Assessing the Impact of Interest Limitations on Corporate Taxation and Foreign Investment in Tanzania/Magesa Jackson Sambila

 Assessing the Impact of Interest Limitations on Corporate Taxation and Foreign Investment in Tanzania

.Student Name: Magesa Jackson Sambila

Submission: 30th November, 2024  

1. Introduction

The rise of international tax issues, due to economic integration, highlight the limitations of century old-tax frameworks, allowing for BEPS. Policymakers are reforming tax systems to tax profits where value is generated. Driven by OECD’s BEPS Project, many countries now implement interest limitation rules to counter profit shifting via excessive interest deductions in low-tax jurisdictions. For developing countries like Tanzania, interest limitations, corporate taxation, and foreign direct investment (FDI) are closely interconnected.

2. Literature review

Interest limitation rules are essential for preventing BEPS by multinationals. Devereux, Freedman, and Vella argue that these rules protect tax revenue by limiting profit shifting through high debt in high tax countries. Buettner and Wamser empirically show multinationals use internal debt to shift profits to low tax jurisdictions, making such rules vital. The OECD’s BEPS Action 4 and the EU’s Anti Tax Avoidance Directive cap net interest deductions at 10-30% or 30% of EBITDA, respectively, to curb excessive deductions. In Africa, interest limitations offer both opportunities and challenges. ATAF highlights the need to balance revenue protection with investment. In Tanzania, interest limitation rules targeting companies with high debt-to-equity ratios, Mwinuka and Mwombela in Tanzania Economic Review show that while Tanzania’s thin capitalization rules align with anti BEPS goals, they may deter foreign investment in capitalintensive sectors. Despite of protect tax revenue they might reduce Tanzania’s attractiveness compared to regional peers.

3. Regulatory Framework

Tanzania’s interest deduction regulations, set out in Section 12(2) which provide that the total amount of interest that an exempt controlled resident entity may deduct in accordance with section 11(2) for a year of income shall not exceed the sum of interest equivalent to debt-to-equity ratio of 7 to 3, enforce thin capitalization rules to limit excessive interest deductions by highly leveraged. This cap on interest expenses aims to curb profit shifting, where inflated debt levels reduce taxable income in Tanzania. However, studies indicate that strict enforcement may deter FDI, particularly in-debtdependent, capital-intensive sectors.

4. Impact of interest limitation

Interest limitation rules in Tanzania impact both local and foreign investment by capping interest deductibility, these rules can reduce local businesses profitability and restrict growth, as limited deductions raise borrowing costs. However, these rules are vital for revenue collection, as they reduce profit shifting and protect the tax-base.

5. Challenges and Policy Recommendations

Tanzania like other developing countries faces challenges in enforcing interest limitation rules, including Tanzania Revenue Authority’s limited capacity, high compliance costs for local businesses, and loopholes allowing debt-to-equity manipulation. Effective enforcement is hindered by TRA’sadministrative constraints, while compliance burdens can strain SMEs. Strengthening TRA capacity, easing compliance for businesses, and considering alternative models like fixed-rate caps could improve enforcement and maintain an investment friendly climate.

6. Conclusion

Tanzania’s interest limitation rules protect tax revenue by reducing profit shifting but challenge FDI. Balanced enforcement and streamlined compliance can foster a tax environment that supports revenue and growth.