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Rationale for a hike in tax rates for RMG sector

Published: Tuesday, May 19, 2015

FE-PRI EAU Special

Posted : 19 May, 2015 00:00:00


Rationale for a hike in tax rates for RMG sector

Saeba Ruslana

Rationale for a hike in tax rates for RMG sector

Tax resource mobilisation in Bangladesh has been unsatisfactory and much lower than that of other countries at a similar stage of economic and social development.

With the limited sources of tax revenue (mainly value added tax or VAT domestic and income tax) and gradual reduction in import-based revenue, it has become more essential for the government to increase its tax base and areas of revenue generation.

Despite being the most dynamic and profitable sector of Bangladesh, it is a fact that the readymade garments (RMG) sector remains the most under-taxed one. The export basket of Bangladesh is dominated by RMG, accounting for almost 80 per cent of its total export earnings.

By taking advantage of an insulated external market under the provision of Multi-Fibre Agreement (MFA), complemented by the right support policies at home, it attained a high profile, in terms of foreign exchange earnings, exports, industrialisation and contribution to gross domestic product (GDP) within a short span of time.

During the last five years, exports of RMG have grown by an average of 15 per cent.  This growth has been partly achieved owing to preferential treatment from the European Union's (EU's) Generalised System of Preferences or GSP and Rules of Origin (ROO) facilities and the Duty-Free Quota-Free (DFQF) access granted by Canada, Japan, Australia etc.

The sector currently contributes to about 16 per cent of Bangladesh's GDP. Estimates suggest that there are more than four thousand garment factories in the country employing more than four million workers.

Given its status as a critical export sector for Bangladesh, it enjoys various fiscal incentives---cash incentives, duty drawback and bonded warehouse facility---from the government. Tax at source on export of knitwear, woven garment and other selected sectors is considered as final settlement and the sectors need not pay any other taxes.

For nearly two decades, the RMG sector was exempt from all taxes until a tax of 0.25 per cent on export receipts was levied in FY 2005. The tax at source was raised subsequently to 0.4 per cent in 2011, 0.6 per cent in 2012 and 0.8 per cent in 2013. Until 2014, the tax at source for apparel item exporters was 0.80 per cent on their export proceeds. However, in April, 2014, National Board of Revenue (NBR) reduced the tax at source to 0.30 per cent that would continue until June 30, 2015 in a bid to increase competitiveness of the sector in the international market in a situation of rising costs faced by it and the political turmoil that ensued in the country.

The NBR assessed that reduction of tax at source on export of RMG products would cost at least Tk 20 billion (2000 crore) in revenue.

Alternative scenarios involving different rates of profit and their respective turnover tax rates are given in Table.2. If we assume an average profit of 10 per cent on RMG exports' turnover and the top income tax rate of 30 per cent of taxes, the turnover tax will stand at 3.0 per cent. Even if we were to consider the 30 per cent income tax is charged on a mere 3.0 per cent profit rate, it will result in a turnover tax rate of 0.9 per cent which is still quite meagre in amount.

A report published in 2007 stated that share of profits of the RMG industry enjoyed by the garments factory owners were well above 25 per cent. The current tax rate of 0.3 per cent is far too less given the profit margins of RMG producers and has resulted in significant revenue losses for the NBR.

In two main competitors of Bangladesh in the RMG sector -- neighbouring countries India and Pakistan -- corporate taxes have to be paid by the enterprises in the sector. The RMG producers in Bangladesh are not subject to any corporate taxes.

The corporate tax rate currently stands at 30 per cent in India and 35 per cent in Pakistan which is uniform for all businesses.

Thus despite exhibiting its massive potential for generating revenue for the government, the taxes levied on to the RMG sector are minimal in the light of their expected profit margins.

This also appears discriminatory when compared to other sectors and with taxation in competing countries. Herein lies the rationale and scope for higher taxation of income of RMG producers and exporters.

(The writer is Saeba Ruslan, Senior Research Associate, PRI. FE-PRI Economic Analysis Unit)