asssessing tax incentives for investment: a case study of ... · and devereux and griffith(2003),...

Southeast Asian Journal of Economics 4(2),July-December2016:105-128

Asssessing Tax Incentives for Investment: A Case Study of Thailand

Athiphat Muthitacharoen

Faculty of Economics, Chulalongkorn University, Bangkok, Thailand.Email: [email protected]

Abstract ThisstudyexaminesThailand’staxincentivesforinvestment.Ittakesinto account important tax provisions under standard and preferential treatments,andcomputeseffectiveaveragetaxrates(EATRs)appliedtothecountry’sfocusedindustries.ItthencomparesThailand’sEATRswiththoseofASEANpeers.Suchindustry-specificlensiscrucialsincethetaxbenefitsofferedaswellasthecompositionofinvestmentassetscanvarysubstantiallybetween industries. It finds that, Thailand’s tax incentives are broadly comparable to those of itsASEANpeers.Under themaximum incentives, theEATRsrangefrom6-9%dependingontheinvestmentintensityineachindustry.Thissuggeststhat,withtheexceptionoftargetedincentivesforthebiotechindustry,thereisnotmuchneedtoexpandtaxormonetaryincentives.The results also indicate that accelerated depreciation and investment tax allowances are two options that may perform better than tax holidays in term ofminimizingtheincentiveredundancy.

Keywords:Effectiveaveragetaxrate,Investmentincentives,Taxholiday

JEL classifications:H25,H32,K34

106 • Southeast Asian Journal of Economics 4(2), July-December 2016

1. Introduction Tax incentives for investment are very popular among developingcountries.Thailandisnoexception.Itsgovernmenthasimplementedseveraltaxincentives.Examplesaretheactivity-basedincentivesystems,thespecialeconomiczones,andtheinvestmentaccelerationmeasures.Thosemeasureshavecomeontopofthestatutorytaxcutover2012to2013whichbringsthetaxrateto20%.

Thosetaxincentives,however,arecostlyandunlikelytocompensateforallofthecountry’sshortcomings.AccordingtotheFiscalPolicyOffice’sestimate,thetaxexpendituresassociatedwiththeincentiveshandedoutbytheBoardofInvestmentaccountfor1.7%ofGDPin2014andarejustsmallerthan total personal income tax revenue (see Figure 1). More importantly, althoughempiricalevidencesuggeststhattaxdoesmattersignificantlyonfirms’investmentlocationdecision(see,forexample,DevereuxandGriffith,1998),itisjustoneofthedeterminants.Otherfactorssuchasresourceavailability,policycontinuityandeaseofdoingbusinessarealsoatplay.Itisunlikelythattaxincentiveswillbeabletocompensateforallofthecountry’sshortcomings.

Figure 1. Thailand’s Estimate of Tax Expenditure associated with BOI Incentives

Note:CIT=Corporateincometax,VAT=Valueaddedtax,andDuty=dutytax

Source:BudgetBureau,FiscalPolicyOffice

Athiphat M., Assessing Tax Incentives for Investment: A Case Study of Thailand • 107

Itis,therefore,importanttoknowwherethecountry’staxincentivesstand relative to its competitors.1 If the tax incentives are at a comparable level with neighboring countries, then the government can refrain from throwingadditionaltaxbreaksandfocusonaddressingotherimportantfactorssuchaseaseofcomplyingtothetaxlawandinfrastructure.

Inpractice,thetaxincentivescomeinmanyformats.Inthestandardtreatment,therearestatutorytaxrates,depreciationallowances,andvarioustaxcredits.Preferentialtaxregimeincludesnotonlytaxholidaybutalsotaxexemptioncapand investment taxallowance.2Forpolicy-makingpurpose, itisusefultobeabletosummarizetheimpactoftaxationontheincentivesconcerninglocationchoicesinasinglemeasure.

In thisstudy, I investigate2questions:1)howdoesThailand’s taxincentives compete with its ASEAN peers?, and 2) is there any sign of redundancy in the current incentive system? I answer these questions by computing the effective average tax rate (EATR) using the methodology proposedbyDevereuxandGriffith(2003).TheEATRisaforward-lookingtaxrateanditmeasurestheaveragetaxrateafirmmightexpecttofaceonaninvestmentoverthepossibledistributionofprofitability.Itinformslocationchoices. I then apply that framework to the tax context of fourASEAN countries which are the largest recipients of net FDI inflows (excludingSingapore)3. These countries are referred to as ASEAN4 throughout this articleandincludeIndonesia,Malaysia,ThailandandVietnam.

Thispapercontributestotheliteratureintwoimportantways.First it takes into account relevant features in the tax code used in theASEAN

1 In practice,many factors could influence the tax competitiveness of a country.Theseinclude,forexample, taxburdenandtheamountoftimetakentocomplywithtaxregulations.Thisstudyfocusesononlythetaxburdenaspect.

