Tax incentives for Investment with a Special Reference
to Egypt
Introduction
Tax legislation is tax law issued by the legislative authority (people's
council) according to the institutional rule: the right of establishing, adjusting and
canceling taxes is a pure right for the legislative council of the community.In Japan, tax holiday is granted mainly to new businesses that are directed
toward exporting and petrochemical industries and toward "targeted industries"
that are related to developing technology and environmental protection and
achieve social equity, however, in times of extended budget deficit this tax
incentive becomes less important. In Morocco, new investments in tourism sector
are granted tax holiday for five years, and then this grace period is extended to a
subsequent period of taxation at a reduced rate (50% of the formal tax rate). Almost all countries grant tax exemption for savings, this permanent tax
holiday is important since investments depend partially on quantities of savings
for financing investments. In Spain, this incentive is called Tax Preferred Pension
Fund. In England, payment for servicing debt related to buying houses as well as
pension and capital gains are exempted from personal income tax and this is
called Special Saving Accounts Tax Exemption. In the US, retained profits as well
as, pensions, life insurance and installments for buying houses are exempted
from personal income tax. In Italy, returns to bank deposits, post office deposits,
personal bonds, and capital gains are exempted from the personal income tax. In
Germany, savings are exempted. Tax holiday is extended to the greatest scope in
Bahamas where there are no taxes on capital gains, corporation income,
personal incomes, sales as well as returns to shares for individual, personal
firms, and for corporations. Tax holiday is also used in commercial preferential trade agreements among
countries, in these agreements countries agreed to grant mutual custom's
exemptions for tradable goods that fulfill the origin criteria, usually a good that
has a local components equivalent to 40% of the value added of the final product
will satisfy the national origin criteria. Tax Holiday in Egypt
 According to tax law 91 for year 2005 two kinds of investments are
temporally exempted form income tax as following:
1- Profits of land reclamation or cultivation enterprises, for ten years from the
date of activity inception. 2- Poultry farming, apiculture, livestock husbandry and fattening, fisheries, fish
farming enterprises and fishing boats enterprises profits, for a period of ten
years from the date of activity inception. On the other hand permanent exemptions from income tax according to law
91 for year 2005 includes: 
1- Physical persons' income received from their investment in securities
registered with the Egyptian Stock Exchange Market. 2- Physical persons proceeds from: a) Securities and financial deeds of different
types, registered with the Egyptian Stock Exchange Market, whether issued
by the State or shareholding companies. b) Dividends from shares in joint
stock companies and partnerships limited by shares. c) Dividends from equity
quotas in limited liability companies, partnerships, and partnerships limited by
shares. d) Dividends from investment securities issued by investment funds. 3- Interest which physical persons receive from their deposits and saving
accounts in banks registered in the Arab Republic of Egypt; investment,
saving and deposit certificates issued by said banks; deposits and saving
accounts in post office funds and securities and deposit certificates issued by
the Central Bank. 4- Profits from new projects set up by funding from the Social Fund for
Development (SFD) to the extent of such funding for a period of five years
from the date of starting the activity or starting production, as applicable. This
exemption will only apply to those whose names were signed in the loans of
the Fund. 5- Educational institutions, subject to the supervision of the government, public legal
persons, Public Sector or State-Owned Enterprises (SOE). 1- Revenues of self-employed professionals registered as members of their
professional syndicates in their fields of specialization, but only for three years from
the date of practice. 2- Revenues of areas planted in desert lands for a period of ten years starting from the
date the land is considered productive
Low Tax Rates
 Regimes applying reduced tax rates to certain activities or enterprises require
a number of rules to minimize tax avoidance. A typical example can be given of
low tax rates applied to income earned by small businesses. The first problem is
to define small businesses in relation to a given threshold. The threshold can be
measured in terms of assets, capital, number of employees, or total sales. The
choice among these criteria, which can be used in combination, will depend in
part on the type of business being targeted and on the compliance and
administrative costs that are entailed. Care must be taken to target the low tax
rate to appropriate types of activity and to prevent it from being used to avoid
taxes that should be paid at the personal level. Tax legislator reduces the tax rate for the targeted industries relative to other
industries. Targeted industries are more important and vital for the society, e.g.
