Tax Incentives in Three Common Markets

• Publication year: 2022
• Citation: Vol. 50 No. 2

Tax Incentives in Three Common Markets

Sarah Khaled Alsultan^*

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TABLE OF CONTENTS

I. INTRODUCTION.....................................................................................444

II. THE TAX MIX IN GULF COOPERATION COUNCIL STATES......................445

III. THE CLASSIC ARGUMENTS AGAINST TAX INCENTIVES........................447

A. Compensate for Countries' Disadvantages............................448
B. Create Harmful Tax Competition..........................................449
C. Ineffective.............................................................................453
D. Transfer Revenue to Investors' Home Countries....................456
E. Undermine Tax Revenues......................................................459
F. Distort Investment Decisions.................................................464

IV. TAX INCENTIVES' LEGAL FRAMEWORK IN THREE COMMON MARKETS 464

A. United States.........................................................................465

i. The Commerce Clause: Between the Congress and the Court..............................................................465

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ii. How Companies Manipulate States; Amazon HQ2 as an Example..........................................................................469

B. European Union...................................................................472
C. Gulf Cooperation Council.....................................................477

V. THE MERITS AND DEMERITS OF THE THREE APPROACHES TO MANAGE INCENTIVES..................................................................................482

A. Bidding War.........................................................................483
B. Predictability........................................................................484
C. Policing................................................................................486
D. Flexibility.............................................................................487

VI. CONCLUSION......................................................................................488

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ABSTRACT

There are three approaches to dealing with tax incentives within common markets: permit them, limit them, or harmonize them. Broadly speaking, the United States (U.S.) follows the first approach, the European Union (EU) adopts the second, and the Gulf Cooperation Council (GCC) pursues the third by harmonizing some tax incentives, particularly those offered to the industrial sector. Unlike the U.S. and EU common markets, where incentives have gained significant scholarly attention, no academic literature exists on the legal framework of tax incentives in GCC common market. This work attempts to compensate for this insufficiency in scholarship and compares the three approaches.

This work also explores the case against locational tax incentives and concludes that the conventional case against tax incentives is overall debatable, and further evidence considering the ongoing changes in international tax policy is needed to better evaluate the case. Furthermore, this work analyzes the advantages and disadvantages of the three approaches to dealing with tax incentives. In particular, this work explores how effective the approaches are in managing bidding wars, increasing tax law predictability, allowing flexibility to reform domestic tax policy as needed, and policing tax incentives. It concludes that each method has its limitations, advantages, and disadvantages. Thus, another contribution that this work offers is the inclusion of a holistic examination of the three approaches that merits focusing beyond the one consideration on which much of the existing literature focuses, that is, bidding wars between competitor states.

Although this work primarily aims to assist GCC policymakers in deciding the best policy option for managing tax incentives, this scholarship is helpful even beyond the GCC. Federal countries and regional blocks that see and experience incentives competition can benefit from this work since it analyzes the merits of different approaches to managing incentives in general. Keywords: Tax Incentives, State Aid, Dormant Commerce Clause, Tax Competition, Gulf Cooperation Council, GCC.

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I. INTRODUCTION

In an unprecedented shift in tax policy, most of the Gulf Cooperation Council (GCC) states (Kuwait, Bahrain, Kingdom of Saudi Arabia (KSA), Qatar, United Arab Emirates (UAE), and Oman) have introduced locational tax incentives.¹ These include tax holidays for up to fifty years or other forms of tax incentives granted at the authorities' discretion on a case by case basis to lure foreign businesses' investments in the last two decades.² Some GCC states have announced that they are planning to adopt generous tax incentives in their impending special economic zones. Their introduction across the GCC states at approximately the same time suggests the emergence of tax incentives competition in the GCC common market.³ The rise of this competition evokes the following questions:

• What is the legal framework for locational tax incentives in GCC common market?
• How valid is the classic case against tax incentives?
• How are other common markets, in particular the United States (U.S.) and the European Union (EU) common markets, dealing with tax incentives?
• What lessons can be learned from the three common markets' experience in addressing tax incentives?