2 Tax holiday is a period of time that the government exempts corporate income taxliabilitiesforataxpayer.Taxexemptioncapisalimitontotalcorporateincometaxliabilitiesexemptedusuallyinpercentoftheinvestmentcost.Investmenttaxallowanceisanallowancethatcanbeset-offagainstcertainpercentofthepre-taxincomeeachyearuntiltheallowanceisfullyutilized.Suchallowanceistypicallygiveninpercentoftotalinvestmentcost.

3 SingaporehasthehighestamountofnetFDIinflowsinASEANbutmostofthemisinthefinancialsector.


countries.ExamplesareThailand’staxholidaywiththecapontaxexemptionand Malaysia’s extra allowance on investment cost (Investment Tax Allowance).Seconditexaminesthetaxcompetitivenesswithindustry-specificlens. Previous studies have looked atmaximum incentives or broad types of incentives such as those given to high-tech sector or those given to manufacturingindustry.Thetaxbenefitsofferedaswellasthecompositionofinvestmentassets,however,canvarysubstantiallybetweenindustries.Thiswill likelyproducesignificant impactson thegroupof industries thathavebeenchosenbytheThaigovernmentasitsshortandmediumtermpriorities(Sangsuphan,2015).Itconsistsofautomobile,biotech,electronics,processedfood,andtourism.

Theremainderofthispaperisorganizedasfollows.Thenextsectiondescribesrelatedstudies.Section3illustrateshowtheimpactoftaxesontheinvestmentincentivesismeasured.TheresultsandtheirpolicyimplicationsarediscussedinSection4.Thefinalsectionconcludesthestudy.

2. Related Studies Thisstudyisrelatedtotwosetsofliterature(seeTable1).Thefirstsetis on the formulation of the forward-looking effective tax rate on firm’s investmentdecision.Auerbach (1979)andKingandFullerton (1984)havedevelopedanapproachtomeasuringtheeffectivemarginaltaxrate(EMTR).Thisapproachessentiallyassumesaprofit-maximizingfirmwithrisk-neutralshareholders and calculates the cost of capital (the minimum pre-tax rate of return necessary to earn zero post-tax economic profit) associatedwith its investment.ThecostofcapitalisthenusedtoconstructtheEMTR,whichisrelevantfordecisiononthefirm’sinvestmentscale.ForThailand,Aemkulwat(2008)hasestimatedtheEMTRsclassifiedbyfundingmethodsandinvestortypes.


Table 1:RelatedStudies

AnimportantlimitationoftheEMTRisthefactthatitassumeszeroeconomicprofit—makingitapplicableonlyformarginalinvestmentprojectsinwhichthelastunitinvestedyieldsjustenoughpre-taxreturntobreakevenaftertaxes.Inmanysituations,however,afirmfacesachoicebetweentwoprojectsthateachearnmorethanitscostofcapital.Thisincludescaseswhenafirmwithcertainspecificadvantages,suchasinnovationandpatents,decideswheretolocateitsplants.

DevereuxandGriffith(2003)hasaddressedthislimitationbyproposingtheeffectiveaveragetaxrate(EATR).ItcomputestheEATRbyconsideringaninvestmentprojectwithpositiveeconomicprofitandidentifyingthewedgebetweenpre-andpost-netpresentvalue(NPV)oftheinvestmentproject.Itthus helps inform policymakers on the measurement of the impact of taxes on the investment location decision. Many studies including Devereux andGriffith(1998)andBellakandLeibrecht(2009)havefoundthattheEATRhasasignificantimpactonfirms’decisionregardingwheretoinvestabroad.4

The second set of literature is on the assessment ofASEAN tax incentivesusingtheeffectiveaveragetaxrates.Overthepastseveraldecades,ASEAN countries have adopted tax holiday incentives in order to attract

4 Inparticular,DevereuxandGriffith(1998)’sresultsindicatethatapercentagepointdropintheUKEATRwouldraisetheprobabilityofaUSfirmplacingitsinvestmentintheUKbyonepercent.


foreign direct investment. Klemm (2012) has extended the Devereux andGriffith EATR framework to accommodate those tax holiday incentives. Botmanetal.(2010)computestheEATRforASEANcountrieswithitsfocusmainlyonthePhilippines’taxpolicyoptions.Itfindsthatthemaximumtaxholiday incentives lower the EATRs significantly and make the EATRs comparableamongtheASEANcountries.

