security information on number of jobs created or salary).
Some incentives are designed to support economic and other development goals
Many countries use investment incentives in an effort to advance certain economic, social, environmental and other goals. As noted, this can be through incentive eligibility conditions that require investors to meet certain performance criteria (e.g. job creation) or operate in certain sectors (e.g. renewable energy), or by designing the incentive to reduce the costs of certain activities (e.g. R&D, training), and increasing the revenues associated with others (e.g. exports).
The main goals of CIT incentives in SADC are to encourage infrastructure development, exports, and job quality and skills development (by nine out of 16 Member States, respectively) (Figure 4.6, Panel A). Other goals include promoting the green transition (in seven countries, mostly by targeting renewable energy and waste management/recycling), employment and job creation (in six countries) , while few seek to advance social inclusion (in three countries) (Figure 4.6, Panel B). Only South Africa used a tax incentive to promote linkages with the local economy, however, the incentive got recently repealed.3 Although not illustrated in the figure, some SADC member states also have incentives to support innovation or research and development (e.g. an accelerated depreciation rate of 40% for R&D expenditure in the Seychelles).
Figure 4.6. Most SADC countries target incentives to support sustainable development goals
Note: See Box 4.1 for information on countries covered in reach regional group and Annex A for indicator methodology. Panel B indicates that countries support respective SDGs with at least one CIT incentive. The total number of incentives in each region is: 168 (SADC), 69 (ECOWAS), and 245 (other developing regions).
Source: OECD ITID, April 2023, based on 53 economies and 482 CIT incentive entries.
The ITID shows that incentives are used to promote a range of SDGs including quality jobs, skills, green transition and social inclusion. While incentives have the potential to contribute to these goals, the costs of administering and monitoring compliance with stated performance criteria can be high. Furthermore, tax policy or other types of incentives (such as grants or in-kind subsidies) are not the only way to encourage the industrial development or influence investor behaviour, and tax incentives should at most be complementary to other policy tools (OECD, 2022[25]).
Three‑quarters of SADC Member States tie at least some of their incentives to SDGs (Figure 4.6, Panel B) Most of these incentives are tax allowances that seek to stimulate a behaviour by lowering its relative costs, for example encouraging job creation. Angola, Mauritius and Zambia offer enhanced tax allowances for costs of salaries or other emoluments (e.g. pensions contributions) for employment of disabled workers. Angola provides deductions for new jobs created for women. The Seychelles offers allowances for hiring national employees from technical and vocational training institutions for technology, farming, maritime and tourism. A number of countries offer incentives that support the green transition: Mauritius and the Seychelles provide accelerated depreciation for machinery and equipment to generate renewable energy and increase energy efficiency; Madagascar provides a tax allowance of 50% of investment costs for the renewable energy sector; South Africa used to provide a tax deduction of 95 cents per kilowatt hour of verified energy efficiency savings;4 Angola taxes income from sale of renewable energy at a reduced rate. Monitoring and evaluation are key to assess whether these incentives support stated goals.
Most incentives are granted by the Ministry of Finance
Governance of incentives includes how tax benefits are authorised in laws or regulations and awarded to investors. It also concerns whether incentives are transparent, and whether eligibility conditions to receive incentives are clear and specific, or based on interpretation and approval from administering authorities. Governance also involves how compliance with incentive conditions is monitored and incentive policies evaluated ex-post.
Most SADC Member States introduce tax incentives via the tax law and them through the Ministry of Finance (Figure 4.7). The Ministry of Finance is often best placed to grant incentives and monitor their costs. Other ministries or agencies may be more inclined to offer fiscal benefits as they are not in charge of tax collection or necessarily aware of the state’s fiscal needs (James, 2014[6]). There is broad international consensus that consolidating all tax incentives in tax laws enhances transparency and reduces potential redundancies and confusion over the administering authority (IMF-OECD-UN-World Bank, 2015[12]).
Figure 4.7. Most SADC countries grant tax incentives through the Ministry of Finance but some countries also use other authorities/bodies
Note: See Box 4.1 for information on countries covered in reach regional group. The number of incentives for which the details of granting authorities are available in each region is 69 (ECOWAS); 168 (SADC); 245 (Other).
Source: OECD ITID, April 2023, based on 53 economies and 482 CIT incentive entries.
Similar to other regions, most SADC Member States also grant some incentives through other government agencies, including investment promotion agencies (IPA), line ministries, and SEZ authorities (Figure 4.7). In half of SADC Member States, different agencies share responsibility for granting at least one incentive. Different agencies can bring valuable insights for incentive design, monitoring and evaluation. But without clear co‑ordination incentives may overlap or be inconsistent (IMF-OECD-UN-World Bank, 2015[12]). Administration of incentives by multiple authorities with overlapping responsibilities, can also increase opportunities for aggressive tax planning by investors.
