By Jorge Moreira da Silva, Director of the OECD Development Co-operation Directorate and Pascal Saint-Amans, Director, OECD Centre for Tax Policy and Administration
Should projects financed by foreign aid be subject to tax? Historically, donors have claimed tax exemptions on most projects funded by Official Development Assistance (ODA), reasonably arguing this would maximise the impact of ODA, not least by sparing these projects from the perceived hazards of high taxes, lack of transparency and corrupt or inefficient government institutions. However, these assumptions have been increasingly challenged in recent years. Many developing countries have made strides in improving their tax systems, simplifying regimes, professionalising administration and reducing the burden of compliance.
In addition, there has been growing reluctance to take the economic benefits of tax exemptions for granted. While this has mostly been focused on tax exemptions for investment, where evidence points to stable governance as a much more effective incentive for investment, questions are also being asked of ODA tax exemptions. Here there are also concerns about broader negative economic spill overs, for example, distorting local markets where exemptions make imports artificially cheaper than local production.
As a result, policy makers are looking again at policies on the taxation of ODA-funded projects. In 2015, the Addis Ababa Action Agenda committed donor countries to review their policies on the taxation of government-to-government aid starting with customs and value added taxes (VAT). While there is a commitment to review policies, little information has been available until recently either to donor or to recipient countries.
Getting these policies right is all the more important as developing countries look to reduce dependence on ODA and generate sustainable tax revenues. According to research by Ferdi, exemptions on ODA can amount to 2%-3% of GDP in some developing countries – almost equivalent to how much governments are spending on education in sub-Saharan Africa. A survey of 20 developing countries by the African Tax Administration Forum and the Overseas Development Institute found that tax exemptions on ODA were widespread in developing countries, with 95% providing VAT exemptions. Meanwhile, 70% of developing countries do not have estimates of the impact of exemptions on VAT; of those that did, only one-third made those estimates publicly available.
To increase transparency on this issue, 12 donors, accounting for over 50% of gross bilateral ODA in 2020, have now agreed to publish information on a new online transparency hub on the tax treatment of ODA. This highlights how a number of donors are making progress on the Addis commitment to review their policies, as well as making efforts to align policy with the new UN Guidelines on the tax treatment of government to government aid projects. This information highlights the challenges of designing policy on ODA taxation by addressing questions such as which taxes, actors and activities should be covered, or how to deal with projects financed by multiple donors.
Donors have an opportunity to provide information and encourage greater transparency and dialogue between all actors on the policy and practices of ODA taxation. All donors are encouraged to contribute to a better understanding of the issue, including by participating in the hub, and to review their policies in order to meet their Addis commitments.
 To find out more, join the OECD Tax and Development Days on 17 February 2022 for a live session on “The OECD Official Development Assistance Taxation Transparency Hub – A new tool to increase the understanding of ODA taxation”. Register here