Are the IMF's expectations for Lebanon’s tax system realistic?

Not everyone seems to agree with the recommendations made in the international organization’s recent report.

Are the IMF's expectations for Lebanon’s tax system realistic?

The Directorate General of Finance in Beirut. (Credit: Philippe Hage Bourtos/L'Orient-Le Jour)

The International Monetary Fund finalized a report in November and made it public in January, in tandem with the passage of Lebanon’s budget for 2022.

Entitled “Lebanon: Technical Assistance Report on Putting Tax Policy Back on Track” and accessible via the IMF website, the report details, in about 80 pages, the organization’s advice from experts on the direction Lebanon should take in terms of taxation.

In other words, the IMF explains how the country, which has been in a deep crisis since 2019, should change the way it sets and collects taxes to increase revenues and ensure that its institutions can function normally — all without raising taxes and fees too steeply, so as not to undercut any growth prospects.

The report starts from the fact that tax revenues have been halved between 2019 and 2021 and that Lebanon has lost a great amount of money by not adjusting the exchange rate used to calculate compulsory levies according to the market reality.

As a result, the report projects a series of corrective measures to be implemented immediately and others to be imposed in the medium and short term.

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However brutal they may be for taxpayers, the measures of the 10-month overdue 2022 budget are milder than the adjustments recommended by the IMF, which calls for applying the parallel market exchange rate or, at the very least, that Banque du Liban’s Sayrafa exchange platform to calculate VAT, among other measures.

While the Sayrafa rate stood at LL38,000 to the dollar last Friday, the lira rate reached an all-time low of more than LL63,000 to the dollar on the same day.

Prior to Nov. 15, 2022, all taxes were still calculated on the basis of the previous official peg of LL1,507.5 pounds to the dollar, which fell out of use at the beginning of the crisis.

Adjusting the exchange rate used to calculate taxes is only one of the many IMF recommendations, which must be coupled with a series of other adjustments targeting existing compulsory levies and exemptions provided for by Lebanese law.

However, these proposals do not have unanimous support, and even those who are in of favor IFM measures note that they leave out certain aspects.

L’Orient-Le Jour contacted the Beirut Traders Association president, Nicolas Chammas, and tax lawyer Karim Daher to discuss these points.

Good principles

For Chammas, the IMF report “aims, in spite of everything, to be right in terms of principles, but lacks economic realism.”

“We can only agree with some of the main principles stated in the report, such as the fact of wanting to stop the erosion of the country’s tax base [the income that can be taxed], or trying to enlarge this base, or wanting to re-establish vertical equity by guaranteeing the progressivity of taxes, as well as guaranteeing horizontal equity,” meaning that people with the same income pay the same taxes, Chammas explained.

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He also recognized that the country’s new financial situation requires tax reform.

“Between 2018 and 2021: the tax burden has fallen from 15.5 percent to 6.6 percent, according to official figures,” Chammas explained. “This means that the state’s room for maneuver is extremely small, especially to finance public servants’ salaries.”

Chammas added, “We have also seen that without the state, the economy cannot function. The budget must undertake a minimum level of spending to make this possible.”

In 2019, Pierre Duquesne, France’s ambassador in charge of coordinating international support to Lebanon, had already judged that Lebanon’s level of taxation at around 11 percent was too low.

The World Bank advocates that a country’s public revenues should reach at least 15 percent of GDP to allow a state to be viable and ensure a business environment conducive to growth.

A questionable approach

Daher, the tax lawyer, appeared more enthusiastic about the IMF's approach.

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“The IMF has really changed its habits. At this stage of discussions with a country requesting its assistance, its experts consider that the priority is to increase revenue and give priority to taxes that are easy to collect,” such as corporate taxes or VAT, he said.

“Rather than going down this path, the IMF experts have chosen provisions that are mostly adapted to the Lebanese reality by favoring inclusion and broadening the tax base [in an equitable manner],” Daher said.

“The report’s authors consider, for example, that increasing VAT by a certain percentage will be neither efficient nor fair. Instead, they suggest looking at the many exemptions or loopholes that exist in the Lebanese law,” he added.

