Business Profit Tax - Does it make us better off?

Recently the Majlis has passed the Business Profit Tax Act, and it has come into effect on 18th January 2011. According to the Article 41 of this Act, the law has to be implemented within six months, (by July 18th 2011). This means, businesses in Maldives have to pay tax on business activities carried out after that date. I wonder how many firms or businesses actually are aware of this., and I wonder whether the relevant authorities are doing enough to make the public aware of this. Anyway, that is not the issue that I intend to cover here. I guess what's more interesting would be; how much does this Act reduce the gap between the rich and the poor (ie, make the distribution of income and wealth more even); and by how much does this Act raise the government's tax revenue. There are many other issues relating to taxation that we need to talk about, and I may talk about such issues in a later post. Issues like the efficiency of a tax; compared to the amount of tax revenue raised, the cost of raising such revenue must be minimized in order to make it more efficient.

First of all, let me raise the question; why do we need taxes? Yes, to raise government revenue. Last year (2010), an estimated Rf3.0 billion was raised through taxation by the Government; mainly consisting of import tax, tourism bed tax, and bank profit tax. Through tax revenue, government is able to provide public goods, and provide benefits to the poor, hence, help in reducing the gap between the rich and the poor.

The existing tax system, however has done little in terms of addressing the issue of income distribution in the country. As import tax is paid on all goods imported and consumed, both the rich and the poor pay the same amount of tax. Making this a very regressive form of tax, as considering the income of the rich, the tax burden on them will be very small, compared to the poor. Even the bed tax from tourism industry is very regressive, as the same amount, $8 is paid by all resorts/hotels, irrespective of the room charge. In order to narrow the gap between the rich and the poor, taxes need to be more progressive in nature; meaning to collect a higher percentage of the rich people's income, and a smaller percentage from the poor.

Another objective of taxation is to discourage consumption of certain goods or services. For instance, import tax of certain goods like cigarettes can be increased, in order to discourage consumption.

So, how does the Business Profit Tax (BPT), reduce the income gap in Maldives? There are certain categories of businesses specified in the Act, and taxable incomes are specified. For example, Article 3 highlights on registered companies that are not partnerships, and Article 4 specifies businesses other than companies and partnerships. According to Article 7, all companies, partnerships and other businesses are required to pay 15% of the profits, provided that total profits exceed Rf500,000. If the profits do not reach Rf500,000, no tax has to be paid.
According the 2011 budget, an estimated Rf612 million is to be raised through BPT. This is highly unlikely, as the taxable period only starts from July of this year.

How does BPT help in narrowing the gap between the rich and the poor? Unlike the $8 bed tax, at least its not the same absolute amount that larger businesses and smaller businesses will be paying. A proportional tax rate of 15%, from all types and sizes of businesses in the Maldives may not be the ideal solution for evenly distribution of income.

Larger businesses if required to pay a higher percentage of tax, would make the tax system much progressive in nature. However, will it encourage further investments in Maldives? Will it attract more foreign investments in the country? One of the ways we can encourage businesses to innovate, and increase investments would be to reduce the direct tax on the income or proft, and move towards more indirect forms of taxation.