Annex A. Benchmark approaches across OECD countries
Tax expenditures (TEs) are deviations from a benchmark tax system. The benchmark acts as a reference point and should not be interpreted as optimal from a tax policy perspective. A benchmark tax system is typically defined using one, or some combination, of the following three approaches (OECD, DIAN and Minhacienda, 2021[1]):
Reference tax law approach. Under this approach, a country’s existing tax system becomes the starting point for defining the benchmark. A TE is an explicit concession that departs from what is considered a generally applicable tax provision under the existing tax law.
Conceptual approach. This approach defines a normative benchmark tax system based on a theoretical concept of comprehensive income or consumption that provides guidance on how tax policy should be defined, irrespective of whether this benchmark accurately reflects existing tax law.
Expenditure subsidy approach. This approach seeks to cost only those concessions that are clearly analogous to an expenditure subsidy. This method is rarely used in practice (see (Australian Government the Treasury, 2021[2]) for an example) and it would likely result in a narrower list of TEs than under the other two approaches.
While most countries follow a reference tax law approach (see Table A A.1), some countries apply a hybrid approach defining the benchmark more broadly than under a legal reference approach by including some of the most fundamental aspects of the tax systems into the benchmark. For example, Canada defines its tax benchmark as the “tax structure that is characterized only by the most fundamental aspects of a tax system” (Department of Finance Canada, 2021[3]). In a similar spirit the Australian TE reports states “The choice of tax benchmark unavoidably involves judgment and therefore, may be contentious in some cases. These judgments are informed by long-standing features of the tax system, practice in TE publications in other jurisdictions and consultation with stakeholders.” (Australian Government the Treasury, 2021[2]) Finally, all TE reports that follow a mixed approach indicate that the tax benchmark should not be interpreted as an indication of the way activities or taxpayers ought to be taxed.
Only the United States uses a purely conceptual approach for defining the benchmark but also presents estimates based on a legal reference benchmark. Mixed approaches are found in Australia, Canada, Chile, Mexico and Norway. The rest of countries that were reviewed use the tax law as the benchmark. It is worth noting that among the countries reviewed, the Australian and Canadian TE reports stand out as those that define the benchmark in a more detailed and clear way.
All countries measure TEs using the revenue forgone approach. Unlike most countries, Canada estimates revenue forgone assuming as counterfactual benchmark scenario that the taxpayer choses the optimal alternative solution once the TE is abolished. Australia includes a chapter that includes revenue gain estimates for selected TEs.
The taxes covered vary across TE reports, which is related to the defined benchmark (Table A A.2).
The United Kingdom and Canada distinguish between structural and non-structural TEs. According to the United Kingdom TE report, while non-structural reliefs help or encourage particular types of individuals, activities or products in order to achieve economic or social objectives, structural reliefs exist to define the scope of the tax, calculate income or profits correctly, make the tax progressive or simplify the tax code.
Unlike all other OECD countries, Germany and France do not consider VAT rate reductions for food as a TE because these countries view these provisions as fundamental features of their tax system based on a general and redistributive logic. France applies the same argument for medicine.
A few countries (e.g. Belgium, Czech Republic, the United Kingdom) list the fact that small traders do not have to register for VAT as a TE, though it is not quantified.
Australia includes most excise taxes as part of the benchmark (e.g. fuel and health taxes). However, it views certain excise rates that are higher than standard treatment as a negative TE. For example, the luxury car tax in Australia is a negative TE as the benchmark tax treatment stipulates that purchases of new motor vehicles are only subject to the GST. The same applies to the 5% customs levy on car imports because “the benchmark tax treatment is that imported goods are subject to the same taxes on consumption as domestically produced goods”. In addition concessions to certain goods (e.g. alternative fuels) are classified as a positive TE.
In the same way as with other provisions, the treatment of pension systems depends on the benchmark tax system.
The vast majority of countries does not identify a TE regarding the deduction of mandatory social security contributions, the only exemptions being Australia and Spain (and Chile until 2018). While Australia measures both the deduction and the exemption on the returns generated by the contributions, Spain only measures the revenue forgone linked to the deduction of the contribution. In most countries, tax concessions on private health insurance contributions are generally considered a TE.
Additional practises observed in OECD countries
The PIT exempt bracket is not considered a TE except in the Czech Republic. Canada does not consider it a TE but still measures it.
The non-taxation of the unemployment benefit, maternity leave and non-contributory family allowances is considered a TE in Spain.
If simplified regimes exist, they are generally listed as a TE but often not quantified. This includes simplified accounting methods, special regimes for small farmers, locally different tax regimes, or the differential treatment of international shipping for corporate income taxation.
What is required by international agreements to avoid double taxation is usually considered part of the benchmark.
Accelerated-write off schemes for businesses are part of TEs in Australia, France, Germany, Spain and Norway. In the United States, they are TEs under in the conceptual benchmark, but not in the reference law benchmark scenario. This is because a deviation from the economic depreciation rate is only a clear tax expenditure in a conceptual framework.
Australia lists loss carry-backward as a TE but not loss carry-forward.
Benchmark treatment and TEs linked to natural resources in selected OECD countries
The following section summarizes the benchmark treatment of natural resource-related income in three resource rich countries, namely in Canada, the United States, and Australia. Examples of TEs that the countries identify based on their benchmark are listed in italics.1
Canada
Under the income tax benchmark, businesses are allowed to depreciate natural resource assets based on the useful life of the asset. This also applies to successful exploration expenses, which need to be capitalized and amortized over time. Unsuccessful exploration can be expensed immediately.
