New Tax Incentive Regime Offers More to Investors, Overlooks Health and Education

The history of duty-free privileges dates back as far back as 1986, when they were applied to petroleum extraction investments, and 1993 when they were applied to the mining sector. Recently, Ethiopia has adopted a new investment incentive regulation, Number 517/2022, which was approved by the Council of Ministers in May and was published in the Federal Negarit Gazette in July. The incentive regulation has repealed the investment incentives provided under a 2012 Council of Ministers regulation. However, directives issued prior to the enactment of the new incentive regulation will remain under enforcement until replaced by new ones to be issued by the Ministry of Finance . In this article, EBR’s Bamlak Fekadu reviews the new incentive regulation.

The Ethiopian Government’s Investment Policy categorizes activities into those that are reserved for Ethiopian nationals, open to foreigners, and some that are open to foreigners in partnership with the government or Ethiopian nationals. The regulation aims at promoting investment in national priority sectors and increasing foreign direct investment while ensuring that incentives are properly implemented for the intended purpose in accordance with the investment proclamation approved in January 2020.

The proclamation replaced one that had been in use for eight years, and ushered in a synchronized and focused investment administration system and introduced changes of varying degrees to almost all areas covered. For instance, one of the new proclamation’s stated objectives is to enhance the national economy’s competitiveness by promoting investment in production and enabling sectors. This is a revamped objective in that the focus has shifted to making the economy globally competitive.

The most significant change introduced by the 2020 proclamation is its approach towards foreign investment. It has opened all areas of investment to foreign investors, except for areas reserved for joint investment with the government, domestic investors, and joint investment with domestic investors.

The previous proclamation preemptively listed areas of investment reserved for the government or for joint investment with the government, and it enabled the Council of Ministers to issue a regulation to open these areas to private investors. However, under the new proclamation, areas of investment reserved for joint investment with the government, domestic investors, and joint investment with domestic investors are all to be specified by a regulation. Another new development is the introduction of reserved investment areas for “joint investment with domestic investors” – a category that was absent from the previous proclamation.

The 2020 investment law reserved light and labor-intensive businesses for domestic investors, while opening areas that require capital, skill, and technology to foreign investment.

In addition to other things, the investment incentive proclamation sought to increase the role of private sector investment in all economic sectors, develop a fast-track economic framework, improve export performance, boost employment opportunities, increase and diversify foreign investment inflow, transfer technology, skill, and knowledge, and encourage equitable investment distribution.

The Council of Ministers recently passed a new Investment Incentive Regulation No. 517/2022, repealing the Investment Incentives and Investment Areas Reserved for Domestic Investors Council of Ministers Regulation No. 270/2012 and the Investment Incentives and Investment Areas Reserved for Domestic Investors Council of Ministers (Amendment) Regulation No. 312/2014, with the promulgation of a new investment proclamation and regulation in 2020.

The old regulations providing for investment incentives excluded sectors that have not been under the mandate of the Ethiopian Investment Commission (EIC). Incentives for these excluded sectors used to be regulated through laws enacted by the specific sector regulator. One such sector is mining. For instance, the then Ministry of Mines & Energy (now Ministry of Mines) enacted a directive providing for the duty-free importation of vehicles for licensees in the mining sector.

The new Regulation also includes areas that will be eligible for incentives, such as investments in software development, data center and cloud services, business outsourcing procedures, start-up development services, and research, innovation, enrichment, and development projects. The investor is also exempt from income tax if they help Ethiopians find work abroad. The industries that are eligible for investment incentives are those that are included on the “Investment Areas and Income Tax Incentives Schedule” (“Schedule”) of the New Regulation. However, the legislation has given the Ministry of Finance (MoF) considerable latitude to modify the sectors that are eligible for income tax exemption.

It strives to retain fiscal incentives including income tax exemptions and duty-free privileges as incentives available to investors, despite the fact that it has not implemented many new modifications regarding incentives. The Regulation has broadened the spectrum of industries eligible for tax incentives and provided targeted incentives for a few industries that it hopes would expand or spur investment in rural areas.

