The taxation of Official Development Aids (ODA), a debate reactivated by the COVID-19 crisis

The topic presented in this blog reflects an ongoing debate on the relations between countries receiving official aid, mainly in Africa, and donor countries, mainly in Europe and North America, and the information disclosed here does not imply any position of CIAT or of its Secretary General regarding this matter. However, we find it useful to report that the tax exemption for official aid is no longer the object of an automatic and generalized consensus, and in particular that good international practices require the disclosure of said exemptions in bilateral or multilateral cooperation agreements.  

Introduction

Official Development Assistance (ODA) comprise the financial funds that developing countries receive in order to boost their growth and economic well-being. These funds come through international organizations, which they in turn receive from developed countries. The developed countries generated a financial commitment, in principle binding, in which they agree that a percentage of their gross national product (GNP) be allocated to official development aid, with a reference amount of 0.7% of their GDP. This seeks to improve the economies of developing countries through policies and loans from global credit institutions, to eradicate poverty and extreme indebtedness.[1] For some low-resource countries in Africa, this aid represents more than 3% of GDP.[2]

Historically, official aid to developing countries has been tax exempt, but this position is changing. Today there is a growing process towards its taxation. Should recipient countries collect fees and taxes related to projects?  This was the subject of a recent seminar organized by the French Inter-ministerial Platform (MRIP, Mobilization of Internal Resources)[3]

The topic refers mainly to indirect taxes, but can be extended to direct taxes.  According to the FERDI Foundation. “Starting in the mid-2000, exemptions for projects financed with external aid were the subject of debate on the international scene. Their abandonment, often anticipated, was never adopted. However, this issue is again topical. On the one hand, many developing countries have undertaken tax policy and administration reforms to improve the efficiency of their tax systems, eliminating one of the main justifications for tax- exempted aid. On the other hand, the Addis Ababa International Conference in August 2015 identified the mobilization of national tax revenues as the main source of financing for development. However, broadening the tax base, synonymous with a more distributed tax burden, is hampered by the proliferation of tax exemptions, in part fueled by the exemption of official development assistance. The official aid exemption could represent up to 2 or 3% of the Gross Domestic Product (GDP) in countries where tax revenues barely exceed 15% of GDP, or even 10% or less in defaulting states . Beyond the loss of tax revenue, the exemption of project aid has particularly detrimental effects on the formalization of the economies of the assisted countries and the efficiency of their tax and customs administrations. Furthermore, this systematic exemption reduces the credibility of donor countries’ policies and the coherence of their aid policy, which may, in particular, directly support a developing country’s budget while requiring tax exemption for its aid to projects. ”

Traditional justifications for exemptions:

  • A greater amount of aid goes directly to the projects.
  • Reduction of the costs of public purchases, for the recipient country.
  • Distrust towards recipients’ financial institutions (sometimes considered poorly managed, with high rates, lack of transparency, corruption, etc.).

This last justification is obsolete because many recipients have improved their systems, but the taxation of aid should be linked to the fiscal transparency of the beneficiary countries.

Arguments against exemptions:

  • Multiplication of tax regimes, complicated administrative management of exemptions.
  • Loss of revenue; exception regimes are a cause of failure for states.
  • Exemptions affect the ability of countries to mobilize their tax revenues, especially when budgets are affected by the crisis resulting from the current pandemic.
  • The VAT taxation chain is interrupted.
  • Local subcontractors suffer disadvantages compared to exonerated foreign subcontractors and are therefore reflected in their selling price. (Discrimination against local subcontractors).
  • There is an additional administrative burden, and they are tax expenditures. NGOs are numerous, which increases the risk of fraud, and procedures for granting exemptions sometimes take a long time.

2. Evolution of the practices of the main donor organizations

2.1 World Bank: Since 2000, the World Bank began to agree to pay taxes on the projects they finance, “if these taxes are reasonable”.

In general, financial projects are still exempt, but the discourse has changed in favor of the taxation of aid.  For consistency reasons: Cooperation and derogation regimes should not be mixed.

And would this reduce the amount of aid? No, because the tax is similar to a global budget aid.  In 2020, the weakness of the administrations, a consequence of the COVID crisis, would rather justify the taxation of the aid. A gradual approach could start with a list of goods that will not qualify for the exemption (e.g., petroleum products). Rigorous management is also required, ensuring more rigorous supervision of revenues.  The international context is now conducive to the taxation of aid.

2.2 The UN Committee: Demand for more transparency

Presenting the UN Committee non-binding guidelines adopted in October 2020 – Mr. Sasseville highlights its conclusions: Disclosure of all tax measures related to the projects. Some existing international public aid agreements that are not disclosed.  More transparency of tax provisions is needed. The committee is made up of 25 experts approved by each country, and members of the tax authorities. Half come from developing countries. Therefore, the guidelines represent a consensus of these experts.

The forerunner of the Committee was the International Tax Dialogue (ITD) including the OECD, WB, IMF and UN, which highlighted the problems caused by tax exemptions. The committee issued a first draft in 2007, which was relegated for 10 years.

