The Right Incentive
20 September 2016
Posted by: Author: Mohammed Jada
Author: Mohammed Jada (KPMG South Africa)
Incentive schemes are an often used tool used by governments to encourage growth. A recent survey took a closer look at how African countries are using this tool.
Global trend towards regionalism
In the current global economic downturn, protectionism on both a local and regional level is expected to gain momentum. In particular, food and domestic manufacturing production capabilities are expected to take on much more political significance in many countries across the world. An example is the recent year-long prolonged negotiations on the continuation of the African Growth and Opportunity Act (AGOA) treaty between South Africa and the USA, with South Africa being compelled to compromise on allowing US poultry and beef imports into South Africa in order to continue to benefit from the valuable AGOA trade agreement.
Free Trade Agreements (FTAs) can mitigate the impact of protectionist measures, reducing or removing tariff duties and opening access to a market or markets. There is a plethora of FTAs that have been concluded within Asia, the EU and most recently the Trans Pacific Partnership (TPP) involving the USA and 21 countries across the Pacific Rim in what President Obama has described as a prototype for a 21st Century trade agreement and a potential vehicle to establish a free market in the Asia Pacific region.
Africa’s answer to the above is possibly the Tripartite Free Trade Area (TFTA), which covers 26 (out of 54) African countries and is aimed at creating the biggest free-trade area on the African continent. Once implemented, hopefully in this writer’s lifetime, it will result in consolidating the three significant trade blocks: the East African Community (EAC), the Southern African Development Community (SADC) and the Common Market for Eastern and Southern Africa (COMESA).
Negotiating a FTA, especially the TFTA takes effort, vision and strong commitment across governments to see this process through. Often this happens over a period of a few decades.
While this is good in the long term for Africa, countries often have to consider adopting, implementing and monitoring an incentive regime for the short to medium term. Whether a country should offer incentives or not to investors (both local and foreign), is often a debate hotly argued within government circles, and of course in affected business circles.
Any investment carries with it expectations
An example of an incentive regime is the long ranging – and importantly continued – support that the South African government has afforded to the local motor manufacturing and related automotive supply chain through the current Automotive Production and Development Programme ("APDP” which is scheduled to end in 2020). This regime is particularly relevant at a time where the local economy faces a potential downgrading of foreign direct investment (FDI) and the risk of substantial potential industry wide job losses. BMW recently announced in an article in Engineering News (25/3/2016) that it would invest R6-billion at BMW SA’s Rosslyn plant to produce the next-generation X3 sports-activity vehicle for the local and export markets, and that it will take a 10 year view as part of assessing whether it will continue its investment.
We only need to look to the Australian example where the Australian government has put the brakes on supporting its motor industry sector (of course global factors also played its role, mind you). This has led to the Ford and Holden closing shop from as early as October this year and Toyota at the end of 2017. Estimates recon that between 10 000 and 40 000 jobs would be at risk.
Closer to home is the unexpected repeal of the Manufacturing Competitiveness Enhancement Programme (MCEP) last November, which caught many applicants by surprise as they were counting on their applications, which usually take 6-12 months to submit and to be adjudicated, to derive a cash grant for their manufacturing investment plans. It appears that an oversubscription of applications led to the early repeal of this incentive, which in a way reflects the demand that is prevalent in our South African economy for state assistance.
The real question is, given our current economic climate, whether the funds allocated for trade and industry support by government can be sustained?
So, what is happening in Africa on the incentives?
KPMG recently conducted a survey looking at incentives in of a number of African countries. The countries surveyd jointly represents 81 per cent of Africa’s USD 2.4 trillion GDP and they are home to three-quarters of Africa’s 1.2 billion population. It was noted that the overwhelming majority of countries surveyed in Africa offer tax incentives to stimulate the manufacturing, agricultural, and industrial base in their respective countries. Some more advanced African economies also offer incentives intended to help localise financial services industries.
A case in point is Kenya and Cameroon which provide tax breaks for companies that list on their stock exchanges. A trend was identified that more African countries are attempting to diversify their economies and shift away from an over-reliance on extractive industries. Instead they are seeking to branch into mainstream industries such as manufacturing and value-added services industries. To encourage this, African countries seem to be introducing new or revised incentives in order to compete more favourably for both local and foreign direct investment. The success of South Africa in having a diversified economy appears to be rubbing off on its northern neighbours. For example:
- Nigeria is currently striving to attract foreign direct investment to grow other sectors of the economy (such as the motor manufacturing industry) given the decline of revenue from the oil sector. This is evident in the various tax incentives and government grants that have been introduced, which include tax holidays, cash grants etc; and
- Rwanda has gazetted new legislation that contains a package of investment incentives to foreign as well as local investors.
Some of the highlights of the survey are noted below:
- All countries surveyed offer a range of enhanced tax incentives including accelerated allowances for capital expenditure, special allowances for investments in certain industry sectors (such as manufacturing, infrastructure, tourism) as well as tax holidays ranging from three to 10 years;
- Only seven countries have local participation or local job creation requirements for accessing the respective incentives;
- Eight countries offer investors additional tax incentives for companies that invest in training of their own staff;
- Nigeria and South Africa offer a diverse range of both tax incentives and cash grants from government agencies for investing in defined sectors (such as manufacturing, oil & gas, tourism, financial services and the ‘green’ environmental economy).
- Morocco also offers a cash contribution to expenditure for large scale projects greater than MAD 100 million; and
- South Africa offers a dedicated R&D tax incentive regime offering additional 50 per cent super tax deduction for investment into research and development.
The introduction of Special Economic Zones and Free Port Zones (SEZ) now appear as a common theme among various African countries:
- 21 of the 28 countries surveyed offer SEZ areas as additional incentives for companies to invest in specific regions within a country;
- South Africa has also passed into law during February 2016 legislation that will see an initial 15 areas designated as SEZs, and countries such as Swaziland and Zimbabwe working on similar SEZs to be introduced in the near future;
- Such SEZs offer a reduced Corporate Income Tax (CIT) rate of between 0 to 15 per cent (which compares favourably to the average 29 per cent CIT rate across the countries surveyed), as well as other benefits, for example, exemptions from Value Added Tax and Customs and Import/Export Duties together with accelerated capital allowances.
There is no simple answer to the question of what the optimal level of support that any government could seek to offer is. Finding the right balance is often not only affected by where a country finds itself in any given economic cycle and the state of maturity of respective industries at a specific point in time, but also by socio and political factors that a country may be experiencing, such as unemployment, rate of growth, and political and fiscal stability.
Providing an incentive regime is necessary and whether a country gets its optimal "bang for its buck” is a constantly changing dialogue. What is clear is that this is no space for short term decision making as the impact and consequences of changes in direction of incentive policy can be damaging.
This article first appeared on the September/October 2016 edition on Tax Talk.