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‘ P repared for Caribbean Connect: Barbados, 28-30 June 2006’. ESSENTIAL ELEMENTS OF FISCAL AND INCENTIVES POLICY HARMONISATION. Overview. Lessons from Existing Policy Harmonization Initiatives in CARICOM –
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‘ Prepared for Caribbean Connect: Barbados, 28-30 June 2006’ ESSENTIAL ELEMENTS OF FISCAL AND INCENTIVES POLICY HARMONISATION
Overview • Lessons from Existing Policy Harmonization Initiatives in CARICOM – • Agreement for the Harmonization of Fiscal Incentives to Industry/Manufacturing • Intra-CARICOM Double Taxation Agreement • Harmonization of Corporate Tax Structures. • Overview of Provisions of Revised Treaty re: Fiscal Policy Harmonization. • Summary of Main Features of Fiscal Structures in CARICOM. • Elements of a Policy Harmonisation Framework and Agenda.
Existing Harmonization InitiativesHarmonized Scheme of Fiscal Incentives • 1973 Agreement on the Harmonization of Fiscal Incentives to Industry/Manufacturing concluded in 1973 and ratified by almost all Member States. • Basic thrust – encouragement of higher levels of investment and employment generation in the manufacturing/industry sector. • Aimed at reducing competition among States in the granting of incentives to attract investment flows. • Recognized the right of smaller States to apply more generous incentives.
1973 Agreement was generally acknowledged as encouraging Investment flows in some States. But, there were several Un-intended Effects Resulted in distinctly pro-manufacturing bias. Encouraged fast-payoff footloose investments. Served as a barrier to new entrants thereby reinforcing oligopolistic behaviour. Lacked transparency given multiplicity of qualifying criteria. Formula used to calculate domestic/regional value-added biased against foreign ownership, foreign workers and imports. Formula was considered complicated and difficult to calculate. Incentives not provided for small and medium-sized enterprises .
Existing Harmonization Initiatives~Intra-CARICOM Double Taxation Agreement~ • Agreement for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and for the Encouragement of International Trade and Investment was concluded among CARICOM States in November 1994. • Recognised by Article 72 of Revised Treaty • Ratified by 11 Member States. • Applicable to incomes earned by both individuals and businesses. • Intended to encourage intra-regional investment flows and discourage tax evasion. • Provides for source-based taxation thereby removing disincentive to cross-border activities arising from high effective tax rates. • Harmonizes tax treatment of interest and royalties (15%) and dividend payments (0%).
Existing Harmonization Initiatives~Harmonization of Corporate Tax Structures~ • Resulted from 1992 decision of Heads of Government to accelerate implementation of CSME. • Differences in tax structures across States result in distortions which alter returns on investment and impact on investment decision-making. • Article 40 of Original Treaty required that “Member States agree to study the possibility of approximating income tax systems and rates with respect to companies and individuals”. • Incremental Approach to exercise: • standardization of procedures to determine tax base; • determination of ranges for tax rate; • adoption of legal instrument. • Technical work completed on harmonized definitions for elements of the corporate tax structure. Draft Legal instrument under consideration by Tax Administrators.
Lessons from Existing Harmonization Initiatives • Need for appropriate built-in mechanisms for enforcement and automatic periodic review and revision of agreements and instruments. 1973 Agreement reviewed twice but no revision undertaken. • States require flexibility to apply appropriate incentives in accord with national development priorities and the needs of preferred investors. Packaging of incentives considered to be Best Practice. Standard, one size fits all, schemes no longer considered effective in targeting investors. • Regional instruments should address the removal of disincentives while ensuring an equitable distribution of the benefits of integration.
Treaty Provisions Governing Fiscal Policy Harmonization • Article 40 of the Original Treaty - “Member States agree to study the possibility of approximating income tax systems and rates with respect to companies andindividuals”. • Article 44(1)(e) of the Revised Treaty provides for the adoption by the relevant decision-making Community Councils of appropriate measures for the – “convergence of macro-economic performance and policies through the coordination or harmonization of monetary and fiscal policies, including, in particular, policies relating to interest rates, exchange rates, tax structures and national budgetary deficits”. • Article 69 requires that CARICOM States harmonize national investment incentives being used to promote economic activity in the agricultural, industrial and services sectors.
Treaty Provisions Contd. • Article 90 addresses the internal tax regime which should be applied to goods of Community origin, viz goods of Community Origin to be given the same tax treatment as domestic goods. • Article 52(6)(b) of the Revised Treaty of Chaguaramas provides for “the avoidance of double taxation” within the context of CARICOM States undertaking to “establish and maintain appropriate macroeconomic policies supportive of efficient production within the Community”. • Article 72 required CARICOM States to conclude – “among themselves an agreement for the avoidance of double taxation in order to facilitate the free movement of capital in the Community”.
