Why EY thinks it’s time to consider dropping SA’s corporate tax rate
DURBAN – As we approach Budget day next week, it may be time to consider embarking on a program to gradually reduce the headline rate of corporation tax in South Africa over a sustained period in order to foster and support an environment that attracts investments and drives economic growth according to EY South Africa.
Ekow Eghan, Tax Leader of EY South Africa said, "Globally, high corporation tax rates are fast going out of fashion. Cutting the corporate rate should align South Africa with this trend and arguably make it more competitive and provide a much needed boost to Gross Domestic Product (GDP) over time".
Currently the headline corporate tax rate in South Africa is 28 percent. As a comparison with some of our largest trading partners, US federal corporate rate is 21 percent, the UK’s 18 percent from April this year, and Germany’s 15 percent.
But it’s not only the developed countries that have rates lower than South Africa. In fact, South Africa’s 28 percent headline rate could be considered high when compared to our BRICS colleagues, other large African economic countries and some fast growing regions attracting foreign investment as can be seen from the table below:
Source: EY South Africa
Eghan cites three reasons why a lower corporate tax rate in South Africa should be considered
Firstly, "despite its high headline rate, corporate tax is only the third largest contributor to tax revenue and continues to see declining contribution to total tax collection," noted Eghan.
He said, "In addition to crowding out mobile capital when it is uncompetitive, the associated compliance and collection costs of corporate tax are relatively high".
He added that this makes it inefficient in comparison to other taxes because many companies find ways to get around not paying the full 28 percent headline rate. The overall economic impact of a rate cut therefore may be less dramatic for existing taxpayers.
"In contrast, a commitment to cut rates over an extended period could be powerful signaling to prospective entrepreneurs and investors who are critical to unlocking key pockets in our economy. For this group, the important indicator is the actual CIT rate, and not the change from a previous rate - a commitment to a reduction over a period could boost investor confidence," said Eghan.
The second reason is that corporations behave more like tax collectors than taxpayers as the corporate tax burden is ultimately passed on to individuals (for eg through higher prices to consumers or lower wages to employees).
Debates about who ultimately bears the CIT cost – the shareholders, employees or customers - show no clear consensus on what proportion of the burden each of these groupings absorb.
Eghan said. "Because the costs of corporate may partly fall on domestic wage earners, and even if immediate benefits of a rate cut favoured wealthy and foreign investors in the short-term, enabling policy measures – like better labour representation at the board - could ensure that some of those benefits drift to workers and households in the form of permanently higher after-tax real wages".
Finally, the general notion that high corporate rates serve to ensure fair contribution by foreign investors to South Africa’s welfare may be a double-edged sword given the inflection point we find the economy at.
He said, "Our corporation tax regime must balance policies that are competitive enough to attract new investors whilst ensuring that that it does not overburden existing highly mobile capital".
"A competitive CIT rate achieves both goals," said Eghan.
He emphasised that he does not propose a corporate rate cut as a short-term stimulus but rather is advocating for a phased-in rate reduction program to minimise short-term budgetary cost while broadening the tax base such that the rate cut pays for itself.
Eghan said, "We believe that you crowd out those who may be key to the much-needed growth process when corporate tax rates remain high. A lower rate could make becoming an entrepreneur more attractive than getting a regular job; our current tax law recognises this outcome by granting several, and often ineffective, incentives to small businesses to lower their burden. Mobile prospective investors are no different and will seek more competitive locations for their investment if it makes sense. For this grouping, a competitive headline corporate tax rate behaves like an ‘invitation to treat".
Eghan is also is hoping for a Budget that complements a credible plan to restore trust in the economy. The country needs a Budget that gives people honesty in spending and fairness in tax. This will require the Minister to reassert Government’s economic reform program and in particular address how new revenues generated from his Budget enhances those reforms.
"We hope that the Minister will recognise the need to put business at the heart of his Budget and set out a clear plan for the reduction of the deficit which continues to threaten business confidence and investment. We will also hope to be informed of where spending cuts in the public sector will fall and how swiftly those cuts will be implemented," concluded Eghan.
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