Africa-Press – Uganda. In their January 2021 report titled ‘What is the fiscal cost of tax incentives in Uganda?’ the International Growth Centre referred to tax expenditure as deviations from tax rules that are motivated by social or economic policy, which reduce or defer the tax liability of a taxable entity to encourage a particular activity.
These can include reduction in tax rate, an exclusion based on different criteria such as investment location and size; an exemption from the tax code; a preferential tax rate; an allowance for capital expenditure; or the deferment of a tax obligation.
Over the years, there have been several arguments on tax expenditure, especially exemptions which are more commonly known to the public.
Tax exemptions are deviations from established tax code intended to ease investment cash flows and make it attractive for investors to build capacity for future taxability. They are usually advanced to support investments in specified areas of national interest which contribute to economic growth. For instance, there are exemptions provided under the Income Tax Act to support exploration in the extractive industry.
Sometimes, tax exemptions are provided with respect to a specific project being funded by donors or bilateral agreement between countries. Even then the exemption must be supported by the existing tax law as well as the agreements.
The exemption may also take the form of an exclusion from the tax code based on some different criteria like the location of the investment or its size.
The exemption regime in the indirect taxes like VAT and import duties usually gives clarity to the type and quality of goods and services that would qualify for exemption and preferential rates.
In the VAT Act under the second schedule, you will find about a dozen goods and services exempted from VAT. For example, the supply of dental, medical and veterinary goods will carry no VAT component. While the third schedule confers a preferential VAT rate of 0 per cent for a few goods and services under this category. For instance supply of educational materials.
The East African Community Customs Management Act lists the exemptions in the 5th schedule. The categories of goods falling under this area do not attract import duty.
Customs rate relief has also provided for a number of goods. The list of goods in both categories is ideally by reference to their harmonised commodity description and coding system also known as the Harmonised System Classification Code. Exemptions are also provided under the Excise Duty Act and the Stamp Duty Act.
Tax exemptions create economic hallways for growth and if properly planned and managed, they safely and conveniently place the benefitting entities into future taxability. However, tax exemptions can also have spill over costs that result from the economic distortions both at entity and industry levels.
The report indicates that at entity level, the firm choices regarding factors of production are distorted depending on which factor the exemption or tax incentive has targeted. It is argued that this distortion could easily lead to misallocation of capital and rent-seeking.
For tax expenditure and specifically tax exemptions to achieve the intended purpose, one of the significantly important areas to manage is clarity in the tax laws and procedures.
The other is the availability of critical and appropriate data on all parties involved. This is a prerequisite for proper planning and monitoring of the various targets set to justify the exemption.
All in all, tax expenditure must always be reviewed in light of the global efforts to strengthen domestic revenue mobilisation and also provide an enabling environment for sustainable national development while protecting our sovereignty.
Patrick Mukiibi is a tax & management consultant
