Shs160b lost annually in tax breaks, says URA

Uganda is faced with a difficult task of meeting ambitious revenue targets while juggling the complex allure of tax incentives it uses to attract investments to drive its economic growth and employment of its young population.

In order to attract significant foreign direct investment, the country introduced 10-year tax exemptions for businesses located in industrial parks.

However, economists are concerned that these incentives may have the opposite effect of what the country intended, as they “uplift firms more than the country itself.” Uganda’s economic narrative has been marked by persistent budgetary deficits, affecting essential public services, public servant salaries, and the stability of the national currency.

The urgency to break free from this cycle has forced the country to turn its attention towards its taxman, with high revenue targets. The broader objective is to reduce the nation’s dependence on debt, a phenomenon that has increasingly strained the country’s economic resilience.

For instance, in the 2022/2023 financial year (FY), the government’s fiscal operations resulted in a deficit of Shs10.1t or 5.5 percent of gross domestic product (GDP). While this surpassed initial projections, it is a marked improvement from 7.4 percent recorded in FY2021/2022, underscoring the government’s steadfast commitment to fiscal consolidation.

“This deficit was strategically financed through a mix of domestic and external borrowing. As a result, the public debt stock rose from $20.99b (Shs79.2t) in June 2022 to $23.66b (Shs89.3t) by June 2023,” national treasury data shows.

The main concern is that some of Uganda’s largest companies are allegedly abusing tax breaks, particularly tax holidays and accelerated depreciation tax incentives for firms operating more than 50km from Kampala. Some of these entities are suspected of leveraging tax havens where they are domiciled and also exploiting available tax incentives to manipulate their operations positively.

The Uganda Revenue Authority (URA) and the UN University conducted a study on this subject in 2021 and unearthed that multinational corporation (MNC) affiliates, particularly those tied to countries with which Uganda has a Double Taxation Agreement (DTA), enjoy an effective tax rate approximately five times lower than their large domestic counterparts.

This disparity raises pertinent questions about the equitable contribution of different entities to the national tax pool, and a potential harm it poses to local firms. Uganda currently has nine treaties in force, partnering with Denmark, India, Italy, Mauritius, the Netherlands, Norway, South Africa, the United Kingdom, and Zambia, according to data from Cristal Advocates.

“We also did a research on profit shifting two years ago and it showed that it’s more prevalent when the multinational is from a tax haven,” said Nicholas Musoke, a supervisor of research and revenue modelling at URA.

According to URA research, companies that are registered as tax havens frequently invest heavily in many countries with positive economic indicators, which makes it easier for them to repatriate their profits. For example, a $25m (Shs94.3b) deal involving a private equity firm domiciled in Mauritius, saw Africa Capitalworks SSA 3 acquire 51.18 percent of Cipla Quality Chemical Industries Limited, as disclosed by the company on November 14.

Over the past decade, the Ugandan government and URA have demonstrated a commitment to addressing tax avoidance. This even prompted revisions in existing tax policies, such as the renewal of transfer pricing regulations in 2011 and thin capitalisation rules in 2018.

However, despite these efforts, the aforementioned study identifies persistent challenges stemming from DTAs and the efficacy of some tax holidays to the economy. The government continues to struggle with low tax revenues, resulting in fiscal deficits that reached Shs2.3t in October 2023. This as it grapples to squeeze taxes from only two million registered taxpayers out of its 45 million population, according to data from the October performance of the economy report.

The taxman says that despite these financial difficulties, the country has continued to give tax holidays to large multinational corporations, a practice that costs the country over Shs160b annually, though tax revenues are still only at 13 percent of GDP rather than the 20 percent target.

The government’s intention behind these incentives is to attract new investments, promote particular industries, and generate employment opportunities. Empirical data, such as findings from a research paper titled The Rise of Ineffective Incentives in Developing Countries, shows that while the use of tax holidays by governments in developing countries has become a global phenomenon, their impact on development remains uncertain. The potential negative ramifications on public finances and welfare investments such as education and health has been illuminated.

“The effect on foreign direct investments is small and does not contribute to actual economic growth. The effect on public finances is negative and thereby undercuts the ability of the government to steer its own road towards development,” Ms Saila Naomi Stausholm, an economics researcher, noted in the aforementioned research.

URA also published a study in November 2023 that examined the function of tax incentives, particularly tax holidays and accelerated depreciation tax incentives, and their effect on firms in its database as well as the economy. This study includes 104 businesses that operate in industrial parks, 11 businesses that process agricultural products, and 15 businesses that specialise in exporting.

“Even though the multinationals are the least firms with 1.9 percent of the sampled firms, they accounted for over 30 percent of the incentives in place. These firms always front the issue of employment, but, according to our research, all the sampled firms invest more and employ more except with agro-processing companies,” said Mr Musoke, adding, “The state needs to target these incentives to those that need them most. For instance, agro-processing firms which are small need them to add value to their produce which they can heavily export.”

In addition, he mentioned that oil companies should begin filing their returns electronically in order to be included in this kind of data. He also disclosed that ongoing oversight is required to determine whether the requirements they included in their proposals to receive these incentives are actually met.

“Firms in agro-processing were shown to export less, which is a problem because you expect agriculture to be labour intensive. Seventy percent of Uganda’s working population or more than eight million people are employed under that sector,” said Mr Corti Paul Lakuma, the head of the macroeconomics department at the Economics Policy Research Centre.

Missing the bullseye
Uganda prioritises lower tax rates and accelerated depreciation for investments situated more than 50 kilometres from Kampala as its incentive tax mechanisms. It, however, offers fewer varied tax holidays than its regional counterparts in Sub-Saharan Africa, according to a study that mapped the corporate tax incentives Uganda offered from 2014 to 2021.

Accelerated depreciation is an accounting method that businesses can opt to use in order to deduct a larger portion of an asset’s cost (it can be equipment like machinery) in the early years of its useful life from its tax returns.

“Our analysis reveals a substantial increase in new investments in plant and machinery following the reintroduction of the accelerated depreciation benefit for investments,” the URA-backed research paper noted.

Contrary to concerns that this effect might be merely a timing adjustment, the persistence of elevated investment levels were realised even in the fourth year after the reintroduction of the accelerated depreciation tax incentive.

“The absence of a definitive list of firms that qualify as potential beneficiaries based on their distance raises operational concerns for both the URA and the firms themselves regarding the manipulability of the 50km threshold,” the research noted.