Summary Features of Fiscal Structures in CARICOM • Tax structures designed to protect the domestic market, encourage domestic production and generate sufficient revenue to meet growing public expenditures. • Tax revenues in most CARICOM States composed primarily of income and trade taxes, and indirect taxes on goods and services to a lesser extent. • Tax structures in CARICOM are broadly similar having been modeled on the British taxation system. • Similarity exists with respect to conceptual definitions of terms like, tax base and taxable goods. • Differences exist with respect to levels of tax burden, tax threshold, proportion of direct taxes to indirect taxes and, more importantly, the components of the tax structure and the rates attached to individual taxes.
Elements of a Tax Harmonization Framework~Approach~ • Rationale – Creation of a level tax-playing field to facilitate the movement of goods and factors of production by eliminating the likelihood of tax arbitrage resulting from the differences in the taxation structure. • Approach - Proposed that CARICOM States should approach tax harmonization as a concerted effort towards the adoption of coordinated fiscal policies and the achievement of similar tax structures and/or rates within the Community. • Allows for the exercise of national interest as a grouping of sovereign states; • Process of achieving a harmonized tax system does not imply complete replacement of national regimes but the preservation and calibration of the best practice features of the existing structures within the Community while avoiding the distortionary effects which can jeopardize the efficient and equitable functioning of the Single Market and Economy.
Elements of a Tax Harmonization Framework~Objectives~ • Objective - to achieve a taxation system which would improve the community’s collective welfare while taking into account the individual needs of CARICOM States. • The harmonized taxation system should result in – • an improved incentive structure for economic activity through the reduction / removal of distortions in the tax system and the eventual elimination of tax competition; • increased revenue mobilization from a more efficient tax system.
Elements of a Tax Harmonization Framework~Strategy and Priorities~ • Strategy - the tax harmonization strategy should – • allow for the exercise of fiscal sovereignty; • should not result in the erosion of a State’s competitive position vis-à-vis other Members or third countries; • not result in any significant loss of revenue or facilitate new forms of tax evasion or avoidance. • Transition and administrative costs should be minimized. • Sequencing of adjustments by Member States should be phased according to agreed timetable. • Dialogue to determine priorities should commence. • Proposed Priorities – • Reform of the indirect taxation system; • Reform of the investment incentives regime; • Expediting completion of the exercise to harmonise corporate tax structures.
Elements of a Tax Harmonization Framework~An Improved Incentive Structure~ • Direct Taxation – • Process started with adoption of the Double Taxation Agreement; • Complete process for adoption of corporate tax code. • Identification of a common corporate tax rate. • Proposal for common corporate tax rate – • Adopt the ‘best practice’ range of 20-30%. 4 States are within this range, some are considerably outside and others apply multiple rates. • Rate range should apply to business profits whether generated by domestic, CARICOM-owned or foreign-owned firms. • Focus of harmonization should be on obtaining concurrence for a phased reduction of the corporation tax rate to the 20-30% range as well as rationalization of the multiple rate and surcharge regimes where applicable.
Elements of a Tax Harmonization Framework~An Improved Incentive Structure~ • Direct Taxation Contd. • Other Elements to be considered for harmonization are – • Extension of the tax treatment of intra-regional earned investment income (interests, dividends, royalties) to all firms operating within the Community. • Rationalization of personal income tax structure and agreement on an appropriate benchmark to determine standard deductions, for example GDP per capita in the ratio of 2:1.. • Adoption of a common taxation method and rate range for property tax.
Elements of a Tax Harmonization Framework~An Improved Incentive Structure~ • Indirect Taxation – • Reform of indirect tax system • Preliminary proposal for the adoption of VAT (with limited exemptions). • Consider harmonization of elements of VAT regime, such as the base, exemptions regime, and perhaps the rate. • Adopt a comprehensive, harmonised system of excise taxes. • Note: 4 States have adopted VAT, 3 have undertaken preparatory work and set definite implementation dates.
Elements of a Tax Harmonization Framework~An Improved Incentive Structure~ • Investment Incentives – • Two-prong proposal proposed – • Adopt a harmonized reduced corporate tax rate (not to exceed 30%) and a limited set of targeted incentives for example, across-the-board industry-wide incentives – for the three major economic sectors in the Community – services including tourism, agriculture, and manufacturing/industry; • The harmonized regime would be based on maximum benefits and time periods that can be offered by any State, leaving the determination of the specific incentives package at the discretion of each State once it remains in compliance with the Regional Agreement; • There should be a built-in mechanism for periodic review and revision of the harmonized regime.
Elements of a Tax Harmonization Framework~Improved Revenue Mobilization and Efficiency~ • Modernization of taxation system towards generating greater efficiency and operational transparency as well as improved voluntary compliance. • Harmonization of tax administration systems through adoption of standardized systems and procedures for tax administration and management thereby leading to sharing of scarce specialized resources, joint training programmes, etc. • Adoption of a tax information exchange and sharing agreement.