industries encourage technological developments, or manufacturing or that
preserves the quality of environment, or industries that exporting their output to
foreign countries. In Lebanon, corporations are liable to lower tax rate than
individual and personal firms who make net profits greater than specific amount. In number of countries tax legislator relates the rate of reduction in income tax
to the turnover number of the firm, or to the new products produced by the firm. This tax incentive may be granted to corporations that have tradable securities in
the stock market. This means that tax incentives may be used to change the
legal form of the firm, and to make these firms more open, which may encourage
family business or closed ones to be changed into joint stock firms. Countries may provide reduced rates of, corporate income or profits tax to
particular types of activity. Some countries provide a reduced rate of tax for
certain types of investment (e.g., the reduced rate for manufacturing in Ireland). Other countries provide reduced tax rates for investment in particular locations or
regions (e.g., the reduced rate for investment in special economic zones and
other designated regions of China). The Egyptian legislation:
a) Used preferential tax treatment in tax law 187 for 1993, where corporation
income tax was reduced from 40% to 32% for industrial business and for
income generated from export. This tax incentive was canceled in the tax law
number 91 for 2005. b) Exempt profits from the revaluation of the assets of a sole proprietorship will be
exempted from income tax when providing this as an in-kind share to the capital of
a joint stock company, providing that the shares corresponding to the in-kind share
are nominal, and shall not be disposed of within five years
c) Deduct 30% of the cost of the machinery and equipment used in production,
whether they are new or used, at the beginning of each tax period during which
such assets are used. The depreciation base shall be calculated for that period
after the deduction of the said 30% amount. The taxpayer must maintain proper
books and accounts. Accelerated depreciation of capital assets
 The term "accelerated depreciation" generally refers to any depreciation
scheme that provides for writing off the cost of an asset, for tax purposes, at a
rate faster than the true economic depreciation.Other tax incentives:
Zones
 Countries use two types of special "zones" to attract investment: (a) duty-free
zones, enjoying exemption from customs duties (and usually from VAT); and (b)
special economic zones, in which investors enjoy other tax privileges not granted
in other parts of the host country. Duty-free zones and export processing zones (EPZs) are intended to facilitate
the trans-shipment of goods, and the processing of imported materials or
components for export. Exemption from VAT and customs duty is granted on
imported goods, because those taxes would normally be refunded on export. To
grant additional tax privileges (e.g., tax holidays) to these activities may be
inappropriate and may violate the WTO prohibition against export subsidies. By contrast, special economic zones are intended to promote economic
activity within a designated area, and are not restricted to exporting. They
consequently should not be given favorable customs treatment. Double taxation prevention treaties
 Signing these kinds of treaties will reduces tax burden for foreign investors and
will encourage them to invest more in the country. It is important for tax legislator
to be sure that this tax incentive is being directed towards investors and not their
countries. This task is not simple. Egypt Has signed 30 double tax prevention agreements with different countries,
these countries includes: Italy, Yugoslavia, Denmark, Libya, Germany, Syria,
Korea, Hungary, Cyprus, United Arab of Emirates, Cheek Republic, Sweden,
Jordan, Belgium, Lebanon, Turkey, Tunisia, Pakistan, South Africa, Bella Russia,
The Arab Union Countries, Bahrain, Palestinian Liberalization Organization,
Bulgaria, The Netherlands, Yemen, Malta, Poland and Ukraine. Indexation
 Advanced countries use indexation to cancel the effect of inflation on the tax
burden of individuals and corporations, through relate tax bases and some kind
of price indices. This method prevents what is called "Brackets Creep" which
implies increasing tax burden without a real increase in the real income; this will
preserve the real levels of profits and income. In
addition one of the important GATT's agreements was "Commercial aspects for
the investment regulations" which requires from any country sign the agreement
not to discriminate against foreign investment "National treatment principle", so
any country should eliminate all investment regulations break this principle. Tax and non-tax incentives
 Some general notes should be considered when discussing tax incentives for
investment, these are as following:
1- The existence of tax incentives is a necessary condition for attracting local
and foreign investments, but it is not a sufficient one. This can be explained
by the need for the existence of important additional conditions (non-tax
incentives for foreign investments) such as: 
a) Political stability and security inside the country, since capital cannot be
attracted to places that lack security and stability. b) Sufficient legal guarantees for investors against confiscating of their
capital, the right to transfer their money abroad, the right to liquidate their
business and to choose a court system different from local system, and
may be the existence of institution to guarantee investments. c) The perception of local people toward foreign investment, for example if