SimilartoBotmanetal.,AbbasandKlemm(2013)alsoconsiderstheEATRassociatedwithmaximumincentives.ItstudiesthedevelopmentoftheEATRfrom1996to2007of50developingcountriesincludingmanyASEANcountries. The study concludes that those countries have competed over thespecial tax incentives,socalled thepartial race tobottom.It,however,doesnotexplicitly report theEATR.Suzuki (2014)estimates theEATRof 12 countries in EastASIA and considers the typical incentives,which are definedasaveragetaxincentivesforatypicalprojectbasedonactualusage.It finds some evidence of tax competition over the period of 1991-2012. WiedemannandFinke(2015)computestheEATRforAsia-PacificcountriesincludingnineASEANcountries.Undermaximumtaxincentives,itfindsthattheEATRsareprettycomparableamongASEANcountrieswithThailandandVietnamhavingthelowesteffectivetaxrates.

3. Conceptual Framework The analysis in this study measures the impact of taxation on location choice incentive by computing the EATR based onDevereux andGriffith(2003)’smethodology.Inthissection,Ifirstdiscusshowtheeffectsoftaxoninvestment incentives are typicallymeasured before illustrating the EATRcomputationframework.

3.1 How to measure the effects of tax on investment incentives

Thereisquitealargeliteratureonhowtomeasuretheeffectoftaxeson incentives to invest. It is, however, important to distinguish between backward-and forward-looking taxmeasures.Bothareusefulbut theyaresuitablefordifferentobjectives.


The backward-looking taxmeasures such as average tax rates aretypicallycalculatedusingobservedtaxpaymentsandscalingitwithameasureofprofit.Theyaresimpleandcancapturemanycomplexitiesofthetaxcode.Theyarealsoverygoodmeasuresfordistributionalanalysisoftaxburden.However,themajordrawbackassociatedwiththebackward-lookingmeasuresisthefactthattheydonotreflecttheeffectontheincentives.Indeed,thetaxliabilitiesofafirmatanypointintimereflectsthehistoryofitsinvestmentupto that point through deductions of depreciation and losses carry-forward.Thiscaninduceendogeneitybiasintoregressions.Forexample,aperiodofhighinvestmentislikelytogeneratehighdepreciationallowances.Thiswilllowerthetaxespaidandcreatesreversecausalityintheregression.

Ontheotherhand,theforward-lookingtaxmeasuressuchaseffectivetax rates are calculated for a hypothetical investment and can be computed for any well-defined investment project. They typically take into account all present and future values of cash flows associated with the project. Consequently, theyaregenerallypreferredmeasureswhenlookinginto theimpact on incentives.Themain drawback is that they are computed for a specifictypeofinvestmentfinancedinaspecificway.Thismakesitdifficultto capture impacts when investment across projects is aggregated. Here I focusontheforward-lookingeffectivetaxrateapproach.

3.2 Computation of the EATR

The computation of effective tax rates in the study is based on a methodology,whichwasoriginallydevelopedbyKingandFullerton(1984)andDevereuxandGriffith(2003),and latermodifiedbyKlemm(2012). Itconsidersaprofit-maximizingbehaviorofafirmwithrisk-neutralshareholders.Forsimplicity,theanalysishereassumes1)nocapitalincomeatthepersonalincometaxleveland2)equityfinanceisadoptedtofinancetheinvestment.

Supposeafirminvestsinperiodt and hence increases its capital stock byoneunit.Theresultingcapitalstockisassumedtobeslowlydisinvestedovertimethroughdepreciation.Thecostoftheinvestmentisassumedtobeoneunit.Thenetpresentvalue(NPV)oftheinvestmentcanbecalculatedas:

(1 )

R dV idD

0

t t jt j

j= =

+

3+

=

/ (1)


where Rt isthenetpresentvaluetotheshareholderoftheinvestment,Vt is the equity value of the firm,Dt is the dividend paid by the firm, and i is the discount rate.Note that, abstracting from risk, thediscount rate equals thenominalinterestrate:(1+i)=(1+r)(1+π),wherer = real interest rate and π=inflationrate.

Theallocationoffundsremainingfromthe investmentcandepend onthewayinwhichtheprojectwasfinanced.Iftheprojectwasfinancedbyretainedearnings,theanalysisassumesthatallremainingfundsarereturnedtoshareholdersintheformofdividendpayment.Iftheprojectwasfinancedbynewequity,itassumesthatthefirmrepurchasesitssharesusingthesameamountofmoneyandleavesthetotalnumberofoutstandingsharesunaffected.Intheabsenceofpersonaltaxation,bothtypesofequityfinancingyieldthesamereturn.

Thedividendpaidis,inturn,determinedbythefirm’sflowoffundsequation.Inabsenceoftaxes,thiscanbewrittenas:

Dt = F (Kt - 1) - It , (2)

where Kt - 1isthecapitalstock,It istheinvestmentundertaken,andF(Kt - 1) is outputoftheinvestment.FurthermoretheadditionalunitofcapitalstockisassumedtogenerateF′(Kt - 1) = p +δ,wherep = the real rate of return on the investment and δistheeconomicdepreciationrate.

