Rwanda plans to implement tax reforms that could see the country scrap some exemptions to businesses in the next three months, as it seeks to shore up its faltering revenues in the wake of growing budgetary needs.

The government is also likely to introduce a flat income tax system in the next financial year which begins in June, though this will largely depend on the findings of a study being carried out by the Ministry of Finance.

Presently, workers are placed in various income bands and charged 30 per cent. The tax proposals are contained in a country review by the International Monetary Fund under the Policy Support Programme agreed between the country and the global financial institution.

It is, however, not clear if the government will raise the minimum salary that attracts tax. This would not only give workers extra cash in the wake of rising cost of living, but also ease pressure on executives to increase wages.

John Rwangobwa, the Rwandan Finance Minister  told The EastAfrican that the decision on  the tax reforms will be made later this month after the government finalises assessing the findings of the tax reviews studies.

Economists and business executives say scrapping tax exemptions — informed by concerns the country was forgoing more revenues than any other country in the region in order to woo investors — would test Rwanda’s standing as East Africa’s most attractive foreign investment destination.

Over the years, Kigali has generously dished out a raft of tax exemptions that experts are warning is denying the country revenue needed for growth.

“Authorities agreed to introduce the revenue measures in order to offset the losses that resulted from the reduction in fuel taxes,” said Dmitry Gershenson, the International Monetary Fund resident representative for Rwanda.

Rwanda’s domestic revenue estimated at 12.7 per cent of Gross Domestic Product as of 2011/2012 is insufficient to fund government expenditure forcing the country to rely heavily on donor aid which accounts for approximately 50 per cent of government expenditure.

Tax revenues have come under attack as the economy grapples with high inflation and as government rolls out incentives to cushion households and businesses.

The total revenue loss from fuel tax reduction of Rwf100 ($0.16) per litre in the fiscal year 2011/12 is estimated at Rwf14.1 billion ($23 million) or 0.4 per cent of GDP.

The government hopes to offset the shortfall  through a tax receipt from a new telecom license offered to Bharti Airtel worth $100 million.

According to the IMF, the government has proposed to introduce new measures to boost domestic revenue including revisions to the investment code to reduce exemptions and remove specially negotiated lower tax rates for priority sectors.

These are expected to bolster domestic revenue by some 0.6 per cent of GDP, keeping revenue at 14.2 per cent of GDP in the financial year 2012/13 — with the overall fiscal deficit declining to 1.1 percent of GDP, the IMF said in the report.

This should also help government to reduce dependency on donor aid and create fiscal space for needed development spending.

Mr Gershenson also noted that government is conducting a study to broaden the tax base, which may include a proposal to introduce a flat tax though he did not divulge the details. However, government faces significant challenges given the weight of its “untaxable” subsistence agriculture on the economy.

“Rwanda’s tax base is small; the tax burden is borne only by companies that operate in the formal sector and by the people they employ. Bringing more businesses into the formal economy is the only way to increase revenue collection in the long term,” Mr Gershenson said.

Tax experts say a review of the tax incentives granted to foreign investors is necessary considering that it will be taking place six years after the enactment of the Rwandan investment code.

They also argue that the cost of tax incentives and exemptions provided by developing countries have been found to be high, while it is difficult to measure the benefits derived.

Last year, a report by ActionAid 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 harmful taxes, distorting competition in the region.

“There is a need to protect the tax base against sophisticated planning, that is, businesses avoiding taxation by taking advantage of incentives and then moving when they are no longer entitled to them,” said the report titled The Impact of Tax Incentives in East Africa- Rwanda case study, prepared by Rwanda’s Institute of Policy Analysis and Research.

Among the key tax exemptions is import of building and finishing materials that are not produced in Rwanda.

IPAR researchers said exempting the first Rwf 12 million ($20,236) of turnover from taxation for farmers may be considered over-generous.

Non-farm small enterprises have to start paying tax when their turnover exceeds Rwf 1.4 million ($2,360) and a proportion with incomes below this threshold pay local taxes from which farmers are also exempt.