The relationship between tax incentives and human rights obligations in the drive to attract foreign direct investment: Are developing countries in Africa getting it right?

• Jurisdiction: South Africa
• Citation: 2018 Acta Juridica 149
• Published date: 19 December 2019
• Pages: 149-182
• Date: 19 December 2019

149

The relationship between tax incentives

and human rights obligations in the

drive to attract foreign direct investment:

Are developing countries

in Africa getting it right?

AFTON TITUS* AND TRACY GUTUZA†

Tax incentives are a key feature of the tax policy decisions made in

developing countries, notwithstanding the literature expressing doubt

as to whether tax incentives are eective in fullling their purpose

of attracting foreign direct investment (FDI). A concern often raised

is that the cost to developing countries of oering tax incentives

may be more than the benets that such tax incentives provide. This

essay contributes to this literature by questioning whether developing

countries factor in their obligations under the international agreements

they have signed when introducing tax incentives. This essay considers

several African countries that have signed human rights instruments –

such as the International Covenant on Economic, Social and Cultural

Rights – and whether the design of the tax incentives these countries

oer shows evidence of an awareness of the obligations undertaken

under the identied instruments.

I INTRODUCTION

It has become common place for developing countries to oer tax

incentives as a means to attract foreign direct investment (FDI).1 FDI

is dened by the Organization for Economic Co-Operation and

Development (OECD) as a ‘category of investment that reects the

objective of establishing a lasting interest by a resident enterprise in

* BCom (Financial Accounting and Law) LLB MCom in Taxation (UCT) PhD

Candidate at the Amsterdam Centre for Tax Law, University of Amsterdam; Senior

Lecturer in Commercial Law, University of Cape Town.

† LLB (UCT) LLM (UNISA) LLM (UCL) PhD (UCT); Associate Professor in

Commercial Law, University of Cape Town.

1 See, eg, Argentina, Brazil, Egypt, India, Indonesia and Mexico, as mentioned

in E Quick, TA Kruise & A Pickering Rules to Give By: A Global Philanthropy Legal

Environment Index (2014).

2018 Acta Juridica 149

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150 FOREIGN DIRECT INVESTMENT AND THE LAW

one economy (direct investment) in an enterprise (direct investment

enterprise) that is a resident in an economy other than that of the

direct investor’. This investment is a long-term relationship with a

signicant degree of inuence in the management of the enterprise.

FDI must be distinguished from portfolio investment, where the

investment is a shorter term investment with the value of the

investment being the shares held, as opposed to the production of

goods and services by the enterprise.2 Tax incentives can take the

form of reduced corporate income tax rates, tax holidays, investment

allowances, and special economic zones (SEZs).3

One of the policy reasons underlying the introduction of tax

incentives is the belief that such incentives will attract FDI, which

in turn will inuence job creation, stimulate certain industries and

projects, and the like. However, there is some debate about whether

tax incentives per se are actually eective in attracting FDI.4 It is

clear, however, that the cost of these incentives often outweighs

their intended benets.5 While the direct costs are taxes foregone

(which could potentially be valued in terms of an expenditure

budget), the indirect costs must also be considered. For example, the

indirect costs of tax holidays include revenue leakages, because once

they are exempt, corporations take advantage of the lax revenue

authority oversight during the tax holiday to manipulate nancial

records so as to reduce declared income once the tax holiday

ends.6 A further indirect cost is the increased administrative burden

2 OECD benchmark of denition of foreign direct investment in Glossary of

Foreign Direct Investment Terms and Denitions 4 ed (2008). It must be further noted

that several jurisdictions use reduced tax rates and tax holidays to attract foreign

investment, but this investment is not necessarily foreign direct investment but

rather passive or portfolio investments.

3 OECD (n2); SMA Abbas & A Klemm ‘A partial race to the bottom: Corporate

tax developments in emerging and developing economies’ (2013) 20 International

Tax Public Finance 596 at 600.

4 Abbas & Klemm (n 3) 600; MB Obwona ‘Deter minants of FDI and their

impact on economic growth in Uganda’ (2001) 13 African Development R 46 at 59;

RL Wellhausen ‘Innovation in tow: R&D FDI and investment incentives’ (2013)

15 Business and Politics 467; FR Root & AA Ahmed ‘The inuence of policy

instruments on manufacturing direct foreign investment in developing countries’

(1978) 9 J of International Business Studies 81; A Klemm & S van Parys Empirical

Evidence on the Eects of Tax Incentives (2009) 136.

5 LT Wells Jr & NJ Allen ‘Tax holidays to attract foreign direct investment’

in Using Tax Incentives to Compete for Foreign Investment: Are They Worth the Costs?

Foreign Investment Advisory Ser vice Occasional Paper 15 (2001) 24.

6 Wells & Allen (n5) 25.

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ARE DEVELOPING COUNTRIES IN AFRICA GETTING IT RIGHT? 151

placed on revenue authorities both during and after the tax holiday

period.7 The biggest cost, however, comes in the form of revenues

foregone as a result of tax incentives. The Tax Justice Network has

provided recent estimates suggesting that Kenya, Tanzania, Rwanda

and Uganda are losing between US$ 1.5 billion and US$ 2 billion a

year in revenues foregone as a result of tax incentives.8

These direct and indirect costs result in a reduction in the

tax revenue collected by government, which may impact on

the government’s ability to provide public goods and services

to its citizens. This reduction in tax revenue may further aect a

government’s ability to deliver on its human rights obligations,

particularly those human rights obligations that require funding by

the government. If the tax incentive does not yield the envisaged

benets, the resultant reduction in tax revenue may result in budget

cuts as governments are forced to make up the shortfall in revenues

elsewhere.9 Not only is there the potential that services to the

most vulnerable parts of society may face these cuts in government

spending, but governments may be forced to raise taxes on ordinary

citizens through higher value-added tax (VAT) rates and excise

duties on goods such as fuels, and on services.10 Tax incentives

therefore cannot be seen in pure nancial terms, and the human

rights implications put a human face to tax incentives.

Many countries have signed international instruments that oblige

them to protect human rights and to implement steps to ensure the

enjoyment of these rights.11 The adoption of the Guiding Principles

7 J Mor isset & N Pirnia ‘How tax policy and incentives aect foreign direct

investment: A review’ in Using Tax Incentives to Compete for Foreign Investment: Are

They Worth the Costs? Foreign Investment Advisory Service Occasional Paper 15

(2001) 94.

8 Action Aid & Tax Justice Network Africa Still Racing to the Bottom? Corporate

Tax Incentives in East Africa (2016) 4.

9 S van Parys & S James ‘The eectiveness of tax incentives in attracting

investment: Panel data evidence from the CFA Franc Zone’ (2010) 17 International

Tax and Public Finance 400; A Klemm & S van Parys ‘Empirical evidence on the

eects of tax incentives’ (2012) 19 International Tax and Public Finance 393; Abbas &

Klemm (n3).

10 Action Aid Give Us a Break: How Big Companies are Getting Tax-Free Deals

(2013) 10.

11 These treaties and instruments have been adopted by the United Nations since

1945 and include the International Bill of Human Rights, which consists of the

Universal Declaration of Human Rights (1948), the International Covenant on Civil

and Political Rights (1966) and the International Covenant on Economic, Social and

Cultural Rights (1966). The other core international human r ights instruments are the

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