handbook-tb

Tax incentives: protecting the tax base2.2.2.7 OvervaluationOvervaluation (or sometimes undervaluation) is a constant problem inany tax system. Tax incentives, however, may provide additional temptationsto inflate the values of assets. For example, where a tax holidayis conditional upon a certain minimum amount being invested,the value of assets contributed to the new firm can be manipulatedto achieve the target figure. Sometimes this is done legitimately. Forexample, firms may purchase machinery rather than lease propertyfrom independent lessors. Other times, however, an inflated value isattributed to the property contributed, especially in the case of intellectualproperty. In cases where investors also receive an exemptionfrom customs duty for newly contributed capital, no compensatingmotivation exists to correctly state the value, and no reason exists forcustoms authorities to pay much attention to the declared value. 342.2.2.8 Abuse of duty-free privilegesA common investment incentive takes the form of an exemption fromcustoms duty on imported equipment. A danger is that, once imported,items may be resold on the domestic market. A partial solution is torestrict the exemption to those assets that are contributed to the chartercapital of the enterprise. Even so, it may be necessary to verify periodicallythat the assets remain in the enterprise. Another approach isto restrict the exemption to assets such as machinery (which are lesslikely to be resold) and to exclude items such as passenger vehicles andcomputer equipment.2.2.2.9 Asset stripping and “fly-by-night” operationsMany countries have experienced problems with “fly-by-night” operatorsthat take advantage of tax incentives to make a quick, tax-freeprofit and then disappear to begin operations in some other country34Sometimes there is a further problem. Foreign investment agencieshave an incentive to boost their investment figures, so that there is somesort of common interest between the agency and the investor to inflate theamount of the investment. It is thus important for the tax administration tobe involved in the valuation process.479