Thepre-taxNPVoftheinvestment(Rt*) is:

1(1 )

(1 )( )

(1 )

(1 )(1 )R i

pi r

p r*

0

t

j

j

r d r d

d=- +

+

+ +

+

+ -=

+

-3

=

c m/ (3)

Inthepresenceoftaxes,thecomputationisalittlemorecomplicated.Thedividendinequation(2)becomes:

Dt = (1 - τ)F(Kt - 1) - It +τϕ(It +K Tt - 1), (4)

where τdenotes the statutorycorporate income tax rate,andϕ denotes the depreciationtaxallowancerate,andK T

t - 1isthecapitalstockfortaxpurposes.Notethat,fortaxpurposes,thecapitalstockisassumedtoevolveaccordingto (1 )K K I1t

TtT

t{= - +- .Thepost-taxNPV(Rt) can then be written as


( ) ( )

1R rp

A1

t d

d x=

+

+ -- + , (5)

where ( )

A idI K1 j

t j t jT

j

1

0

/ xz+

+3+ + -

=

/ denotes the present value of the depreciation allowances.5

Nowconsiderthethreetermsontherighthandsideofequation(5).The first term represents the present value of the investment returns. The second term represents the present value of the cost of investment which equals 1. The final term represents the present value of the depreciation allowances and its value depends on the depreciationmethod chosen. Fordecliningbalancemethod,A becomes

( )

A i ii

1

1 1j

j 0

xzz

z

xz=

+

-=

+

+3

=

c m/ . (6)

If the allowance is instead given at the same rate in subsequent periodsonastraightlinebasisuntilthewholecostoftheinvestmenthadbeenallowed,thentheallowancewillbegivenforT periods where 1T

z= .A then

becomes

1

1A i0

1 j

j

T

xz=+

=

-

c m/ . (7)

The effective average tax rate (EATR) is computed as the presentvalueof thecorporate incomepaid(thedifferencebetweenthepre-taxandpost-tax values of the investment) divided by the net present value of the incomestreamintheabsenceoftax.Thatis,

(1 )

(1 ) / ( )EATR

p r

R Rp rR R

1

1

* *

j

j

j

d d=

+

--

=+-

3 -

=

/. (8)

The analysis so far assumes that the statutory tax rate (τ) remains constantthroughout.Itispossibletoallowfortime-varyingtaxrates(τj).Thetaxholidayschemeadoptedbymanydevelopingcountriesisthecasewhere

5 Notethattheanalysisimplicitlyassumesthatthefirmhassufficienttaxableprofittoabsorbthisallowance.


there is a period of Y yearsatthebeginningoftheinvestmentprojectduringwhich the statutory tax rates (τj)aresettozero.

With the tax holiday of Y years,Klemm(2012)hasshownthat thepost-taxNPVofequation5becomes:

( )

( )1

1

11R r

pr At

Y

d

dx

d=+

+-

+-

- +c m; E (9)

where 111A i i

1Y

xzzk z

=++

+

- +

c cm m fordecliningbalancemethodand

( )

A ii

i i Y1

1

1

1

1 11if

0 otherwise

/Y 1 1

1xz

z=+

+-

+-

{+

c cm m; E* forstraight-linemethod.

IncorporatingspecialincentiveschemesemployedbyASEAN4intothis framework is relatively straightforward. My analysis has taken into accountthefollowingschemes:taxratereductionafterholidayexpiration(allcountries),taxholidaywithcaponthetaxexemption(Thailand),accelerateddepreciation6(Malaysia),andinvestmenttaxallowance(Malaysia).Detaileddiscussiononthisisavailableintheappendix.

ThecomputationofEATRisnecessarilybasedonafewparameterassumptions.Iassumetherealinterestrateof5%andtheheadlineinflation of 2%. Those two parameters are based on Thailand’s average values of headlineinflationandminimumlendingrateofovertheperiodof2011-2015.7 To be consistentwith previous studies, e.g.Devereux andGriffith (2003),Suzuki(2014)andWiedemannandFinke(2015), Iassumethat the invest-mentyieldstheprofitrateof20%.Also,followingSuzuki(2014),economic

6 Accelerateddepreciationisadepreciationmethodthatallowsgreaterdepreciationrate in the earlier years of the life of an investment asset than the rate under the traditional straight-linemethod.This results in higher present value of the totaldepreciationallowanceandlowerpresentvalueoftaxliabilities.

7 According to theBankofThailand, theaverageheadline inflation from2011 to2015 is2.0%,while theaverageminimumlendingrateofallcommercialbanksover the same period is 6.9%.The real interest rate is based on the difference betweentheminimumlendingrateandtheheadlineinflationrate.


depreciation rates are assumed to be 12.25% for machines and 3.6% for building.Finally,Icalibratethesharesofinvestmentassetsemployedbyeachindustry using theOffice ofNational Economics and Social DevelopmentBoard’s Input-Output Table of Thailand (2010).As expected, automobile,biotech and electronics are heavily machinery-intensive, whereas tourismputsmoreemphasisonstructures(seeFigure2).