This paper examines these questions.

There are three approaches to deal with tax incentives within common markets: permit them, limit them, or harmonize them. Broadly speaking, the U.S. follows the first approach, the EU adopts the second, and the GCC pursues the third by harmonizing some tax incentives, particularly those offered to the industrial sector. Unlike the U.S. and EU common markets, where incentives have gained significant scholarly attention, to the best of this author's knowledge, no academic literature exists on the legal framework of tax incentives in the GCC common market. This work is the first to investigate the legal framework of tax incentives in the GCC common market and compare it to the legal framework of tax incentives in the U.S. and the EU common markets.

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The paper also considers the conventional case against tax incentives, specifically that incentives:⁴ should not be used to compensate for disadvantages, distort behavior, create harmful tax competition, are ineffective, undermine tax revenues, and transfer tax revenues from host countries to investors' home countries. This paper concludes that, overall, the arguments are open to debate. This paper exposes the fact that the recent ongoing changes in tax policies worldwide have impacted the conventional case against incentives.

Finally, this paper analyzes the advantages and disadvantages of the three approaches that deal with tax incentives. While much of the existing literature often focuses on just one consideration—tax competition or a so-called "bidding war" between states or local governments—to argue in favor or against regulating tax incentives, this article considers three other important aspects—how effective the approaches are in increasing tax law predictability, tolerating flexibility to reform domestic tax policy as needed, and policing tax incentives.

Although this work primarily aims to assist GCC policymakers on whether to permit, limit, or harmonize locational tax incentives within the GCC common market, this scholarship is helpful even beyond the GCC. Federal countries and regional blocks that witness incentives competition can benefit from this work since it analyzes the merits of different approaches to managing incentives in general.

This work is divided as follows: Part I briefly introduces GCC states' tax mix in order to provide a necessary background. Part II reassesses the arguments against foreign investment tax incentives. Part III discusses the legal framework of tax incentives in the United States, EU, and GCC. Part IV examines and compares the advantages and disadvantages of each approach to manage tax incentives.

II. THE TAX MIX IN GULF COOPERATION COUNCIL STATES

The GCC states are high-income developing countries where oil plays the central role in funding states' spending.⁵ The region can be characterized as a low or no tax jurisdiction regarding indirect taxes, direct

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taxes on individuals, and corporate income tax (CIT) on domestic enterprises. For example, no personal income tax and no gift or inheritance tax exists in any GCC state.⁶ There are limited property taxes and social security taxes that exist in all six states.⁷ So far, four states have implemented value added tax (VAT) at a 5% rate with the other states soon adopting such a tax.⁸ Sin taxes are also levied on a few items, such as tobacco products, alcohol, and energy drinks. The VAT and sin consumption taxes were harmonized in GCC agreements in late 2016.⁹

Regarding CIT, the normal domestic tax regime generally favors domestic companies. In Kuwait, the KSA, UAE, and Qatar, either the tax laws or the tax authorities provide such treatment. Kuwait applies different tax rates to national and foreign companies; the latter are taxed at a 15% rate, and national companies are either not taxed at all or taxed at a 1% to 2.5% rate depending on a company's form.¹⁰ Similarly, KSA national companies are

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subject to Islamic Zakat at 2.5%, while a 20% rate is applied to foreign companies.¹¹ Qatar tax law exempts national companies but taxes foreign firms at a 10% rate.¹² The practice in the Emirates of UAE is to only tax foreign banks and oil companies.¹³ However, not all GCC states follow this trend. Oman applies the same regime to both national and foreign companies, taxing them all at a 15% rate.¹⁴ Bahrain, on the other hand, does not tax non-oil national and foreign companies.¹⁵ Since 1989, under the GCC tax antidiscrimination rule, GCC companies are treated as nationals for tax purposes.¹⁶ Thus...