Letter from... Singapore

In a bid to remain competitive as an investment destination, Singapore is considering cutting its corporate taxes further and, to balance this cut, it is likely to raise the Goods and Services Tax (GST), similar to VAT, from 5% to 7%. GST now accounts for 19% of the Government’s tax revenue.

Details and timing of the tax changes will be spelt out in the 2007 Budget to be unveiled on 15 February, but Prime Minister Lee Hsien Loong has already warned that these changes will be necessary to ensure the country remains competitive against others in the region, especially Hong Kong which is considering introducing GST to cut back its corporate tax rate.

Singapore’s corporate tax rate is one of the lowest in Asia at 20%, but still above Hong Kong’s 17.5%. ‘With competitive taxes, they [Hong Kong] will attract investments which may otherwise come to Singapore,’ Lee warned in November.

Governments around the world are under enormous pressure to curb headline tax rates, especially corporate taxes. Over the past 14 years, the global average tax rate has fallen from 38% to about 27%, and recent research from KPMG International points to a clear link between low tax and economic success. Countries with favourable corporate tax regimes, such as Ireland, Norway, Sweden and Denmark, have posted higher than average economic growth.

‘From a tax point of view, globalisation is giving corporate taxpayers more choice in terms of where they locate their assets, people and intellectual property. This means for governments that their tax base can come and go. That’s why governments are trying to find ways to get a steady tax base for revenues,’ said Loughlin Hickey, KPMG’s global head of tax and a UK partner.

‘By lowering tax rates you actually bring more wealth into the country, which means you get more to tax that you can tax at a lower rate.

‘Countries like Singapore, Hong Kong or some from the EU are all gambling that if they are bringing their tax down more corporate wealth will come in which will create more corporate profits, employment profits for indirect tax,’ he said.

The shift from direct taxes to a GST in Singapore is expected to ensure that not only does the country remain internationally competitive, but that it relies on a more stable source of tax revenues, as GST tends to be less affected by economic cycles and international corporates can come and go.

Despite a lack of natural resources and a small consumer base, the Lion City has managed to attract large investments from multinationals over the years by consistently lowering the cost of doing business on its shores. Customs duties are non-existent (except on alcohol, cigarettes and cars) and there is no tax on capital gains.

GST was introduced in 1994 and has already been raised twice. The last increment was from 3% to 5% in two equal instalments in 2003 and 2004, but it remains at one of the lowest rates in Asia. China’s consumption tax rate stands at 17% and India and New Zealand follow, with rates at 12.5%.

While budget expenditure has been kept low at 14%–15% of GDP, the Government has indicated its willingness to increase public spending over the coming years to implement new social programmes and strengthen the social safety net for lower income groups and its growing elderly population.

Apart from tax revenues, the Government can also draw on investment income from its reserves to fund its expenditure. The Constitution currently provides for the Government to spend up to half of the net investment income (NII) on past reserves. NII is defined as dividend and interest and does not include realised capital gains; the Government intends to make constitutional changes for the latter to be included.

While maybe unpopular, the timing of this new GST increase corresponds with a period of strong economic growth, which will make it easier to absorb, says Hickey. GDP is forecast to expand as much as 7.5% this year, while unemployment is down to 2.7%.

Sonia Kolesnikov-Jessop is a freelance journalist regularly contributing to Newsweek and the International Herald Tribune.