It states that an investor who invests in disadvantaged and remote areas with poor infrastructure from Addis Ababa will be rewarded a 30 Pct income tax deduction for three consecutive years and will be entitled to an additional deduction after the expiry of the tax holiday. Furthermore, if new investments are made in hotels and properties that are similar to hotels in specific tourist areas, they will be exempt from paying income tax for five years.

When it comes to exportable goods and services, investors who make investments outside of industrial parks and who export or provide supplies to exporters are entitled to at least 60 Pct of their final products or services as well as a one-time income tax exemption for two years in addition to the regular tax holiday. Investors who make investments in industrial parks and who export or give supplies to an exporter of at least 80 Pct of their goods or services are also beneficiaries.

The venture kinds, area, expansion, and other factors influence the incentive eligibility. Expansions include adding new production or service lines to an existing enterprise, expanding the volume of an existing business by at least 50 Pct of its feasible production or service rendering capability, or increasing both the volume and diversity of an existing business by at least 100 Pct.

The stipulation exempts capital goods and building supplies from customs duty in relation to another fiscal incentive, duty-free or customs-related. An investor is entitled to a refund for import duties paid on raw materials and component parts used as input for the production of goods if they purchase the goods from local manufacturing industries. An investor can import capital goods or construction material duty-free for new investments or use it to upgrade existing investments. Additionally, the Regulation lays forth guidelines for the transferability of duty-free goods and products as well as penalties for breaking those standards.

The new Investment Incentive Regulation maintains the distinguishing characteristics of the 2012 Incentive Regulation, namely the itemization in a schedule of particular investment areas entitled to (sometimes denied) investment incentives, according to Tadesse Lencho (Ph.D.), an assistant professor at Addis Ababa University who has taught for over ten years and is an expert in tax and bankruptcy law.

Tadesse perceives itemization reduces administrative manipulation of incentives, which has been a cause of controversy for a long time. However, it increases the administrative uncertainty associated with the incorrect classification of investment areas. As there are variable tax holiday periods, investors might classify themselves in a category accorded a higher tax holiday period only to realize later on that their investment area falls under another category. The expert recommends incentivized investment areas, centralized tax incentive administration, and consolidation of tax incentive rules.

Tadesse recognizes the role of the MoF in being the primary authority in supervising tax incentives as it is the fiscal policy arm of the federal government. The tax incentive regulation centralizes administration, relegating previously key actors such as the Ethiopian Investment Commission (EIC) to processing, collating, and submitting investor requests to the MoF for approval. This centralization is expected to encourage sharp focus on the rationality of forgoing government revenues for the sake of gains in investment, employment opportunities for Ethiopians, and the transfer of technology.

It will be simpler for beneficiaries and regulatory agencies to use a single point of legislative reference as a result of the consolidation of tax incentive laws into one body of law for authorizing, executing, and overseeing investment incentives in Ethiopia.

“Let’s hope this discipline endures in the future,” Tadesse told EBR.

Previously, tax incentive directives might be found in other fragments of law, including non-tax regulations like those governing mining and oil exploitation. Some of the key sectors that the Regulation has focused on are ICT, hospitality, health, agriculture, transport, and logistics.

“It doesn’t sound as new as it appears,” Tadesse notes.

However, a few notable new investment sectors were added to the existing list of tax-incentivized investments, such as “atypical” and novel investments in hotels with a certain number of stars, resorts in particular tourist destinations, investments that open up job opportunities for qualified and certified Ethiopians to work abroad, investments in Information and Communication Technology development (ICT), investments in tertiary specialized hospital services, and logistic services. As a result, they may consider exceptions based on the project’s location, effectiveness, and kind. Directives will clarify what “atypical” and “designated tourist destination locations” are in the meantime.