Most CIT incentives in SADC are transparent, in that eligibility criteria to receive the benefit are clearly stated in laws and regulations and tend to be specific (e.g. lists of eligible sectors). However, as in other regions, some incentives offered in SADC are less transparent: either the incentive has broad and less clearly defined eligibility criteria (e.g. contributing to economic development and job creation), or investors may be eligible for additional tax benefits not specified in laws. Some SADC Member States require investors to receive a special certificate, investment licence or industry status, particularly in SEZs, based on an application to relevant authorities. While requirements are usually clear, this is not always the case; applications can also introduce a layer of discretion in awarding incentives.
When granting authorities have wide discretion to determine who can receive incentives and the extent of benefits, it increases the risk of rent-seeking behaviour and corruption, as well as unfair competition between firms (IMF-OECD-UN-World Bank, 2015[12]). The OECD ITID also only covers CIT incentives introduced in legal texts, many countries grant incentives on an ad hoc negotiated basis with investors (e.g. through bilateral contracts); these are by their nature non-transparent. Incentives for specific large oil and gas or mining companies can be granted on a contract basis. Further analysis is required to assess governance across the full life cycle of the incentive, including monitoring and evaluation.
Assessing the impact of incentives: next steps
For governments, better understanding whether incentives contribute to policy goals, and at what costs, requires monitoring and evaluation (M&E), although this requires data and resources that are often not available. Short of more in-depth cost-benefit analysis (including through use of forward-looking ETRs, discussed in Box 4.5), governments can do more to track incentive goals and use. An important first step to create accountability and transparency is identifying and describing all available incentives, their policy goal, and legal reference in publicly available documents. This is particularly important if different agencies are involved in granting incentives. Governments can regularly assess if stated goals of tax incentives (directing investment in particular sectors or activities), align with investment promotion strategies and national development goals.
As a next step, information on incentive uptake and characteristics of beneficiary firms can provide important insights into how incentives are used, and if incentives appear to be supporting projects most in need. Many SADC Member States, as in other regions, require that firms apply to receive benefits. Though this can introduce a risk of discretionary awarding of incentives, if based on clear and specific eligibility criteria, incentive applications could form the basis of initial monitoring. More in-depth monitoring of firm compliance with the terms of the incentive (for example, jobs created, value of exports), can assist in determining if the incentive is contributing to development goals.
To compare how these benefits measure against costs, tax expenditure reports are key to estimate revenue forgone. Based on research by the Global Tax Expenditure Database, seven out of 16 SADC Member States (Madagascar, Mauritius, South Africa, Tanzania, the Democratic Republic of Congo, Lesotho, and the Seychelles) have reported estimates on revenue forgone from tax incentives to the public at least once between 2000 and 2019 (Redonda, von Haldenwang and Aliu, 2022[19]; 2021[34]). Often this information is aggregated as total tax expenditures, without clear descriptions on how estimations are calculated. There are however examples of countries that regularly publish more detailed information, notably Mauritius (which began reporting in 2007) and South Africa (which began in 2011). Tanzania has released a single report covering 12 years of estimates. These are important developments key to both public transparency on costs of incentive programmes and as a first step towards cost-benefit analysis. However, these countries do not publicly report on costs of specific incentives (provision-level data), which is key to assessing performance of different types of incentives (Redonda, Von Haldenwang and Aliu, 2021[34]).
Many governments face challenges to tax expenditure reporting, including resource constraints and lack of co‑ordination across agencies involved in granting tax incentives. Some incentives are by their nature more difficult to monitor. Beneficiaries of full CIT exemptions may be exempt from filing tax returns, complicating estimates of costs in revenue forgone (Klemm, 2009[35]). The SADC Tax Subcommittee, in partnership with donors, developed a Tax Expenditure Model in 2015, updated in 2022, to support tax administrations to estimate and analyse tax revenue forgone. It is not clear, however, whether this model is used.
Tax expenditure reporting and monitoring can help identify incentives that are no longer efficient. A few SADC countries provide good examples of such reform. South Africa is phasing out certain tax allowances for industrial projects, including the most generous allowances to projects in SEZs (repealed in March 2020). As of August 2021, Mauritius repealed most of its temporary tax exemptions for new manufacturing businesses (Celani, Dressler and Hanappi, 2022[33]). Namibia repealed full CIT exemptions under its Export Processing Zones at the end of 2020, with transitions for existing companies to a new SEZ regime. Namibia’s Finance Minister cited the decision as linked to a review that high costs to the government exceeded sought after benefits in terms of investment and job creation. The reform also complies with EU requirements for removal from the list of non-co‑operative jurisdictions for tax purposes (a “blacklist” of tax havens); the EU removed Namibia in February 2021 (Reuters, 2020[36]; Deloitte, 2021[37]).
