MOST countries, especially emerging markets, have used tax incentives to attract foreign direct investments. Even developed economies such as Europe and America provide incentives to attract investments by providing tax breaks or cash grants.
Emerging markets do not have the capacity to give grants, and they are confined to providing tax breaks. Being in a competitive world, Malaysia cannot avoid giving tax incentives because our neighbours also compete for similar investments by providing equal or better incentives.
When investors decide on Malaysia, they base their decisions on a multitude of factors. Inevitably, tax incentives are one of the key factors they will compare against that of our neighbours.
Since capital is mobile, Malaysian private investors, too, will look at the availability of incentives although they are likely to be biased towards Malaysia since their home is in Malaysia and they are based here. However, in maximising the return on capital, whether they are foreign investors or local investors, the weightage given to the sentimentality of their home base is negligible because they are looking for maximum returns for their shareholders and stakeholders.
Government concern
The government, however, is always concerned about the potential loss of taxes due to the availability of incentives as it will negatively impact the federal budget. The concern may be valid, but it becomes redundant once they are willing to understand that, in the long run, there will be a pay-off which will outweigh the taxes forgone.
This will come in the form of providing new employment, which will have a multiplier effect on the economy due to the increased consumer spending. The whole supply chain that will support the new investment (such as local suppliers through logistics, materials, consumables, professional and financial services, etc) will be an additional contribution to the economy.
Incentives bring in additional taxes
Tax breaks provided to new investments are not a loss to the country. At times, there will be additional taxes which outweigh the incentives given to the investor.
Everybody engaged with the investor will pay taxes. Employees, suppliers, professional advisers and service providers, financial institutions providing financial products will pay their share of taxes when there are transactions with the new investor.
Benefits outweigh the loss of taxes
It is important for the authorities to carry out a proper cost benefit analysis. The benefits should not only include the taxes collected from the employees and suppliers but should also consider the multiplier effect it will have on the economy through the additional spending by all the stakeholders involved or connected with the new investment.
A good example of a non-tax benefit which is rarely considered is investments located in remote areas which bring in new infrastructure that will also benefit the community at large in that area which otherwise might not have been forthcoming. The social and economic effect of that infrastructure should not be ignored.
Another important ripple effect of new investments is the upskilling of the workforce.
Incentives are also extremely useful for reducing the financial risks for local companies investing in new technology and products, which will make them more competitive and dynamic especially in a fast-changing world. This will also encourage innovation, particularly if incentives are given for research and development activities.
A proper cost benefit analysis taking into account quantitative and qualitative factors should be considered and, in many cases, it will show that providing the benefit and attracting the investments will outweigh the tax forgone.
It must be remembered that attracting such investments is an addition to the economy which did not exist in the past and, therefore, there is no loss to the government.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).
