Foreign Financed Projects in Developing Countries and VAT Exemptions G

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Foreign Financed Projects in Developing
Countries and VAT Exemptions Gérard Chambas
CERDI Université dAuvergne Franceemail
G.Chambas_at_u-clermont1.fr
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• I Introduction
• II Overview of tax exemptions on Foreign Financed
  Projects (FFPs)
• III Consequences of VAT exemptions on FFPs
• IV Orientations to prevent the harmful effects of
  tax exemptions on FFPs

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I Introduction

• For many LDCs, foreign aid represents a major
  source of revenue
• Aid 2 to 5 percent of GDP in Burkina Faso,
  Benin, Togo
• Aid 70 percent of the government revenue in
  Mozambique

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FFPs are an important component of foreign aid
Tax exemptions on FFPs lead to substantial tax
expenditures For WAEMU, tax exemption amount
5.4 of tax revenue For Mali and Niger 9.9
and 9.7 of tax revenue (Source c. de Mariz
Roseira, 2004)
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II Overview of tax exemptions on FFPs

• 1 Some facts
• 2 The donors rationale
• 3 Tax exemptions a high cost
• 4 Tax exemptions weak justifications

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1 Tax exemptions on FFPs. Some facts

• Current practice tax exemptions on FFPs
• Various opportunities for frauds
• by overreporting the prices
• by diverting goods and services from their
  initial purpose,
• To prevent fraud, control tax exemptions on FFPs
• Tax exemptions certificate (no ceiling)
• Direct cash payments from the government budget
• Voucher systems

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2 Tax exemptions on FFPs the donors rationale

• Tax exemptions help to reduce projects costs
• Project aid is seen as more efficient than
  budgetary supports (poor governance, corruption)
• Project aid ensures more visibility

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3 Tax exemptions result in a high cost

• Tax revenue losses and tax distortions.
•  Projects implementation problems.
• Significant administrative burden for tax and
  customs administrations.
• Lack of transparency

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Tax revenue losses and tax distortions

• In all cases, tax revenue losses (tax
  expenditures)
• First hypothesis, without fraud tax exemptions
  are adverse to tax neutrality
• Tax exemptions are easier to get for imported
  goods than for locally produced goods
• Distortion between exempted and non exempted
  activities
• Tariffs exemptions can lead to a negative
  effective protection

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Tax revenue losses and tax distortions

• Second hypothesis, with fraud
• Fraud is stimulated by weaknesses in the
  administrative control
• Consequences
• Tax revenue losses
• Economic distortions

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Projects implementation problems

• Tax exemptions procedures are complex high
  administrative costs for FFPs
• Some tax or customs administrations refuse the
  vouchers and ask for a net payment
• Unavailability of public resources for direct
  payments

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Significant burden for tax and customs
administrations

• Tax exemptions are not applied to every FFP or
  donor (conventions ad hoc). Hence, monitoring
  tax exemptions is complex
• Heavy administrative burden for tax and customs
  administrations (one specialized unit in Benin)

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Lack of transparency

• Management of vouchers is often weak
• The system of FFP tax exemption leads to numerous
  and heavy costs costs evaluations are not
  available

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4 Tax exemptions weak justifications

• Case 1 donors finance both projects and
  budgetary support
• Paying for taxes on FFP is equivalent to a
  budgetary support

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4 Tax exemptions weak justifications

• Case 2 donors finance exclusively projects
• Aid is fungible
• Efficiency argument projects are not efficient
  in a country with poor governance
• No evidence that a project is more efficient than
  a budgetary support

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III Consequences of VAT exemptions on FFPs

• 1 VAT, focal point of tax transition
• 2 Inefficiency of voucher schemes for monitoring
  VAT exemptions on FFPs
• 3 An harmful hole in the VAT system

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1 VAT, focal point of tax transition

• Constraints upon a tax transition through direct
  taxes
• A dramatic decrease of tariffs revenues

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Table 1 International trade taxation in
developing countries Unit  of public revenue 
T sample size. Source Chambas (2005).
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1 A tax transition through VAT

• The relative share of domestic taxes in the
  government revenue is increasing

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Table 3 Indirect domestic taxes (VAT and excise
taxes) in developing countries Unit  of public
revenue 
T sample size. Source Chambas (2005).  
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1 VAT, focal instrument of tax transition

• Substantial progress towards increasing VAT
  revenues are possible
• Economic neutrality of VAT

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2 Inefficiency of voucher systems for monitoring
VAT exemptions on FFPs

• For traditional taxes as sales taxes a voucher
  scheme is not so complex.
• Issued vouchers amount sale tax amount
• For VAT on imports
• Issued vouchers amount VAT amount

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2 Inefficiency of voucher systems for monitoring
VAT exemptions on FFPs

• For VAT on local products and services, the
  system is getting complex
• Issued vouchers amount VAT due on output minus
  VAT charged on inputs
• Difficulties with VAT refunds

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Difficulties with VAT refunds consequences

• Projects contractors ask for extensive VAT
  exemptions
• Hence, VAT exemptions undermine the whole VAT
  system

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3 VAT exemptions magnify the harmful effect of
the other tax exemptions

• Bias against locally produced goods
• Often, FFPs definitively beat the VAT burden
• VAT exemptions break the chain of deductions and
  undermine the basic logic of VAT
• Hence, VAT exemptions on FFPs are a major
  constraint on the tax transition

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Which choice for tax exemptions on FFPs?

• Eliminate all FFPs tax exemptions and especially
  VAT exemptions on FFPs

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By eliminating tax exemptions on FFPs

• Reduction the costs of transaction
• Tax revenue reinforcement
• Strengthen the VAT consistency
• Reduction of the negative impact of new projects
  on the budget deficit

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New facts and decisions

• Multilateral donors World Bank April 2004
• Bilateral donors France
• Debt reduction contracts (C2D), France is already
  financing taxes on FFPS
• A recent report (Chambas et al. 2005) at the
  request of the French Ministry of Foreign Affairs
  recommends the elimination of most tax
  exemptions, including tax exemptions on foreign
  financed projects .

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