Rwanda will reduce tax exemptions to businesses as it seeks to shore up faltering revenues in the wake of key donors’ move to channel aid away from the central government.

The reductions, which entail revising the investment code, are among tax reforms the government last week agreed to implement as it adjusts to reduced aid. Other reforms are complementing withholding taxes on dividends and interest with a capital gains tax at a similar rate and reforming the value added tax (VAT) in the next fiscal year.

The changes will be part of the new Policy Support Instrument designed by the International Monetary Fund for countries that do not need balance of payments financial support, expected to be approved by the IMF board by December this year.

“The IMF identified gaps in our tax system, including the issue of exemptions and incentives; they feel there is a lot of revenue leakage through the incentives, in particular legislative exemptions in terms of investment promotions,” Ben Kagarama, the Commissioner General of the Rwanda Revenue Authority, told The EastAfrican.

Mr Kagarama said Rwanda would review its VAT regime in comparison to the tax rates in the region.

“We have a final draft of the revised investment code that is ready for presentation to other stakeholders,” he said, without elaborating.

In the financial year 2013/2014, total domestic revenues are estimated at Rwf994.9 billion, which is 60.2 per cent of the total budget.

READ: Domestic revenue to fund Rwanda’s budget

External resources are estimated at Rwf.658.6 billion of 39.8 per cent or the total budget.

Tax experts argue that the cost of tax incentives and exemptions provided by developing countries has been found to be unacceptably high, while it is difficult to measure the benefits derived.

Rwanda continues to face the challenge of adjusting to lower aid levels, despite improved donor sentiment following the signing of a regional peace agreement in February 2013, with economic growth slowing to 5.9 per cent during the first half of this year owing to a shortfall in donor budget support.

The IMF last week cut the country’s growth forecast for 2013 to 6.6 per cent, down from 7.5 per cent.

A 2011 report by Action Aid titled “The Impact of Tax Incentives in East Africa-Rwanda case study” estimated that Rwanda is forgoing at least 25 per cent of potential government revenue and 14 per cent of the country’s annual budget in incentives and exemptions to businesses.

Rwanda has the most generous incentives in the EAC for both domestic and foreign investment, ActionAid researchers noted, which could potentially be seen as distorting competition in the EAC.

READ: Rwanda to review ‘too generous’ tax incentives

“There is a need to protect the tax base against sophisticated tax planning — businesses avoiding taxation by taking advantage of incentives and then moving when they are no longer entitled to them,” said the report, authored by Rwanda’s Institute of Policy Analysis and Research.

Yet Rwanda’s domestic revenue, estimated at 12.7 per cent of GDP, is insufficient to fund government expenditure, forcing the country to rely heavily on donor aid, which accounts for approximately 40 per cent of government expenditure.

However, this year, RRA started enforcing tax reforms including introducing a new tax regime for small and medium businesses that now pay a flat rate of three per cent instead of four per cent.

And though the government has not been explicit about which sectors will be affected by the revised investment code, some reforms have already been implemented, affecting the construction sector, which has expanded aggressively over the years.

For instance, construction materials are now subject to the EAC common external tariff (CET) rate of 25 per cent, up from 0 per cent (for local investors) and 10 per cent (for projects worth $1.8 million) though construction materials not locally available are not subject to VAT.

It also introduced the use of licensed Electronic Sales Devices with 800 devices deployed in the pilot phase to increase efficiency in collection of VAT and e-tax payment.

Other reforms include strengthening public financial management, improving the effectiveness of monetary policy, increasing financial access and diversifying exports.