Tajudine Seid, a transistor, harshly criticizes the change that hands authority to MoF to decide on customs and tax-related packages.

“The federal government must consider ratifying flexible and clear directives as customs and tax-related issues are confusing in nature,” Tajudine said. “Confusing articles are the common power source for embezzlement.”

Daniel Fekadu, an expert on business law, advises investors to keep books of accounts and report the same to the tax authority as the regulation requires investors to prove eligibility. If the investor engages in multiple sectors eligible for incentives, a separate record should be kept for each investment activity.

“Failure to keep books of accounts results in the denial of the incentives for that specific year,” Daniel told EBR. “There must also be a separate record of income derived from investment expansion or upgrading.”

Further, the eligibility periods for income tax exemption start to run from the date the investor is issued a business license or an investment expansion/upgrading permit. However, Daniel sees this article as unappealing for investors expanding or upgrading their existing investment because the period of income tax exemption begins to count down from the date the expansion permit is granted.

“In order to avoid confusion, clear and structured directives have to be developed since some sectors are eligible for both customs duty exemption and income tax exemption while others are only eligible for customs duty exemption,” Daniel suggests.

The schedule specifies the length of time that investors will be excluded from paying income tax, which for the majority of the qualifying sectors runs from one year to six years. The building and renting of industry parks (including ICT parks) and investments in forestry and related industries both enjoy comparatively longer periods of income tax exemption, surpassing eight to nine years for the former and 10-15 years for the latter.

Like its predecessor, this regulation intends to promote the expansion of already-existing firms while simultaneously promoting a welcoming environment for newcomers. Examples of such legislation are those that allow investors to benefit from both duty-free and temporary tax exemptions. According to experts, the modification is a move made to distribute the cost of new investment by businesses.

The new regulation provides a complete list of tax and duty incentives for income that are given to promote investment in areas that qualify. Additionally, tax relief has been granted to a number of high-priority industries, including those in the food industry, chemical and chemical products industries, textile and textile products industries, leather and leather products industries, and textile and leather products industries.

The same is true for the production of beer and beer malt, which is exempt from income tax for two or three years under the beverage industry. The production of alcoholic beverages is exempt from income tax for one to two years, depending on the investment sector, and the production of wines is exempt from income tax for three to four years.

The use of incentives has been the ongoing topic of discussion. Government officials saw them as being critical to promoting the expansion of domestic companies in all sectors, which is essential for eventually raising more money through taxes. Increasing Foreign Direct Investment (FDI), which has been hovering at around USD 3.5 billion over the last five years, is also considered by authorities as having a comparative advantage.

Despite the fact that the regulation grants the MoF this authority, the investment board was given the authority to decide on incentive packages. The National Bank, the main Department of Immigration and National Affairs, the Ministry of Trade and Industry, the Ministry of Foreign Affairs, the Ethiopian Customs Commission, the Ethiopian Investment Commission, the Industrial Park Development Corporation, and regional administration on the incentive package made up the Ethiopian Investment Board, which was chaired by the Prime Minister on the 2012 incentive regulation.

A recently passed investment law, however, provides tax relief for alcohol-related investments while excluding investments in health, education, printing, and other industries from the privilege. The provision doesn’t give duty exemptions for investments in the health sector such as hospital service, the provision of diagnostic service, or clinical service, but it does provide for tertiary specialized hospital service.

The legislation does not, however, offer tax or duty concessions for investments in the hotel and tourism sectors, the building contracting industry, or the printing sector, unlike the previous directive. This covers both information technology services and other services provided with the aid of information technology.

Prime Minister Abiy Ahmed (Ph.D.) announced during the inauguration of the first free-trade zone in Dire Dawa town that, in addition to the new investment proclamation, upcoming directives will leverage the private investment sectors. He urged the local investor to be the beneficiary of upcoming policies, directives, strategies, and directives that will support and beef up local investors’ productivity. EBR

11th Year • Jan 2023 • No. 114