On 11 February 2022 a blog by the Director of the OECD Centre for Policy Administration and the Director of the OECD Development Cooperation Directorate looked at the taxation of projects financed by foreign aid.
Developing countries have frequently given tax exemptions to government-to-government aid projects, mostly in relation to value-added tax (VAT) and customs duties, but also for corporate income tax, personal income tax and payroll taxes.
The donor countries have requested tax exemptions on most projects funded by Official Development Assistance (ODA), on the grounds that these projects could give maximum benefit if they are not burdened by high taxes, lack of transparency or problems caused by inefficient government institutions. In recent years, however, as developing country tax systems have been upgraded and tax administrations have increased their professionalism, the potential problems from taxation have diminished.
Problems arising from tax exemptions
The economic benefits of granting tax exemptions have increasingly been questioned. Giving a tax exemption reduces government revenue and is an obstacle to domestic resource mobilisation. There are also further negative consequences of tax exemptions which may distort local markets by making imports artificially cheaper than locally produced goods. For investors, stable governance is a more effective incentive for investment.
The Addis Ababa Action Agenda in 2015 included a commitment for the donor countries to review their approach on taxation of government-to-government aid, beginning with a review of their position on customs duties and value added taxes.
Developing countries need to find the right approach to taxing development projects as this could help them to reduce their dependence on overseas development assistance and collect more tax revenues. Research has shown that these tax exemptions can amount to 2% to 3% of GDP in some developing countries
Online Transparency Hub
In January 2022 an online transparency hub on the tax treatment of ODA was added to the OECD website. The hub shows the approaches taken by a number of donor countries to claiming tax exemptions for the goods and services provided with funding from official development assistance (ODA). Currently twelve donor countries are participating in the hub. There are also includes links from the hub to additional resources.
The information disclosed on the hub shows how a number of donors are making progress on their commitment under the Addis Ababa Action Agenda to review their approaches to the taxation of government-to-government aid. beginning with a review of their position on customs and value added taxes.
UN Guidelines
The donor countries are also looking at alignment of their policy with the UN guidelines on taxation of government-to-government aid projects. The guidelines examine issues such as which taxes, entities and projects should be covered, and issues raised when projects are financed by a number of donors.
The UN Guidelines note that donors are free to establish the conditions on which aid is provided, but the giving of tax exemptions by developing countries does not help efforts to strengthen domestic resource mobilization.
