Why corporate tax cuts fail to make companies happy

Infograph: TBS

In a perfect world, Bangladesh, a country known for its rapid economic growth, should be an attractive destination for foreign investors. The reality is not so rosy as the country suffers from a starkly low Foreign Direct Investment (FDI) inflow. This already limited FDI may see even more cuts in the future as investors express their disappointment with the burdensome tax regime and volatile policy of the country.

Despite the government's efforts to ease the burden by gradually reducing corporate tax rates by 7.5% over three years, potential beneficiaries of these measures express dissatisfaction claiming that the benefits remain elusive.

Businesses say the effective tax rate shoots up to nearly 50% due to various disallowances and tax deductions at source.

Consider this scenario: A company records a revenue of Tk100, with a true profit of Tk15. According to the reduced corporate tax rate of 27.5%, the tax should be Tk4.12 (on the Tk15 profit). However, if a hefty 7% is taken as TDS (Tax Deducted at Source) on supply of goods. With no system in place to adjust the deducted TDS, the effective tax rate skyrockets to almost 50%.

Currently, tax deduction at source is up to 7% for goods supply and 10% in case of service. Some of this is again deducted as minimum tax. With this, whether the company has income or not, that tax cannot be adjusted as a final settlement. As a result, if a company has no income or less than the amount of tax deducted, its effective tax is increasing.

Investors also think that the limits on expenses for things like promotion, royalties, and technical services, per the existing tax laws, are impractical .

For instance, they said, companies now can only spend up to 0.5% of their yearly earnings on promotional activities. Any additional spending is taxed as income, pushing up their taxes.

Also, companies are burdened by the obligation to provide Proof of Submission of Return (PSR) for 43 services, essentially performing the tasks of the tax department themselves. Any errors made in this process put them at risk of facing double penalties.

Investors further said increased import taxes, based on inflated assessments of raw material values, further burden companies.

Consequently, compliant companies find themselves facing greater challenges, they added.

Ahsan H Mansur, executive director of Policy Research Institute (PRI) told TBS that those who want to do business with compliance are in trouble as a result of high effective tax in Bangladesh.

"This is one of the reasons behind not only foreign investment, but also domestic investment not increasing," he added.

He also pointed out harassment by tax officials as a reason for lower investment and higher corporate spending.

He cited a personal experience: "I had to give a Tk5,000 bribe just to get my own tax certificate. And for our organisation (PRI), the tax officer asked for Tk5 lakh bribe. When we refused, they sent us a tax demand of Tk4.5 crore, even though we're not involved in tax evasion."

A senior officer of the NBR told TBS that the current tax policy is aimed at businesses avoiding tax by increasing various expenses and showing lower profits or losses.

The official, however, acknowledged that some businesses are suffering losses due to this policy. "However, it is important to consider the broader impact, rather than catering to individual cases."

The effective tax rate is the real amount of tax a company pays after factoring in all tax benefits and incentives. It's not the same as the statutory tax rate, which is the nominal rate companies are obligated to pay.

What experts say

During pre-budget meetings with the National Board of Revenue (NBR), business leaders said despite the reduction of the corporate tax rate, the effective tax rate has risen to nearly 50%, as opposed to going down which was attributed to several disallowances and tax deductions at source.

"One of the primary reasons for the low foreign direct investment in Bangladesh is the significantly high effective tax rate, which can reach up to 45% mainly due to multiple disallowances and excessive tax deductions at source," Zaved Akhtar, president of the Foreign Investors Chamber of Commerce and Industry (FICCI) told TBS.

Naser Ezaz Bijoy, chief executive officer of Standard Chartered Bank in Bangladesh, told the Business Standard that the nominal tax rate is decreasing (corporate tax) but the effective tax is increasing due to different types of disallowances on expenditures and TDS.

"As a result, investors are not able to take advantage of the tax reduction," he added.

Nasiruddin Ahmed, former chairman of NBR, told TBS that higher effective tax does not lead to more revenue in the long term. Instead, it encourages tax evasion.

"Bangladesh's effective tax rate is too high and it should be lowered," he added.

FDI backtracks

Nestle Bangladesh in a discussion meeting in the capital on Thursday said it was withdrawing from a plan of FDI in Bangladesh due to the increase in the effective tax rate.

Debabrata Roy Chowdhury, company secretary and head of legal and taxation of Nestle Bangladesh, said they decide whether to invest or not, based on the effective tax rate.

"Currently, the corporate tax rate is 27.5%. But we have to consider additional 5% to 15% additional taxes through various kinds of disallowances," he added.

He mentioned that because of customs setting a minimum value, the import tax along with supplementary duty has skyrocketed to as high as 800%. "This new tax is causing us to delay some of our foreign investments."

FDI contracted to $3.25 billion in FY23, which accounted for 0.72% of GDP. The previous fiscal year's FDI was $3.44 billion.

The FICCI in study last year highlighted how the increasing effective tax rate is raising the cost of doing business.

"While statutory tax rates may appear competitive, it is the effective tax rates that foreign investors ultimately face," said the report.

"Various factors, such as the application of multiple taxes, fees, and compliance costs, can significantly raise the effective tax burden on businesses. This high tax incidence can erode the competitiveness of the country, making it less appealing to foreign investors," the report further said.