Vanuatu Business Review » BROADENING THE TAX BASE BY TAXING DONOR FUNDS

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BROADENING THE TAX BASE BY TAXING DONOR FUNDS

– SHOULD FOREIGN-AID PROJECTS BE ZERO RATED?

While the Revenue Task Force have been looking for new revenue streams for the Government, perhaps a closer inspection of tax exemptions, and zero-rated inflows would have been a more appropriate task given the current pandemic and SOE.

as it is called is generally zero rated for VAT by our Tax Office, presumably at the request or insistence of the Donor Country or Organisation. This thinking dates back to the formation of the UN and its various connected bodies, (e.g. the IMF) in the 1940s where international treaties were formed to exempt these organisations and their employees from many forms of taxation. Although the concept of tax exemption for aid has now become entrenched with most ODA funding, some of the more Developed Countries providing ODA are now highlighting the associated problems relating to tax exempt or zero rated assistance, and are opting for now allowing their ODA funding to be taxed.
One of the historical rationale for circumventing the recipient Countries tax systems in Least Developed Countries, (LDC’s) was that these tax systems were seen as being fragile, with poor tax policies, high rates, lacking transparency and weak administration. This realisation resulted in many developing Countries investing in reforms of tax policy and addressing administrative weaknesses, (e.g. the Introduction of the Tax Administration Act in Vanuatu.) and therefore eliminating the main justification for exempting aid inflows. What some donors are now realizing is that their aid policies of tax exemption funding are in direct conflict with Domestic Resource Mobilisation, (DRM), (i.e. the process through which Countries raise and spend their own funds to provide for their people.) Questions are now being asked as to why Donors should not contribute to the Governance of the aid recipient Country through its tax system, and encourage balanced budgets, as opposed to direct handouts for Budget deficits. Some of the negative effects of tax exemptions and zero rating for aid are as follows, and they present arguments that are worthy of consideration.

  1. Tax exemptions, and zero rating for ODA leads to a loss in tax revenue, erodes the tax base, and deteriorates Domestic Resource Mobilisation. Taxing project aid broadens the tax base, improves the recipient Countries tax revenue to GDP ratio and helps formalise the economy.
  2. Increase in administration costs. Processes for obtaining zero rated documentation, or understanding procedures for granting exemptions often involve different departments, and are generally time consuming.
  3. Exempting aid fuels a culture of exemptions. Non taxation of project aid encourages the development of a governance culture of exemptions, incentivises claims for exemptions and reduces effectiveness in tax auditing.
  4. Distortions in favour of imports at the expense of locally supplied goods and services. Exempting products that are imported for aid projects means it’s less attractive to buy locally.
  5. Increased risk of fraud and corruption by offering a path to circumvent the rules. Tax Officials must ensure that exempt goods are used for the projects intended and not sold in the domestic market in competition with businesses that have to comply with the tax code.
    In Vanuatu’s case, where we have a natural disaster and there is an increase in the flow of aid, losses in VAT revenue would be replaced by increased ODA levied income, providing a more consistent revenue stream for the Country.
    The argument is well summarised in an article written earlier this year by Andre Dumoulin after a recent International seminar on the matter. He states, “Beyond the loss of tax revenue, the exemption of project aid has particularly detrimental effects on the formalization of the economies of the assisted countries and the efficiency of their tax and customs administrations. Furthermore, this systematic exemption reduces the credibility of donor countries’ policies and the coherence of their aid policy, which may, in particular, directly support a developing country’s budget while requiring tax exemption for its aid to projects.”
    Ian G. Kerr.
    Investor in Vanuatu.



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