Figure 2.ShareofInvestmentAssetsbyIndustries

Source:NationalEconomicsandSocialDevelopmentBoard

4. EATR Estimation and Implications In this section, I first examine how each country fares under the standardtaxtreatment.Ithenshowhowpreferentialtaxregimeshaveloweredeffectiveaveragetaxratesforthefocusedindustries.Finally,Iinvestigatetheincentiveredundancyofthecurrentincentivesystem.

4.1 Standard Tax Treatment

Aninvestmentprojecttypicallyrequiresacombinationofinvestmentassets.Themixofinvestmentassetsvariesacrossindustriesanditalsoaffects


the incentives. For example, producing Solid State Drive (SSD) would emphasizeinvestmentinmachinery,whereaslaunchingahotelwouldrequirerelatively more structures. The tax code allows relatively higher rate of depreciationallowanceformachineryinvestment.ThatexplainswhytheEATRformanufacturing is 17.7%, about a percentage point lower than services (seeFigure3).TheEATRforatypical(oraverage)investmentis18.2%.

Figure 3. How the standard tax treatment affects investment incentivesacrossindustries(Thailand,2016)

Source: National Economics and SocialDevelopment Board and author’s estimates

ComparingtheEATRontypicalinvestmentwiththeotherASEAN4countries(seeFigure4),IfindthatThailand’sstandardtaxtreatmentcurrentlyappearstobethemostcompetitiveamongtheASEAN5nations(Figure5).CombiningThailand’sstatutorytaxrateof20%totheverygenerousdepre-ciation allowance results in the EATR being slightly above 18%. This is significantlybelowtheaverageEATRforASEAN4of20.9%.Interestingly,Vietnam has the same statutory tax rate as Thailand but its depreciation allowance rate onmachinery is about half ofThailand.That results in itsEATRbeingover19%.

TheimpactofthedepreciationallowanceontheEATRissimilartowhatisobservedbyBotmanetal.(2010)andWiedemannandFinke(2015).Inthosestudies,thedifferencesbetweenthestatutorytaxrateandtheEATRunderthestandardtaxarearound1-2percentagepointsinallcountries.


Figure 4.OverviewofStandardTaxTreatmentsacrossASEAN4

Source:PWC,Deloitteandnationaltaxauthorities

Figure 5.EATRunderthestandardtaxtreatmentacrossASEAN4(2016)

Source:Author’sestimates


LookingbackoverthepastdecadeputsThailand’srecenttaxcutintoperspective(Figure6).Thetaxdevelopmentintheregionischaracterizedbyroundsoftaxcuts.Thefirstroundappearstooccuraroundtheglobalfinancialcrisisin2008.AllcountriesexceptThailandhascuttheirstatutorytaxrates.Three years later,Thailand has aggressively cut its statutory tax rate from 30 to 20%.This delayed response fromThailand has potentially triggeredanother roundof ‘race to thebottom’.VietnamandMalaysiahavealreadyresumedcuttingtheirtaxrates.ThisdevelopmentofEATRsupportsthefindingof tax competition over investment tax incentives byAbbas and Klemm(2013).

Figure 6. Development of EATR under the standard tax treatment acrossASEAN5


4.2 Preferential Tax Regimes

Thestandardtaxtreatmentalonedoesnotgivecompletepictureabouttheregion’staxlandscape.AllASEAN4countriesoffertax-holidaytypeofincentives.Theyvaryonthenumberofyears.Severalcountriesmodifythetaxholidayincentives.Thailand,forexample,imposesthelimitontheamountoftaxexemptionduringtheholiday(exemptioncap).Malaysiainterestinglygives2options:1)taxholidayand2)investmenttaxallowance(ITA)whichworks by granting an allowance in percent of total investment cost. This allowancecanbeset-offagainstacertainpercentofthepre-taxincomeeach


yearuntilfullyutilized.TheITAisgivenontopofthestandarddepreciation.TheincentiveschemeinVietnamconsistsofbasicrate,preferentialbasicrateandtemporaryreductions.Thisresultsinataxsystemwitheffectivelyfourtaxratesovertheinvestmenthorizon.

Thisstudyconsidersthe5focusedindustries(auto,biotech,electronics,processed food, and tourism) and assignsmaximum incentives to each ofthem.8ForThailand,allindustriesexceptbiotechreceivethetaxholidayof 8yearswiththeexemptioncapplustheextra5yearsof50%taxratereduction(see Figure 7). Biotech is the only industry that is not capped by the tax exemptionlimit.Thisreflectstheemphasisofthegovernmentonthatparticularindustry.Itisalsoimportanttonotethatthosetaxincentivesareavailabletobothdomesticandforeigninvestors.Figures8liststhemaximumtaxincentivesbyindustriesfortheotherASEAN4countries.

