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State-Owned Enterprises: Tax Neutrality

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Practice Advice on Public Financial Management

State-Owned Enterprises: Tax Neutrality (OECD) 

Summary Advice: The equal treatment of public and private business activities is important for competitive neutrality. The OECD recommends governments to adopt tax neutrality approaches to ensure that government businesses face similar price signals as comparable private sector businesses.

Main Points:  Public, private and third sector operators are subject to a different tax treatment due to their legal form or ownership structure. Differences in tax treatment, especially in the range of direct or indirect taxation such as corporate/income taxes, value-added taxes, property taxes, and registration taxes, lead to complaints from the private sector regarding the unfair advantages faced by public sector businesses. 

To ensure a level playing field, government businesses should face similar price signals as comparable private sector businesses. State-owned enterprises (SOEs), whether ordinary stock companies or statutory corporations.  The OECD recommends adopting a competitive neutrality framework, which would impose a tax neutrality rule, ensuring that government businesses bear a similar tax burden as their private sector competitors. Given the sometimes subtle and indirect nature of exemptions, governments should consider a number of approaches to deal with taxation:

  1. Firmly enforced principles of non-discrimination for incorporated business
  2. Compensatory payments in lieu of taxation for unincorporated business activities
  3. Adjusting prices for government services to reflect increased cost of taxation.

Concerns about a level playing field increase considerably when SOEs operate in a cross-border context.  An on-going debate covers a number of interrelated, but distinct issues surrounding state-owned enterprises. First, the perception that foreign SOEs in some countries benefit from concessionary finance and indirect subsidies such as tax exemptions, allow them to compete stronger and also to embark on a series of corporate takeovers abroad. Second, governments have sometimes been accused of raising regulatory barriers unfounded in genuine public-interest objectives with the purpose of protecting their own enterprises.  Third, while public procurement procedures are subject to rigorously enforced laws and regulations in virtually all OECD countries, SOEs are mostly found in sectors where complex contracts and multiple bidding criteria are common. Governments have been accused of benefiting from the complexities and gray zones to effectively give preferential treatment to national companies.  The OECD provides the following guidance points:

  • In cross-border trade, business in similar situations carrying out similar transactions should be subject to similar levels of value added taxation.
  • In cross-border trade where specific administrative requirements of foreign businesses are deemed necessary, value added tax should be administered in a way which does not bear disproportionate or inappropriate compliance costs for business.
  • In cases where tax rules cannot be evenly applied, governments should ensure transparency surrounding such tax exemptions in order to determine and rectify possible advantages associated with them.

Another potential source conflict is partial exemption from income tax. It is a potential distortion because the effect on prices charged by state enterprises, in comparison to those charged by private competitors will depend on how rates of return targets are expressed.  If a SOE faces and achieves a rate of return target that is expressed as an after-tax rate of return on assets employed, which is comparable to its private competitors, then that state enterprise will have significant competitive advantage if its business is mainly directed at sales to state agencies.  Alternatively, if the same SOE were to set a before tax rate of return target comparable to its private sector competitors, then the tax exemptions should not flow through to lower prices.

Source: OECD (2012) "Competitive Neutrality: A Compendium of OECD Recommendations, Guidelines and Best Practices" at http://www.oecd.org/daf/corporateaffairs/50250955.pdf  (accessed February 12th, 2013).

Page Created By: Khilola B. Zakhidova on 18 February 2013, updated by Ian Clark on 8 March 2013. The content presented on this page is drawn directly from the source(s) cited above, and consists of direct quotations or close paraphrases. This material does not necessarily reflect the official view of the publishing organization.

 

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