handbook-tb

Protecting the tax base of developing countries10. Tax incentives10.1 GeneralTax incentives are widely used by both developing and developed countriesto attract foreign investment. Although it seems likely that multinationalenterprises use tax incentives to erode the tax base of both developingand developed countries, developing countries may be more susceptibleto such base erosion because of a greater need for foreign investment andless capacity for the effective administration of tax incentives.Tax incentives for foreign investment can be divided into twomajor categories:(a) Incentives that directly reduce the cost to a non-residentof an investment in the source country (for example, a taxholiday or reduced tax rates); and(b) Incentives that indirectly reduce the cost to a non-residentof an investment in the source country (for example, the laxenforcement of thin capitalization or transfer pricing rulesby the source country).The key issue for developing countries is how to design andadminister tax incentives for foreign investment in order to maximizetheir effectiveness.10.2 Cost/benefit analysis of tax incentivesThe ostensible benefit of granting tax incentives for foreign investmentis increased foreign investment and the consequential economic benefitsfor the source country. Often these benefits are simply assumedto occur and rarely are attempts made to quantify them prior tothe granting of the incentive. The benefits of tax incentives must beweighed against their costs, which include:‣ ¾ forgone tax revenues;‣ ¾ the costs of administration and enforcement;‣ ¾ possible misallocation of economic resources;‣ ¾ opportunities for corruption.43