Figure 7.Thailand’sMaximumIncentivesacrossFocusedIndustries

Notes:ABS=Anti-lockBrakingSystem,SEZ=SpecialEconomicZone

Source:BoardofInvestment(BOI)

8 ThesearethefiveindustriesthathavebeenchosenbytheThaigovernmentasitsshortandmediumtermpriorities(Sangsuphan,2015).


Figure 8.MaximumtaxincentivesbyindustriesacrossASEAN4

Source:PWC,Deloitteandnationaltaxauthorities

Under themaximum tax incentives,Thailand’sEATRs are signifi-cantlylowerthanthatunderthestandardtreatment.Theyrangefromaround6-9% depending on the investment intensity (see Figure 9).The first four industries are relatively intense inmachinery and their EATRs are around6-7%.Tourism,ontheotherhand,putsmoreemphasisonstructuresanditsEATRisaround9%.

Figure 9.EATRundermaximumincentivesacrossASEAN4(2016)



Thailand’smaximumincentivesarebroadlycomparabletoASEANpeersinmostsectors(seeFigure9).ItsEATRsforallsectorsexceptbiotechare the lowest orwithin 1-2 percentage point from the countrywithmost attractiveincentive.OneexceptionisBiotechwhereMalaysiahasbeenputtingastrongemphasison.ItsEATRis5percentagepointlowerthanThailand’s.Thissuggeststhat,withtheexceptionoftargetedincentivesforthebiotechindustry, the government should refrain from throwing any more tax or monetaryincentivesandfocusonfixingstructuralshortcomings.

Comparingthesefindingswiththoseobtainedbythepreviousstudiesis a little difficult. This is because this study takes industry-specific lens,whereas the previous studies have looked at broad types of sectors such as manufacturingorhigh-techindustry.Nevertheless,theyaregenerallyinlinewiththepreviousstudies.Forexample,WiedemannandFinke(2015)findsthatThailand’sEATRunderthemaximumincentivesisaround7-8%.Asacomparison, this study finds that Thailand’s EATRs under the maximum incentives range from 6% to 7% for automobile, biotech, electronics and processedfood.

Itisimportanttonotethatalthoughitispossiblethatasmallnumberof firms may qualify or be willing to fulfill the requirements needed for themaximumtaxincentives,thissetofEATRsisusefulforcomparingthegenerosityofthemaximumincentivesacrossASEAN4.

4.3 Redundancy Examination

In addition to maintaining sufficiently attractive tax incentives, policymakerhastominimizetheforegonerevenue.Onewaytoachievethatistoavoidpotentialredundancyintheincentivescheme.HereIinvestigatetwoquestions.First, are the tax incentivesmore attractive for investing inshort-livedassets?Ifthatistrue,thenwemaysimplybedrawingcompaniesthattendtobefoot-loose.Second,arethetaxincentivesmoreattractiveforhighlyprofitablefirms?Ifthatisthecase,itispossiblethattheyhaveinvestedevenwithoutthetaxincentivesoffered.

Ineachquestion,IcomparetheresultingEATRsunderthecurrenttaxholiday system to the alternative incentive system which involves accelerated


depreciationandinvestmenttaxallowance(ITA).Theaccelerateddepreciationschemeincreasesthedepreciationratesduringthefirstyearofinvestmentto40%and10%formachineryandbuilding, respectively.The ITAproposedhereissimilartotheschemeemployedbyMalaysia.WiththeITA,aninvestorcandeduct60%oftheinvestmentcostagainst70%ofpre-taxincomeeachyearuntilfullyutilized.Oneadvantageofthealternativesystemoverthetaxholiday is that it avoids providing tax planning opportunities for investorswho may try to shift taxable income earned by associated firms into the tax-holidayfirm.

With the taxholiday, theEATRdeclines significantlyas economicdepreciation rates increase (see Figure 10). It will be almost zero for an investment in which all assets completely depreciate just before the end of the holiday.Incontrast,undertheaccelerateddepreciationscheme,theEATRsdonotdeclineasmuchwheneconomicdepreciationratesincrease.Thisillustrateshowthetaxholidaytendstofavorfoot-looseindustries.Consequently,ifthegoal is to attract long-lastingassets, theaccelerateddepreciationmaybea betterpolicyoption.

Figure 10.EATRforelectronicsindustrybyeconomicdepreciationrates,

Notes:Economicdepreciationratesformachineryare6.3%,12.5%,25%and50%,whiletheratesforbuildingsare1.8%,3.6%,7.2%and14.4%.



