Uganda faces the challenge of balancing a complex array of tax incentives with ambitious income goals to attract investments that will drive its economic growth and benefit its young population.
The country introduced 10-year tax exemptions for companies located in industrial parks to attract significant foreign direct investment.
However, economists are concerned that these incentives might end up benefiting businesses more than the state itself, potentially leading to persistent fiscal deficits that could affect the stability of the regional currency, salaries for public servants, and essential public services, thus defining Uganda’s financial narrative.
Uganda has had to focus on increasing tax revenue collection, given the need to break free from this cycle. Reducing the government’s reliance on debt is the larger objective, as this dependence puts significant strain on its financial resilience.
For example, in the 2022–2023 fiscal year (FY), the government’s fiscal operations resulted in a deficit of Shs10.1 trillion, equivalent to 5.5 percent of the gross domestic product (GDP). While this exceeded initial expectations, it still represents a significant improvement compared to the 7.4 percent recorded in FY2021/2022, highlighting the government’s unwavering commitment to fiscal consolidation.
To address this imbalance, the government has resorted to a combination of domestic and external loans. National treasury data reveals that this has led to an increase in the public debt stock, from $20.99 billion (Shs79.2 trillion) in June 2022 to $23.66 billion (Shs89.3 trillion).
The key issue is that some of Uganda’s largest businesses are allegedly exploiting tax cuts, particularly tax holidays and accelerated loss tax incentives, for businesses located more than 50 kilometers from Kampala. Some of these entities are suspected of using tax havens to influence their operations and take advantage of available tax incentives.
A 2021 study conducted by the Uganda Revenue Authority (URA) and the UN University found that affiliates of multinational corporations (MNCs) have effective tax rates about five times lower than their sizable domestic counterparts, particularly those linked to countries with which Uganda has a double taxation agreement.
This disparity raises significant concerns about the equitable contribution of different entities to the national tax pool and the potential harm it could cause to local businesses. Uganda currently has nine such agreements in place, collaborating with countries including Zambia, Denmark, India, Italy, Mauritius, the Netherlands, Norway, South Africa, and the United Kingdom, according to statistics from Cristal Advocates.
Nicholas Musoke, a superintendent of study and revenue modeling at URA, stated, “We conducted research on profit shifting two years ago, and it showed that it is more common when the multinational is from a tax haven.”
Companies registered in tax havens often make substantial investments in multiple countries with favorable economic indicators, making it easier for them to repatriate their profits. For instance, on November 14, Africa Capitalworks SSA 3 acquired 51.18 percent of Cipla Quality Chemical Industries Limited as part of a $25 million (Shs934.3 billion) deal involving a Mauritius-based private equity firm.
Ugandan authorities and URA have demonstrated a commitment to addressing income evasion over the past decade. This has led to changes in existing tax policies, such as the narrow capitalization rules in 2018 and the revision of transfer pricing regulations in 2011.
However, despite these efforts, the study mentioned above highlights ongoing issues with double taxation agreements (DTAs) and the impact of certain tax breaks on the market. Low tax revenues remain a challenge for the government, resulting in fiscal deficits that reached Shs2.3 trillion in October 2023. According to statistics from the October business efficiency report, the government struggles to collect taxes from only two million of its 45 million registered taxpayers.
Critics argue that, despite economic challenges, the country continues to grant tax breaks to large multinational corporations, costing it over Shs160 billion annually, even though tax revenues remain at only 13 percent of GDP, falling short of the desired 20 percent.
These incentives are intended by the government to attract new investments, promote specific industries, and create job opportunities. However, empirical data, including the findings of a study titled “The Rise of Ineffective Incentives in Developing Countries,” suggests that while the use of tax breaks by institutions in developing nations has become commonplace worldwide, their impact on growth remains unclear. These incentives can potentially have negative effects on public finances and vital sectors such as education and health.
Economic scientist Ms. Saila Naomi Stausholm noted in the mentioned study that “The impact on foreign direct investments is negligible and has little bearing on actual economic growth.” She pointed out that the impact on public finances is detrimental and undermines the government’s ability to chart its own path to growth.
In November 2023, URA released a study examining the effectiveness of tax incentives, particularly tax holidays and accelerated depreciation tax benefits, and their impact on both the economy and the businesses benefiting from them. The study covered 104 companies located in industrial parks, 11 involved in processing agricultural products, and 15 focused on exports.
“Multinationals accounted for more than 30% of the incentives in place, despite being the least profitable companies among the sampled firms.” According to Mr. Musoke, these companies often face employment issues. He continued, “The state needs to target these incentives to those who need them most.” For example, smaller agro-processing companies need these incentives to add value to their products for larger-scale trading.
Mr. Musoke also suggested that oil companies should start filing their returns remotely to be considered for such data. He emphasized the need for ongoing monitoring to ensure that the criteria included in their proposals to receive these incentives are effectively met.
Agro-processing companies were found to import less, which is concerning as this sector relies on labor-intensive crops. According to Mr. Corti Paul Lakuma, the head of the economics department at the Economics Policy Research Centre, this sector employs over eight million people, accounting for 70% of Uganda’s workforce.
In conclusion, Uganda’s preference for lower tax rates and accelerated depreciation for businesses located more than 50 kilometers from Kampala has raised concerns. A study mapping business income incentives offered by Uganda from 2014 to 2021 found that the country provides fewer and less diverse tax breaks compared to its regional counterparts in Sub-Saharan Africa.
Accelerated depreciation allows businesses to deduct a larger portion of an asset’s cost from their tax returns in its early years of use. According to research supported by URA, the reinstatement of accelerated depreciation tax incentives led to a significant increase in new investments in sectors like flowers and machinery.
Even in the fifth year after the reinstatement of this incentive, increased investment levels remained resilient, contrary to concerns that this effect might be merely a timing adjustment.
The study also revealed concerns about the manipulability of the 50-kilometer threshold, as there is no definitive list of qualifying firms based on their distance, according to the URA and the companies themselves.