Faced with a shortage of capital, Uganda has made a significant effort to attract foreign direct investment. Uganda has cast out generous tax incentives as bait to draw in the big fish of investment capital. From the incentives in Uganda’s first investment law in 1991 to the current investor incentives in the various tax laws, the attempts have continued.
Parliament’s recent report on Vinci Coffee revealed that the government had outdone itself in offering incentives and had, in many instances, even broken the law. This discovery has revived the debates on how and why tax incentives are given and the controversy over ministerial discretion in granting tax exemptions.
Background
Vinci Coffee signed an agreement with the government for the establishment of a coffee processing plant in Uganda to add value to Uganda coffee.
Under the agreement, the government undertook to ensure that Vinci Coffee would operate on a tax-neutral basis and therefore Vinci Coffee would be entitled to all tax exemptions available under the laws of Uganda. These extensive exemptions included:
- import duties on any form of machinery, motor vehicles or any other material for use in the project;
- value-added tax on the domestic purchase of goods and services;
- excise duty on all locally produced goods and financial instruments;
- corporate income tax of any form except for expatriates;
- withholding tax on imported services;
- stamp duty for all its transactions;
- National Social Security Fund contributions;
- local service tax;
- all employee related impositions, such as Pay as You Earn, work permits fees/charges;
- corporate income tax for 10 years; and
- any other tax or imposition levied.
The agreement further provided that where no tax exemption was allowed under the law or the exemption provided was inadequate, the government would bear the cost of all such taxes. The agreement did not detail what would amount to an inadequate tax exemption.
Vinci Coffee was also to be shielded from any change in the tax law impacting on the commitments given in the agreement. In the event of any changes in the tax laws impacting Vinci Coffee, the government was obliged to take immediate steps to restore the company to the economic position it should have been in but for the change in tax law. This is called a stabilisation clause.
The law
Under the various tax laws, a foreign investor such in agro-processing such as Vinci Coffee would qualify for incentives if it had an investment capital of at least USD10-million; would use at least 70% of locally sourced raw materials subject to availability; and 70% of employees would be Uganda citizens earning an aggregate wage of at least 70% of the total wage bill. The tax incentives would include:
- A 10-year income tax exemption.
- VAT exemption on the supply of services to conduct a feasibility study and design; the supply of locally produced materials for the construction of a factory or a warehouse and the supply of locally produced raw materials and inputs or machinery or equipment.
- Excise duty exemption on locally produced construction material (cement).
- No stamp duty in respect of transaction documents for the financing of the company or acquisition of land (debenture, further charge, lease of land, increase of share capital, and transfer of land).
The findings of parliament
Parliament ruled that shielding Vinci Coffee from the application of various tax laws fettered the discretion of parliament to impose taxes as well as overriding law on taxes. Parliament found that the acts of the government to vary the tax imposed by parliament was unconstitutional, illegal and irregular.
Parliament also found that under the Income Tax Act, tax could only be waived for an entity earning income and that therefore Vinci Coffee, who had begun operations to earn income could not be granted a waiver. Further, according to parliament, Vinci Coffee did not qualify for the tax exemption since it had not proven that it met the investment threshold of USD10-million.
Parliament also took issue with the exemption of Vinci Coffee from value-added tax, asserting that the law did not provide for exemptions. It also contended that the government’s assumption of Vinci Coffee’s tax liability on a multi-year basis could only be done with the approval of parliament, which had not been obtained.
Parliament also found that the minister could not waive the requirements relating to the National Social Security Fund and Local Service Tax.
Parliament concluded that the minister had usurped the power granted to parliament under the Constitution and exercised powers not granted to him under the tax laws to enter into an agreement substituting the statutory scheme for levying, collection and the payment of taxes due to the government.
Parliament also condemned the stabilisation clause as violating the constitutional powers to impose taxes.
History does indeed repeat itself. The Auditor General’s report for 2016 showed that government had promised several tax incentives to Bidco Oil Refineries in April, 2003 for the development of the oil palm industry. An investigation by parliament’s Budget Committee revealed that the government had committed to pay taxes for other companies as well such as CIPLA Quality Chemicals, Uganda Electricity Generation Company, Southern Range Nyanza Textiles, Aya Investments and Steel and Tube Industries. The committee also found that in many instances the government had not paid the committed taxes. Parliament recommended the introduction of statutory tax incentives and abandoning the use of discretionary incentives by the minister.
Challenges with the agreement
It is not clear that Vinci Coffee will be required to meet the conditions stated in those tax statutes such as those relating to employing a minimum percentage of citizens in order to qualify for the exemptions.
Aside from the qualification requirements, the agreement gives exemptions that are much wider than those given by the tax laws. For example, whereas the Stamp Duty Act exempts qualifying investors from paying duty on specific instruments, the agreement exempts Vinci Coffee from paying stamp duty on all its transactions. Similarly, the VAT Act exempts specific supplies to qualifying investors while the agreement exempts VAT on all domestic purchases.
It is also wrong for the government to claim to exempt Vinci Coffee from PAYE. This is a tax on employees and not the employing company. The exemption is therefore either being given to the employees of Vinci Coffee or the company is being permitted to collect PAYE from their employees but retain the amounts collected instead of remitting them to URA.
Parliament was putting the cart before the horse in wanting Vinci Coffee to qualify for incentives and start earning from the project before receiving the promise of the tax exemptions. An incentive is exactly that - it comes before the action sought to be induced in this case, investment in Uganda. Incentives are not a reward to come after the promised action by the investor.
It is therefore fine for the government to provide Vinci Coffee exemptions, based on the project. Of course, the exemptions would then never apply unless Vinci Coffee had at least started its project.
We also disagree with parliament’s finding that the stabilisation clause violates the Constitution. The Vinci Coffee stabilization clause did not fetter the discretion of Parliament to impose taxes nor did it seek to alter the statutory tax regime. The clause only sought to preserve over the life of the project, the tax advantages that had been given by the Minister. While Parliament was free to levy taxes as it pleased, Government was bound to ensure that Vinci Coffee remained with the privileges promised to it.
Rethinking tax incentives
It is questionable whether tax incentives are good bait to foreign investors or indeed ultimately good for the country. As one report puts it, ‘the societal costs of tax exemptions are high and the benefits, in terms of additional investments are low’. The larger investments that typically benefit from tax exemptions are the least in need of such preferential treatment and would likely have invested even without them. Use of tax incentives to attract foreign direct investment yields a net transfer from taxpayers in a poor country to investors from a richer one because many countries provide their firms investing abroad with foreign tax credits. Therefore, a lower tax rate in a developing country may be directly offset by a higher rate in a firm’s country of origin.
Tax exemptions are likely to attract investors in footloose industries which can skip from one jurisdiction to another once they have exhausted the incentives. The use of tax incentives, especially discretionary non-transparent ones such as this one, encourages rent-seeking and corrupt practices. It is often perceived by ordinary citizens as unfair and can result in tax resistance and lower tax morale.
It is a better investment for the government to focus on enhancing the business climate in Uganda and harnessing the East African Community’s advantages. This also includes addressing basic infrastructure (roads, electricity, water), strengthening the rule of law (that contracts will be enforced and property rights respected) and reducing the costs of public administration that swell the tax burden.
Click here for more on the Vinci Coffee case.