Anotherfindingisthat,underthetaxholiday,theeffectivetaxratesbecomesignificantlylowerforfirmswithhigherprofits(seeFigure11).Thispossiblysignalsredundancyinthecurrentincentivesystem.Incentivesmaybeofferedtofirmsthatwouldhaveinvestedwithoutthem.Therefore,makingthe incentives well-targeted is very important when handing out the tax holidaywithoutthetaxexemptioncap.Withthecap,theeffectivetaxrates are significantly higher for very profitable firms. Using the same Biotech example,thetaxexemptioncapstartskickinginattheprofitrateof140%andsignificantlyraisestheEATRforfirmswithverylargeprofits.ThissupportsBOI’spracticeinputtingthetaxexemptioncaponthetaxholidaygiventomostactivities.

Figure 11. EATRsundermaximumincentivesforbiotechindustrybyincen-tive instruments

Notes:1)Profitratesrangefrom20%to200%toillustratehowEATRswouldchangeforfirmswithhigherprofitlevels.2)AD=Accelerateddepreciation,ITA=Investmenttaxallowance.


Inaddition to the taxexemptioncap,acombinationofaccelerateddepreciationandinvestmenttaxallowancecanhelpminimizetheincentiveredundancy. As shown in Figure 11, for firms with moderate profit, the combinationofaccelerateddepreciationandinvestmenttaxcreditgeneratesEATRs comparable to those under the tax holiday.On the other hand, forhighlyprofitablefirm,thecombinationgeneratessubstantiallyhighertaxrates.


4.4 Limitations

Theframeworkhereprovidesahelpfulwaytosummarizetheeffectsof taxpolicyoninvestment incentives.However, it is important tonote itslimitations.Firstitconsidersonlytaxationatthedomesticcorporatelevelanddoes not take into account personal and international taxations. Since theanalysisfocusesessentiallyonthesmallopeneconomycontext,itispossiblethatthemarginalprovidersoffundsareforeignfirmsorindividualsandtheirtaxtreatmentsmaydifferfromthatofdomesticinvestors.Inordertoevaluatethe country’s industry-specific tax competitiveness, it would therefore be sensibletoabstractfromcapitalincometaxesatthepersonalincomelevel.Future studies focusing on investment decisions associatedwith particularhomecountriescouldtakealookattheinternationaltaxationaspect.

Secondthisstudyassumesequityfinancing.Debt-financingislikelytoyieldlowerEATRbecauseoftheabilitytodeductinterestexpensesinallcountries. It is,however,unlikely tomaterially impact thecompetitivenessevaluation.

5. Conclusion This study evaluates the impact of taxation on the location choice incentives using the EATRmeasure. It assumes the perspective of a firmadopting equity finance and takes into account tax provisions under both standardandpreferential tax treatments.Theresults indicate that, fromthetaxation perspective, Thailand is an attractive destination for internationalcapital.With the exception of the Biotech industry, its EATRs under the maximumincentivesare lowestorwithin1-2percentagepointof themostcompetitive country.Another important finding concerns the choice of taxinstrumentsemployedunderthepreferentialtaxtreatment.Itfindsthatthetaxholidaytendstofavorfoot-loosecompaniesaswellasthosewithlargeprofit.ThisfindingsupportsBOI’spracticeinimposingthetaxexemptioncaponmostactivities. It also suggests thatpolicymakers shouldalsoconsider thescheme involving accelerated depreciation and investment tax allowance.Those two instruments are likely to outperform the tax holiday in term of avoidingthepotentialredundancy.


Acknowledgements ThisprojectreceivesfinancialsupportfromChulalongkornEconomicResearchCentre.Iwouldliketothanktwoanonymousrefereesaswellastheparticipants at theAsian Development Bank InstituteWorkshop (January2016),theFiscalPolicyOfficeTaxPolicySeminar(February2016),andthePueyUngphakornInstituteforEconomicResearchSeminar(February2016)fortheirhelpfulcommentsandsuggestions.

ReferencesAbbas,A.,&Klemm,A.(2013).APartialRacetotheBottom:CorporateTax

DevelopmentsinEmergingandDevelopingEconomics.International Tax and Public Finance,20(4), 596-617.http://dx.doi.org/10.1007/s10797-013-9286-8

Aemkulwat,C.(2008).MarginalEffectiveTaxRatesinThailand.Chulalongkorn Journal of Economics, 20(3),155-181.