they perceive foreign investments as necessary for development and for
creating work opportunities for local people, and the social environment is
open, then this will encourage these kinds of investments. d) The existence of a good infrastructure and good investment opportunities,
this is because foreign investments are attracted to less developed
countries not to develop these countries but to participate in the
development process of these countries and to take advantage over this
participation. e) The existence of stock markets especially to develop indirect investments
in order to expand existing capacities and to develop the already
established business. f) Joining WTO as an important signal for openness of country's markets of
goods and services and that there is no control over foreign exchange. 2- Excessive generosity in providing tax incentives to encourage investors
may not work; in fact these excessive incentives may increase economic
problems of the national economy; creating or increasing budget deficit
because of the decrease in tax revenues due to the incentives. Budget
deficit's problem may be very difficult for economies suffering from expanding
public debt, in this case a country will find itself forced to finance budget
deficit through either borrowing more money from the banking system which
creates inflationary pressures or through imposing more taxes and this will
affect economic sectors negatively and will reduce the efficiency of tax
incentives themselves.. 3- Countries attracting foreign investments should be interested not only in
the quantity of investments but also by the quality of them. It is noticed that
most of foreign investments attracted to the Arab world are from the
traditional industries and not from the high technology industries like the case
for Asian and Latin American countries. High technological investments
increase the competitive position of these countries in the future. One reason
for the lack of high tec. Industries in the Arab world is the ineffective
protection for property rights. 4- The severe competition among less developed countries in attracting
foreign investments, especially in this era of WTO, may increase the cost of
foreign direct investment to LDC's in terms of increasing public expenditure
on infrastructure and other facilities and a reduction in government revenues
because of tax incentives. One of important conferences addressed this issue "Investment's horizons
and guarantees" was held in Beirut in 2002 has reached that the major reasons
for low level of foreign investments attracted to the Arab countries were:
a) Bureaucracy and value judgment of the administrative authorities in these
countries.For those countries,
however, that do not generally provide accelerated depreciation, a tax incentive
can provide for deducting the cost of acquisition more quickly than would be
allowed under the normal "benchmark" depreciation schedules. The cost of accelerated depreciation, in terms of tax revenue foregone, is
normally less than that of tax holidays or investment allowances/credits, since it
is only the timing of the tax payable, and not the amount of tax, that is affected. That, of course, can still be a substantial benefit to established businesses that
are planning to increase their investment, but in the case of most initial
investments, where there may be no profit for several years, accelerated
depreciation will be of no benefit. To understand how this tax incentive works let us analyze the following
exercise: the acquisition, cost of a productive asset is one million pounds the
expected economic life of this asset is ten years, net annual profits for this asset
is 200,000 pounds, the nominal tax rate is 15%, if the discount rate is 10% and
the salvage value for the asset is zero at the end of the asset life. Calculate the
increase in the net present value and the internal rate of return when applying the
accelerated method (five years) instead of the normal depreciation method. First: normal depreciation method: 
Annual depreciation installment = 10% or L.E.100,000
Net present value of the asset = L.E 136,700 
Internal rate of return =13%
Second: Accelerated depreciation method: 
Annual depreciation installment = 20% or L.E.200,000 during the first five 
years, then it becomes equal to zero during the last five years of the asset life. Net present value of the asset = 13.8%
 Now by comparing between the two methods we found that accelerated
depreciation has increased the net present value by L.E 21,900 or 15.79%, at the
same time internal rate of return has increased by 6.15% in the case of
accelerated depreciation. This tax incentive has been used by many countries, In US, during the Korean
War; accelerated depreciation was used in industries that support the war. In
particular, businessmen are required to have a certificate from the department of
defense that their product is important for defense purposes to have the right to
use the method of accelerated depreciation. By the end of the war, US
government stopped using this method of depreciation for defense purposes. In Canada tax legislator use this method in the manufacturing, capital,
agriculture industries, and mining, where a special accelerated depreciation
scheme of two years is used, they call this method "Accelerated Capital cost
Allowances".In fact investment in tools, equipments, machineries and productive capacities
(formation of human capital through good education and health programs and in
natural capital through increasing the absorptive capacity of the environment)
achieves economic growth through two avenues; direct method (increasing the
capabilities of the national economy by building infrastructure: electric power,
