The myth of foreign investment - II

ARTICLE: Since Pakistan's FDI policy and its legal framework is conceptually flawed and by itself the cause for this failure therefore the country needs to adopt new FDI policy/legal framework or may have to scrap even some of concerned departments (as was done in India) to start afresh altogether with a policy which needs to have the following features:

Abandon import substitution

Pakistan must abandon/scrap the present policy of import substitution for FDI projects as import substitution for FDI projects has been discarded in other successful FDI models. The new FDI policy has to be geared for attracting the type of FDI called export platform FDI by diverting or even restricting FDI to export-oriented manufacturing industries in which FDI project output is exported to third countries at least to some minimum extent.

Statute amendment required

For diverting FDI to export-oriented manufacturing industries the statues/laws of the country in this regard play important role. However, Pakistan's statutes in force in this regard are not supportive or conducive for this purpose. The standing SEZ Act 2012 is the latest basic governing statute in this regard but it is not geared up for attracting or giving preference to export platform FDI as it grants equal tariff benefit/tax exemption at par to local sale of FDI project output without any condition of export at all. The relevant extract of the SEZ Act 2012 in this regard reads as under:

"37 Benefits for zone enterprises.- All zone enterprises shall be entitled to the following benefits, namely:-(a) one time exemption from customs duties and taxes on import of plant and machinery into SEZ - {b) exemption from all taxes on income for enterprises commencing commercial production by the thirtieth June, 2020, in the SEZs for the next ten years".

As per the quoted extract of Pakistan's basic statute SEZ-12, FDI projects are entitled to claim full tariff benefit/exemption of all taxes on all of its income even if it is based on 100% local sale of its output without any export of FDI output or even zero export. So the SEZ Act 2012 is not even designed to attract export platform FDI in the first place or the basic statute is rather antae export. Not only is that SEZ-12 counterproductive for turnaround, the IT Ordinance 2001 also grants exemption from." All taxes on income" of FDI projects without any qualification or condition of FDI output export but exemption is granted to income of FDI enterprise under all heads of income for a period of ten years. Since there is no condition of export of FDI output for exemption in these two statues thus an FDI plant even producing cigarette/shoes/bottle water, etc, selling 100% locally gets exemption from income tax or tariff benefit. Thus our basic statutes by design are counterproductive for economic turnaround.

In this regard Pakistan's case is an exception as other countries have a built-in condition in statute of export of FDI output for claim of income tax exemption/tariff benefit like in India where the statute itself restricts income tax exemption only to the "profits and gains derived from the export, of such articles or things or from services for a period of five consecutive assessment years". Similarly, in China FDI projects are subject to normal income tax but with 50% reduction in income tax if in the year at least 70% of PDI output is exported, or in Brazil where for a claim of exemption the FDI project must export at least 80% of the FDI output. Not only that but foreign companies in India have higher tax @ 40% and@ 50% if a foreign company has income from royalty/technical services but in Pakistan royalty/technical fee is taxed @ 0 to 15%.

Therefore, at the least, section 37 of the SEZ Act 2012 and Clause (126E) 2nd Schedule, Ordinance 2001 need to be amended on an urgent basis to prescribe the condition of export of at least 70-80% of FDI output for claim of exemption. Even otherwise Pakistan must amend its statues/policy framework to be at par with other countries adopting the international practice based on the principle that there should be no tariff on raw material or local tax like VAT, etc., on export goods but income tax exemption for FDI project will be on the condition of 70-80% export of FDI output. Without an amendment to the statute all effort in this regard will fail. Moreover, country's tax rates for royalty/technical fee/dividend need to be reviewed to bring it at par with other countries.

Dividend balancing

The SEZ Act 2012 includes the clause that the benefits granted under the law cannot be withdrawn, thus the required statue amendments may take time or invite litigation, therefore for the moment the option of adopting the condition of dividend balancing for FDI projects is available under which the cumulative remittance of foreign exchange on account of dividend over a period of 5 years to foreign investors shall not exceed the cumulative amount of export earning of the FDI project itself during those years. The dividend balancing condition for FDI projects is in vogue in many countries and the absence of this condition has a damaging effect on Pakistan's economy as the hard-earned foreign exchange by local parties is consumed by the FDI profit remittance, therefore it is a built-in condition in other countries' FDI policies but not in Pakistan which needs to be corrected.

Tax holiday period

As per the standing statute, Pakistan is allowing income tax exemption in some cases for all time to come or for 23 years, 20 years, 15 years and 10 years which is not the normal in other countries. The normal is to grant full income tax exemption maximum up to 5 years and then exemption is replaced by a reduction in tax maximum up to 50% on achieving the prescribed export target. We are in fact practically exporting our taxes in place of exporting goods in perpetuity or otherwise for much longer period and that also without any visible economic benefit. Thus Pakistan needs to follow what has been adopted by other countries; which is to fix maximum full exemption time limit for FDI projects for five years with binding export and thereafter tax credit may be allowed to income on export of up to 70% of FDI output.

Mining sector

In Pakistan's FDI policy or statutes source mining is open to FDI and there is no restriction on area allotment/source mining or export of raw mineral extracted without any value addition. The proven rule for economic turnaround adopted in other courtiers is that mining should not be left as all open for FDI for source mining. Policy must restrict FDI to captive mining to be undertaken for further processing for local value-addition. FDI mining for raw mineral export is not to be allowed except in specified items like oil. Allowing FDI for source mining for raw mineral export has proved harmful to countries and thus stands discarded. Therefore, our FDI policy/statute is completely away from professional advice/prudence. No source mining is to be incorporated in our FDI policy to ensure local processing value-addition and export of finished products based on captive source mining and not otherwise.

FDI ownership

Pakistan is allowing 100% ownership in FDI policy except for the negative list. The FDI ownership has restrictions/limits in almost all countries which is at times as low as 24% or as high as 74%. Pakistan is allowing 100% FDI ownership including ownership for land, remittance of royalty up to 5-10% of sales or remittance of technical fee besides dividend without any turnaround in economy or FDI output export. This has rather encouraged MNEs to come to Pakistan for packing or consumer goods like water/milk/soap for local market, creating imports from Pakistan for MNE HO and earning dividend/royalty/fees at the same time as a bonanza. Prudence demands a review of the ownership limit as done in other countries and the suggested pattern for Pakistan is 49% maximum FDI ownership allowed and higher percentage should require special permission from a higher forum. This will require immediate attention as this is a source of huge loss even on items which require no technology like soap/noodles and so on where lower limit of equity holding is normal in the field.

Besides the foregoing, there are common-knowledge steps which need to be taken like diverting FDI on the principle of "beneficiation and value-addition" which prescribes that FDI can only contribute to growth in host economy when it generates up-stream and side-stream linkages to encourage greater local value addition thus fostering downstream industry. Pakistan is stuck in a few traditional items of export for the last 40 years and needs to go beyond the traditional items. Pakistan has to go into tech products by diverting FDI into tech products with built-in technology transfer condition for which Pakistan needs to make available the required workforce. Therefore, our FDI policy must create a standing arm which works to introduce/sponsor students to tech-related skill development from the age of 16 like in other countries as our present technical education setup has not performed well. Further, there has been an explosive growth of over 5,400 SEZs world over and more are in the pipeline but Pakistan is still required to achieve its full potential in this regard by removing bottlenecks faced by the zones. Moreover, there is a need to allocate special areas in zones or preference for tech/ software/IT-based enterprises.

(Concluded)

(The writer is Chairman of National Industrial Parks)

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