Auerbach, A. J. (1979). Wealth Maximization and the Cost of Capital. Quarterly Journal of Economics, 21, 107-127. http://dx.doi.org/ 10.2307/1883167

Bellak,C.,&Leibrecht,M. (2009).DoLowCorporate IncomeTaxRates AttractFDI?–EvidencefromCentral-andEastEuropeanCountries.Applied Economics, 41,2691-2703.http://dx.doi.org/10.1080/00036 840701320217

Botman,D.,Klemm,A.,&Baqir,R.(2010).InvestmentIncentivesandEffec-tiveTaxRates in thePhilippines:AComparisonwithNeighboringCountries.Journal of the Asia Pacific Economy, 15,166-191.http://dx.doi.org/10.1080/13547861003700299

Devereux,M.P.,&Griffith,R.(1998).TaxesandtheLocationofProduction:Evidence from a Panel of US multinationals. Journal of Public Economics, 68, 335-367. http://dx.doi.org/10.1016/s0047-2727(98) 00014-0

Devereux,M.P.,&Griffith,R.(2003).EvaluatingTaxPolicyforLocationDecisions. International Tax and Public Finance, 10(2), 107-126.http://dx.doi.org/10.1023/A:1023364421914


King,M.A.,&Fullerton,D.(1984).The Taxation of Income from Capital: A Comparative Study of the US, U.K., Sweden and W. Germany—Comparisons of Effective Tax Rates. Chicago, IL: University of ChicagoPress.

Klemm,A.(2012).EffectiveAverageTaxRatesforPermanentInvestment.Journal of Economic and Social Measurement, 37,253-264.

Sangsuphan,K.(2015).Ten Targeted Industries as Thailand’s New Engine of Growth [Powerpoint slides]. Retrieved from http://thaipublica.org/wp- content/uploads/2015/11/BOI_kanit.pdf

Suzuki,M.(2014).CorporateEffectiveTaxRatesinAsianCountries.Japan and the World Economy, 29,1-17.http://dx.doi.org/10.1016/j.japwor. 2013.11.001

Wiedemann,V.,&Finke,K.(2015).Taxing Investments in the Asia-Pacific Region: the Importance of Cross-Border Taxation and Tax Incentives (No.15-014).ZEWDiscussionPaper.


Appendix: Incorporating special incentive schemes employed by ASEAN4 into the EATR framework

The analysis in this study has taken into account the followingschemes:taxratereductionafterholidayexpiration(allcountries),taxholidaywithcaponthetaxexemption(Thailand),accelerateddepreciation(Malaysia),andinvestmenttaxallowance(Malaysia).

Tax holiday with subsequent tax rate reduction

AllASEAN4countrieshaveallowedtaxratereductionforacertainperiodafterthetaxholidayperiodends.Withsuchscheme,thepost-taxNPVbecomes

1 11 1 1

111 1R r

pr r r At

Y Z Y Z

d

dax

d dx

d=+

+-

+-

-+-

-+-

- ++

c c cm m m; E' 1 (A1)

where αdenotesthetaxratereductioninpercentandAisdefinedas:

11 1

11A i i i1

1j

j Y

Y Z Y Z

zaxz

xzzk z

=+

-+

++

+

-

= +

+ + +

c c cm m m/

fordecliningbalancemethodand

0

1

1

1

1

1

1

1

1

1

1

1

1

1

A ii

i i

ii

i i

if i Y

if Y i Y Z

if Y Z i

1 1/

1 1/

Y

Y Z

1

1

#

#axz

xz

z

z

z

=+

+-

+

++

-+

-

- +

+ -

z

z

+

+ +

` c c

` c c

j m m

j m m

;

;

E

E

Z

[

\

]]]

]]]

forstraight-linemethod.

Tax holiday with cap on the amount of tax exemption

Formost activities,Thailandhas limited the tax exemptionduring thetaxholidayperiodupto100%oftheinvestmentcost.Theanalysishasincorporatedthatprovisionbycomputingtheexemptedtaxasthedifference


between the after-tax return with the tax holiday and the after- tax return withoutthetaxholiday.Iftheexemptedtaxisabovethelimit,theportionofthe exempted tax over the limit (C) is then subtracted from the after-tax return

withthetaxholiday.Thatis,/ ( )

EATR p rR R C*

d=

+- + .

Accelerated depreciation

Malaysia has allowed a higher depreciation allowance rate during thefirstyearofinvestment.Theanalysishasincorporatedthatprovisionbycomputingtheincreaseinthepresentvalueof totaldepreciationallowanceassociated with accelerated depreciation and add that to the present value of totaldepreciationallowanceassociatedwithnormaltreatment.

Investment tax allowance

Malaysiahasgivenan investor an investment taxallowance (ITA)option.TheITAworksbygrantinganallowanceofacertainpercentoftotalinvestmentcostincurredwithin5years.Thisallowanceistobesetoffagainstuptoacertainpercentofthepre-taxincomeeveryyearuntilfullyutilized.Theanalysishasincorporatedthatprovisionbycomputingthepresentvalueof the investment tax allowance and add it to the after-tax return associated withthestandardtaxtreatment.

asssessing tax incentives for investment: a case study of ... · and devereux and griffith(2003),...

Documents