ASEAN countries should stop offering aggressive tax incentives in order to attract foreign funds, as it could create an unfair business climate among enterprises and lead to an acute state budget deficit.
Despite a sound economy and immense growth potential, many countries in the ASEAN still collect low amounts of revenue, which the experts believe is the result of large tax incentives to companies, especially for foreign investors.
According to a recent report by think tank Vietnam Institute for Economic and Policy Research (VEPR) and international non-government organisation Oxfam, tax losses due to corporate tax incentives were estimated to be 6 per cent of GDP in Cambodia and 1 per cent of GDP in the Philippines.
The situation could be much worse for countries whose tax revenue makes up nearly 80 per cent of the total budgetary revenue like Vietnam, Indonesia, and Thailand.
These lost revenues could have been crucial now in covering large parts of the extra budget spending on responses to COVID-19, illustrated in the cases of the Philippines and Vietnam whose lost revenues are estimated to be equivalent to a third of their financial efforts in response to the outbreak.
“ASEAN countries are competing with each other by reducing their corporate income tax (CIT) rates and offering aggressive tax incentives to both domestic and foreign investors. International institutions like the Organization for Economic Co-operation and Development (OECD) and the UN Conference on Trade and Development have repeatedly warned the ASEAN to stop offering redundant tax incentives due to their costs on budget revenue, tax base erosion, and creating room for tax avoidance and evasion,” said Babeth Ngoc Han Lefeur, country director for Vietnam at Oxfam.
Lefeur also mentioned that aggressive tax competition also makes the region a fertile ground for profit shifting. Countries like Thailand, Indonesia, and Malaysia are estimated to lose 6-9 percentage points of potential corporate tax revenues due to profit shifting. The race to the bottom is a lose-lose game.
Aggressive not always best
Across the bloc, the average CIT rate has fallen over the last 10 years, from 25.1 per cent in 2010 to 21.7 per cent in 2020. Specifically, there is no country increasing the CIT rates during this period.
Experts state that while countries can attract some foreign investors when providing more incentives than others, some can have more fiscal gains through multinationals’ profit shifting. However, all ASEAN countries lose in this competition.
“There is no significant evidence that tax incentives increase foreign direct investment (FDI) but quite the opposite. Most current corporate tax incentives in the ASEAN do not aim at attracting long-term investments,” added Lefeur of Oxfam. “Rather, they try to compensate for weak governance and poor infrastructure and feed the short-term desire of shareholders to cut corporate tax payments to the bare minimum. Furthermore, tax incentives created an unfair investment environment against local small- and medium-sized enterprises who rightfully deserve at least equal benefits.”
Aggressive tax exemption, tax reduction, and incentives could erode tax bases and implement harmful practices. Thus, governments cannot find sufficient resources for investing in essential sectors.
On the other hand, the OECD argues that tax holidays and government programmes that offer a tax reduction or elimination to businesses, and other profit-based incentives should be reduced and eliminated.
Currently, tax holidays in the ASEAN often last for five-20 years, with Brunei and Indonesia offering the longest periods of tax holiday of up to 20 years.
“The race to lower tax incentives in order to attract FDI is over. There’s a recognition that countries should compete against each other through better infrastructure, education, healthcare system, stable legal framework – but not with aggressive tax incentives, especially those like tax holidays that provide a zero CIT rate for 10 or 20 years,” said Johan Langerock, tax policy expert at Oxfam Novib.
While tax exemptions and holidays are limited to certain groups of investors, tax preferences are more widely applied to various business activities. Businesses can enjoy CIT reductions of 50-100 per cent.
In Vietnam, tax deductions are applicable to additional expenses relating to employing female workers in companies in the manufacturing, construction, or transport sectors and to ethnic minority workers in all types of business.
The shifting sands
But the overuse of tax incentives could consequently bring about a race to the bottom as neighbouring countries try to outdo each other in generosity in their efforts to attract investors from industrialised countries.
“The process of shifting production from China to the ASEAN region may worsen this competition between countries, as they seek to attract overseas funds inflow to further their own interests in boosting economic development, without seeing the wider regional picture,” said Pham Van Long, researcher at VEPR.
According to Setyo Budiantoro from Indonesia’s Ministry of National Development Planning, there was a long history of tax competition between the Philippines, Vietnam, Thailand, and Indonesia, with the countries vying with one another for manufacturing investments and using tax incentives as a tool to attract FDI.
For example, in 1996, competing to lure investment from the US firm General Motors, the Philippines offered a CIT exemption of eight years and Thailand offered a similar exemption, but with an additional amount equivalent to $15 million.
In 2001, Vietnam offered a CIT exemption of 10 years in order to lure Canon’s investment from Japan, but was out-competed by the Philippines, which offered an exemption of 8-12 years.
In 2014, in an attempt to entice investment from Samsung of South Korea, Indonesia offered a CIT exemption for 10 years, while Vietnam offered one for 15 years.
“It is high time for ASEAN members to co-operate and agree upon the common minimum standards for corporate tax incentives in the region. This is an important part to prevent public revenue loss and unnecessary competition among countries, which is also to achieve the common goal of building a more sustainable and resilient region,” noted Nguyen Anh Thu, president of VEPR.
Ah Maftuchan, co-coordinator of Tax and Fiscal Justice Asia added, “ASEAN member states need to collaborate and discard ‘beggar-thy-neighbour’ tax policies, including race-to-the-bottom tax incentives that translate into lost revenues which have left poorer countries and people struggling to make ends meet.”
Fresh data from the State Audit Office of Vietnam reveals that around 50 per cent of foreign-invested enterprises (FIEs) in Vietnam reported losses. In Ho Chi Minh City alone, some 60 per cent of 3,500 FIEs said they have experienced losses for years, noted Deputy State Auditor General Doan Xuan Tien.
While most local companies in the apparel and footwear sectors have capped profitability, FIEs in the same industries reported huge amounts of losses despite enjoying several tax incentives from the Vietnamese government.
Tien cautioned that FIEs might use the trick of selling services and products to their associated businesses at low prices, but buying materials and machines at high prices.
A recent report from the International Monetary Fund showed that governments lose at least $500 billion annually as a result of corporate tax shifting, including in Vietnam.
Source: Vietnam Investment Review