water, roads, airports and communication systems that encourage businessmen
to invest in manufacture industry. This investment will create new jobs and
opportunities for exports and increase gross national product and improving the
standards of living. Readers should remember that the final increase in the
income and production will be a multiple of the initial increase in investment
because of the existence of investment multiplier and investment accelerator. b) Encouraging domestic industries to supply foreign investment with
equipments, materials and services, since FDI usually increases the demand
on local components of these investments.There is another indirect avenue in which investment encourage economic
growth, which can be explained through:
a) External economies achieved to the national economy through transferring
technology and other administrative and marketing skills that foreign direct
investment (FDI) brings to the domestic industry, in addition, through
demonstration effect by the domestic industry to the foreign industries located
locally.Accelerated depreciation method in Egypt:
 This method has never been used for depreciation of assets; however income
tax law 91 for 2005 has, to some extent and implicitly, used this method by
stating specific tax life time for different assets as following:
1- 5% of the cost of procuring, constructing, developing, renovating or
reconstructing any building, establishment, ships and aircrafts, for each tax
period.Non-tax factors are the market size, access to raw materials, e.g., natural
resources, energy supplies, availability and cost of skilled labor, access to
infrastructure, transportation costs, access to output markets, e.g., high
consumer demand in region, low export costs, political stability, macro-economic
stability and financing costs. The mobility of economic resources among countries helps solving two
economic problems: domestic resource gap (when a country needs a level of
investment greater than domestic savings), and foreign exchange gap (when the
value of imports exceeds the value of exports evaluated by the foreign
exchange).b) During this stage, governments may establish free zone areas to encourage
investments located in specific locations or regions like ports, airports and
regions where good investment opportunities are existed for production and
exports.This grace period is might be extended for the whole productive
life of firms, and sometimes is extended to a subsequent period of taxation at a
reduced rate
 Tax holidays have the apparent advantage of simplicity for both the enterprise
and the tax authorities; however a number of technical issues are important in
determining the impact of tax holidays on the return on investments.How useful, and at what cost, depend on how well the tax
incentives program is designed, implemented, and monitored 
 It should be noted that accelerated depreciation and tax credits are more
efficient than tax holiday, since they enter directly into the feasibility studies of the
projects, and are related to the size of investment and profits.The following appendix shows tax incentives in three emerging economies in
south-east Asia: Indonesia, Malaysia and Philippine, it may be a good exercise
for students to compare between the tax incentives in these countries and in
Egypt, and relate these incentives to the size of FDI in these countries in order to
get some useful conclusions.The incentives are used for direct investors to real investment in productive
activities rather than investment in financial assets, and are often directed to
foreign investors on the grounds that there is insufficient domestic capital for the
desired level of economic development and that international investment brings
with it modern technology and management techniques.In the
post-WTO world, developed countries also adopt tax regimes that favor export
activities and seek to afford their resident corporations a competitive advantage
in the global marketplace.Almost all countries have issued investment laws that concern with
encouraging investment; provide different kinds of guarantees to investors in
areas of free trade, transferring profits abroad, freedom of movement of labor,
raw materials, and capital among countries.Not only free trade areas are existed inside countries but also
regional and international free trade areas are established among different
groups of countries e.g. Greater Arab Free trade Area GAFTA which will
encourage intra-trade among Arab countries and encourage FDI in the
region if the Arab countries have a strong political will to make it successful.Tax incentives can take the form of tax holidays for a limited duration,
current deductibility for certain types of expenditures, or reduced import tariffs or
customs duties.Now if Tax
incentives are successful in encouraging more investors, then tax revenues will
automatically be increased as a result of the increase in the gross domestic
product and this will compensate the decrease of tax revenues because of the
provided tax incentives. From the empirical point of view: There exist different kinds of case studies
that proof the great importance of investments to national economies as
following:
a) International comparison among countries shows that there is a positive and
significant relationship between growth rate in GDP and the
investment/output ratio.These two gaps are highly correlated; in addition foreign exchange
gap may not be covered by rising saving rate of the community if the domestic
investment requires equipments and raw materials import spare from abroad.Tax incentives in the developing countries are used to
encourage domestic industries and to attract foreign investment.