It is a universal practice to tax companies that earn a profit for the economic benefits derived in a country. One such important tax that applies in this regard is the Corporate Income Tax (CIT). In Zambia, the CIT rate has been applied at 35 percent until recently in 2022 when it was adjusted downwards to 30 percent for all industries except for telecommunications which is currently taxed at 35 percent. The country’s CIT rate prior to the adjustment was one of the highest in the sub-region and even higher than the Organisation for Economic Co-operation and Development (OECD) member countries’ average of about 25 percent. The downward adjustment by the government was inspired by the need to attract investment and stimulate business growth. The size of Foreign Direct Investment (FDI) inflows as a percentage of GDP has been reducing over the years. Between 2010 and 2021, the average Net FDI was only 3.93 percent of GDP. Over the same period, the annual percentage share of Net FDI to GDP dropped from 8.5 in percent in 2010 to negative 3.7 in 2021.
Generally, developing countries find income taxes a more attractive source of revenues compared to consumption-based taxes such as general sales taxes or Value Added Taxes (VAT). This explains why most developing countries have higher CIT rates. Against this fact, however, is the need for many of these countries to attract Foreign Direct Investment (FDI) to support their deficient resources caused by low levels of savings domestically. Nonetheless, a high CIT rate poses its own risks towards FDI receipts. The CIT rate strongly impacts on the effective tax rate which may influence investor incentives and their choices of where to invest. Moreover, with the capacity gaps that most developing countries have in curbing tax evasion, a higher tax rate may increase taxpayers’ incentives to indulge in base erosion and profit shifting. Tax Planning and other profit-shifting strategies are more likely to occur and can have severe consequences on tax revenue performance.
A high CIT rate can also have a negative effect on employment creation and job sustainability due to capital outflows. This risk is heightened for countries that have a large part of their workforce providing unskilled labour to multinational companies (MNC) as this labour can easily be acquired elsewhere when investor choices shift to other locations with lower rates. Another repercussion is the distortion of competition which is rooted in compliance. Businesses that are compliant tend to be affected the most by changes in taxes compared to businesses that are not compliant. This implies a higher CIT will increase the tax burden more on those businesses that are compliant than those not compliant.
While a lower CIT rate can promote investment in Zambia. It comes with a direct consequence on tax revenues. The revenue loss from the downward adjustment of the CIT rate from 35 percent to 30 percent in 2022 was estimated at K600 million Kwacha. Financing such a huge gap becomes a problem especially when tax compliance is low. What can help is improving the CIT administration to make it more effective. However, changes to tax administration only become effective over time. Thus, the government must lean on quick measures that broaden the CIT base. For instance, a minimum CIT can be considered targeting non-compliant businesses. The amount of this payment can be tied to the company’s turnover. But this minimum payment may also help in dealing with inactive businesses that increase administrative costs when auditing them takes place.
Caution, however, must also be taken not to place the attractiveness of foreign investment solely on CIT. In fact, studies have shown that factors such as labor costs are stronger determinants of FDI than the CIT. Thus, the government should also focus on lowering the tax burden for workers, especially unskilled labor.
Zambia Tax Platform
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