Deepening co‑operation at the regional level on tax incentives use could continue to help reduce tax competition, promote evaluation of policies, and provide guidelines for good governance and transparency. SADC Member States have committed to co‑operate on tax incentive policies, including on a common framework to improve the effectiveness of incentives at achieving their policy goals and the impact of tax incentives on revenue costs (as outlined in Annex 3 of the Protocol on Finance and Investment, and in the Memorandum of Understanding on Co‑operation in Taxation and Related Matters) (SADC, 2023[38]). There have been notable areas of this co‑operation, including, in addition to the Tax Expenditure Model, the creation of an online tax database on all incentives offered – though this has since been removed – and guidelines on co‑ordination of VAT and excise regimes. Assessing how Member States are using these tools is an area for further research, as well as how additional frameworks could be developed to guide governments to monitor and evaluate effectiveness of incentive policies. Building on reforms conducted in certain member states could be a starting point for peer-learning.
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Annex 4.A. Additional details on classifications
The ITID considers policy area being targeted by evaluating whether a specific design or eligibility condition of the tax incentive relates to one of six policy goals (Table 1). The policy areas identified in the ITID build on those identified in the OECD FDI Qualities Indicators (OECD, 2022[45]) and the FDI Qualities policy toolkit (OECD, 2022[46]).
Table 1. Targeting sustainable development through eligibility conditions and design dimensions of investment tax incentives
Column 1 lists policy areas identified in the ITID. The table identifies how economies target these respective clusters, either through eligibility conditions or the design features of tax incentives (columns 2-5).
Notes: Eligibility conditions and design features listed in the table are used by at least one economy included in the database. The list may evolve in the future when economy coverage extends.
1 Includes only tax incentives benefiting electricity generation from renewable energy sources, but not electricity generation from non-renewable sources. Tax incentive may be part of a broader special regime that benefits other sector of the economy.
2 Refers to expenses incurred for the purpose of seeking opportunities and promoting the export of goods or services produced in the economy (e.g. publicity and advertisements abroad, export market research, participation in trade fairs amongst others).
Other policy goals commonly targeted with tax incentives relate to infrastructure and innovation. Infrastructure can relate to a broad set of areas, including transport, utilities (e.g. electricity or gas distribution, water and sewage disposal structures), construction or ICT. CIT incentives promoting innovation commonly target R&D-related costs (e.g. wages of R&D employees, current costs of R&D projects, assets) or income (e.g. income from R&D or registered patents).
Notes
← 1. Forward-looking corporate effective tax rates (ETRs) are a way of measuring the extent to which tax incentives affect tax costs and influence business investment and location decisions. Forward-looking ETRs are a useful indicator to compare the impact of tax incentives on effective taxation. The composite Effective Average Tax Rate (EATR) is constructed as a weighted average across finance- and asset-specific EATRs. It is a synthetic tax policy indicator reflecting the average tax contribution a firm makes on an investment project earning above-zero economic profits over its lifetime. The EATR is a useful indicator to compare the generosity of distinct types of preferential tax treatment relative to the standard tax treatment and to assess tax relief from investing in one as opposed to another sector, region or country or to assess the relief provided through specific incentive designs everything else being equal.
← 2. Data from the Global Tax Expenditures Database (GTED) and OECD revenue statistics. In Eswatini, Madagascar, Seychelles and DRC taxes incentives on goods and services (including VAT, customs duties and excise tax) cost up to double in terms of revenue forgone than CIT incentives (Redonda, von Haldenwang and Aliu, 2022[19]). This shows the importance of looking at the full scope of tax benefits available to investors in considering both the costs of incentives and their policy goals, and would merit further research and analysis. The GTED data covers 18 jurisdictions in Africa, 12 jurisdictions in Asia-Pacific, 33 jurisdictions in Europe and North America and 14 jurisdictions in the LAC region. OECD Revenue Statistics cover 29 jurisdictions in Africa, 23 in Asia-Pacific, 32 in Europe and North America and 26 jurisdictions in LAC.
← 3. This tax allowance in South Africa was introduced in the Income Tax Act, Section 12I, and got repealed in March 2020.
← 4. This tax allowance in South Africa was introduced in the Income Tax Act, Section 12I, and got repealed in March 2020.