The project was relaunched in 2015, with the Addis Ababa Action Plan.[4] The text concludes with “Considering the possibility of not requiring exemptions for government-to-government aid projects.”  It is a very cautious sentence, reflecting possible differences of opinion on the matter.
The new guidelines have already been approved, and include 13 principles, among which

  • Donor countries and their aid agencies are encouraged to refrain from applying for tax exemptions, except when recipient countries have standards that are inconsistent with international standards or are of concern.
  • Transparency: Recipients and donors must make public their tax and / or exemption policies. The fiscal/tax treatment must be made public.
  • Examples of mechanisms and good practices, and finally (principle 13) … donor countries are encouraged to observe the rules of recipient countries with regard to withholding of tax at source.

2.3. The OECD’s point of view

  • Traditionally, donors required exemptions to maximize the impact of aid, and had concerns about the proper use of taxes by recipient countries.
  • Currently, donors adopt divergent attitudes. Some changed their policy towards the taxation of aid. Others are willing to do so if a consensus or majority becomes significant. Others want to continue with the exemptions, but a consensus can be reached on increased transparency. Some countries already offer a good level of transparency (ex: USA) and others continue to propose sometimes undisclosed deals (China).
  • What kind of transparency?  At the political level, donors or borrowers must publicize their intentions. On a practical level, know what happened on the field. Some nations stop claiming exemptions. At the legal level, the agreements should clarify what the rights and duties of each party are. Administratively, it’s about easing the burden. At the financial level, it is about knowing the impacts on income and aid flows. A transparency hub will be organized in 2021. For the exemptions that remain, the state giving up its tax revenue could appear as a co-sponsor of the projects.

2.4. The European Commission’s views

The European Union supports the mobilization of the internal resources of the states, for finance the economic reactivation in developing countries.

Consequently, the commission supports the elimination of exemptions, and administrative simplification. This also reduces the risks of fraud and increases predictability.

However, for the moment, there are divergences: Some beneficiary countries tax the aid and others exempt it, and among donors, there are also divergences. The European Union estimates that the taxation of its public aid could “donate” 3.8 billion euros to the public finances of developing countries in the period 2021-2028.

The commission decided, from now on, not to compel its partners to negotiate exemption agreements, except in the case of specific taxes considered abusive. The main problem with this transition is the implementation (it is a big change) and the difficulty of accessing the information of the existing agreements, for example, the existence of clauses for restitution that may exist in confidential agreements. A serious option to link the taxation of the aid to the fiscal transparency of the beneficiary countries.

2.5. French Development Aid, AFD

AFD continues to apply the principle of exempting financing, and exemptions can be complete or take the form of taxes declared but paid by the beneficiary states themselves. But there are exceptions, such as for the payment of intellectual services (consultants) or for some countries such as Kenya or the Ivory Coast, where the states collect taxes, but donate to the project an amount equivalent to the tax charged.

AFD staff are in favor of the taxation of public aid and financing, since exemptions are an administrative nightmare. In the 2019, business plan, taxes would represent less than 1,000 billion out of a budget of 14,000 billion.  But this transition can cause problems for borrowing states, which may have to increase their debts (in foreign currencies) to finance their own taxes.

It concludes  that the beneficiaries should have the main weight in the decision to stop exempting.

3. Beneficiaries’ point of view and conclusions:

Among the beneficiary countries, Cameroon has decided to opt for full taxation of aid. They consider that if they receive loans for public projects such as the construction of a road work, the taxation helps the state to organize the maintenance of this new public work. In the past, the EU demanded the exemption of financing, but now this is changing. On the other hand, China does not seem to accept this change for now.

These divergent practices between donors or lenders sometimes result in slowing down the help. The state of Cameroon must negotiate with each provider of funds, but the internal vision goes towards the taxation of cooperation funds.  The next stage is an implementation schedule with the IMF.

The seminar did not address specific positions of the Latin American countries, but the debate on the necessary transparency of public aid financing agreements between donors and beneficiaries is reproduced in the region in a similar way to the aforementioned conclusions.

General conclusion of the seminar: To overcome the divergences between donors and the different policies of developing countries, the consensus is to reduce the demands for exemptions, and to demand more transparency on these issues, for example, by prohibiting the existence of undisclosed exemptions.

[1]See https://economipedia.com/definiciones/ayuda-oficial-al-desarrollo.html
[2]See https://data.oecd.org/oda/net-oda.htm
[3]See https://ferdi.fr/evenements/webinaire-la-fiscalisation-de-l-aide-quel-avenir-pour-un-consensus-fragile
[4]See Domestic resources mobilization and tax collection, in https://www.un.org/esa/ffd/wp-content/uploads/2016/03/Report_IATF-2016-full.pdf

 

 

 

 

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Disclaimer. Readers are informed that the views, thoughts, and opinions expressed in the text belong solely to the author, and not necessarily to the author's employer, organization, committee or other group the author might be associated with, nor to the Executive Secretariat of CIAT. The author is also responsible for the precision and accuracy of data and sources.

1 comment

  1. UFABETทางเข้าเว็บไซต์แม่ Reply

    An interesting discussion is definitely worth comment. I do believe that you should publish more about this subject matter, it might not be a taboo subject but usually people don’t discuss these topics. To the next! All the best.

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