Businesses in the natural gas, mining and oil sands sector can depreciate certain investments at higher rates than implied by their useful life. This provision is considered a TE.
Until 2018, businesses engaged in successful exploration projects were able to fully deduct the respective expenses (intangible pre-production development expenses) when they are incurred. As a benchmark deviation, the provision is listed as a TE. In practice, Canada notes that it is often not possible to determine whether or not exploration activities have been successful in the year when the expenses are incurred, since it is often several years afterwards before decisions on production are made.
The deductible depletion allowance (phased out) that was calculated as a percent of gross profits (“percentage depletion”) is listed as a TE as the deduction is unrelated to the actual cost incurred.
The benchmark tax system does not allow credits for particular activities, investments, or industries.
The unit of taxation is the business that carries out the business activity.
The provision that allowed natural resource businesses to transfer certain unused tax deductions to their equity investors is listed as a TE. These “flow-through shares” were typically issued by corporations, which are not yet profitable and therefore not able to immediately use the deductions themselves.
United States
Under the benchmark, expenses incurred to explore and develop natural resource properties need to be capitalized and amortized over time in accordance with their economic life. The benchmark tax treatment stipulates “cost depletion” which allows businesses to reduce the value of capitalized expenses following the percentage of resources extracted from the property.
Independent fuel producers and royalty owners can calculate annual deductions as a percentage of gross income (“percentage depletion”). These deductions are not related to the actual cost incurred and, over the life of the asset, can exceed the total cost of the investment. As the benchmark would ask businesses to amortize the capitalized expenses gradually following their decline in economic value, the excess of percentage over cost depletion is considered a TE.
Current law allows immediate expensing of intangible drilling costs for successful investments in domestic oil and gas wells (even though some limits to immediate expensing apply to integrated oil companies). The same applies to eligible exploration and development costs for domestic coal mines and other natural fuel deposits. As expensing allows the taxpayer to recover costs sooner than under the benchmark treatment, these provisions are listed as TEs.
Some oil companies can amortize geological and geophysical expenditures incurred in connection with oil and gas exploration over two years. As this span is generally shorter than the economic life of the assets, the rule is considered a TE.
The benchmark system limits the deductibility of losses from passive activities against non-passive income (e.g., wages, interest, and dividends).
The benchmark tax system does not allow credits for particular activities, investments, or industries.
The benchmark system taxes all income under the regular tax rate schedule.
Australia
Under the benchmark, expenditure on a depreciating asset is deductible over the effective life of the asset. Business capital expenditures not elsewhere recognised within the taxation laws are deductible over five years.
The benchmark system taxes all income under the regular tax rate schedule.
Under the benchmark, government payments to taxpayers are generally subject to tax. Eligible companies are able to create exploration credits by giving up a portion of their tax losses relating to their exploration expenditure, which can then be distributed to investors. A TE arises because payments made under a refundable tax offset are exempt from tax.
The natural resources benchmark (separate from the corporate income tax) is a 40 per cent tax rate on the economic rents earned on the extraction of petroleum resources including natural gas. The natural resources benchmark includes immediate expensing of project expenditures and losses can be carried forward.
If losses are carried forward because they cannot be utilised immediately, the benchmark treatment would uplift them at the long-term government bond rate (a proxy for the risk-free rate). Under the petroleum resource rent tax, a significant amount of expenditure is uplifted at rates that exceed the long-term government bond rate. These rules are listed as TEs.
Provisions in the calculation of the gas transfer price (if there is no arm’s length transaction to determine the price of that gas) that reduce the estimated upstream gas price by half the difference between the estimated ‘upstream’ price and the estimated ‘downstream’ price where the upstream price is the higher are considered TEs.
Under the natural resource benchmark, crude oil excise is treated as a prepayment of the petroleum resource rent tax (PRRT) liabilities.
As per chapter 1, the tax depreciation of an asset that is aligned with the asset’s loss in economic value over time is considered part of the benchmark tax system. Such a treatment is common in TE analysis in OECD countries as it allows identifying TEs linked to enhanced, accelerated or decelerated tax depreciation. DIAN has shared with the OECD the set of standard tax depreciation rates applicable in Colombia. The table below (Table A A.6) compares the tax depreciation rates in Colombia to estimates of economic depreciation published by the Bureau of Economic Analysis (BEA) in the United States (Giandrea et al., 2018[4]). Where a comparison was possible, the tax depreciation rates in Colombia do not deviate significantly from the economic depreciation of the assets. In particular, the standard tax depreciation rates do not appear excessively high. Therefore, no TEs have been identified in the report linked to the standard tax depreciation rules currently in place in Colombia. Instead, several specific accelerated and enhanced depreciation provisions have been identified as TEs by means of a detailed analysis of tax provisions in the Colombian tax system.
References
[2] Australian Government the Treasury (2021), Tax Benchmarks and Variations Statement 2020.
[3] Department of Finance Canada (2021), Report on Federal Tax Expenditures - Concepts, Estimates, Evaluations.
[4] Giandrea, M. et al. (2018), “Incorporating Canadian Capital Asset Depreciation Rates into US Capital and Multifactor Productivity Measures: A Collaborative Investigation”, Fifth World KLEMS Conference.
[1] OECD, DIAN and Minhacienda (2021), Tax Expenditures Report by the Tax Experts Commission.
Note
← 1. The information is based on country TE reports (but the information has not been validated by the respective OECD member countries) and information available in the IBFD Tax Research Platform.