But things do not stop here. Daher pointed out the fact that the IMF is not proposing any tax increase per se, “which can be seen as a first.”

The organization is suggesting that existing taxes — rates, allowances, brackets, etc. — be aligned with the real exchange rate, the cost-of-living index or an intermediate threshold defined in a transition phase.

“This type of adjustment avoids the need to go through Parliament again in the event of major fluctuations in the exchange rate,” Daher said.

Chammas did not seem to concur.

“Compensating for a loss of revenue by adjusting the exchange rate used to calculate taxes is legitimate, but this brutal [approach] risks causing a fiscal and economic shock because the country is still in a recession and businesses are just catching their breath,” he said.

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“We have already seen how abrupt and haphazard the transition was from the LL1,507.5 rate to the [new] LL15,000-to-the-dollar rate in calculating tariffs last December. Imagine going from LL15,000 to the Sayrafa rate of LL38,000 in one go,” Chammas added.

For the IMF, the use of the exchange rate for calculating taxes should make it possible to compensate for the loss of several GDP points of tax revenue (5.6 points in 2022 and 4.3 in 2023, according to the report).

Reforming the foundations

Daher credited the IMF’s approach to the fact that it also introduces measures that begin to reform the foundations of the country’s tax system.

“IMF is following up on the law on the lifting of bank secrecy,” which passed in October but was stripped of some of its attributes by Parliament, Daher explained.

“Lebanese leaders are recommended to grant the tax authorities the means to have access to the bank accounts of taxpayers abroad and to complete the process allowing it to activate the automatic exchange of tax information mechanism,” Daher said.

Lebanon is indeed a signatory of several multilateral conventions that oblige it to implement the Common Reporting Standard.

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Among the other measures to improve tax legislation requested by IMF in the medium term, Daher cited the following:

    · Changing the principle of permanent residence, establishment and workforce. In its current form, the Lebanese law allows persons residing in Lebanon to receive income from abroad and not pay any tax, anywhere, in case of advantageous taxation in the country where the income is received or adapted to treaty provisions.

    · Reforming the lump-sum tax benefiting a large portion of taxpayers, such as self-employed taxpayers. Under the current system, it is possible to underestimate their declared income — a loophole the IMF associates with a lever facilitating tax evasion.

    · Creating a specific micro-business system to increase the inclusion of small companies in the taxpayer base, which do not pay income tax in large numbers.

    · Inching progressively toward a uniform income tax (as opposed to the current schedular system — a tax based on a particular category of income — which is highly susceptible to evasion).

    · Abolishing the property exemption for vacant built-up properties.

Bad timing

Chammas did not touch on every one of the IMF recommendations, but he pointed out that one of the organization’s main assessment errors is the timing of some of the suggested measures.

“In addition to changing the exchange rate, abolishing the exemption system in the medium term for tourists in order to limit this mechanism to actors with a VAT number [while the benefit is minimal in terms of tax revenue], or eliminating special systems for offshore companies or holdings, will only undermine the attractiveness of the country at the worst time,” Chammas said.

“It is growth that will generate tax revenues, and this requires improving the business environment,” he added.

Meanwhile, Daher has a more nuanced opinion on the issue of holding companies and offshore firms.

He argues that abolishing these companies’ systems would indeed be unfavorable to a country such as Lebanon, whose strong points are to attract investments, and would make the country lose a comparative advantage over other those with a similar profile such as Cyprus, Malta or the United Arab Emirates.

Daher, however, added that abolishing the exemption of share transfers in joint stock companies and taxing dividends from holding and offshore companies paid to Lebanese residents (while foreigners can be exempted through bilateral tax treaties) is not a bad thing.

Significant gaps

Despite their sharply contrasting views, Chammas and Daher agree that there are some shortcomings undermining the IMF’s overall recommendations.

Chammas criticized the organization for having overlooked two major factors, without which any attempt to increase tax revenues will, in his view, “cannibalize what remains of taxpayers who wish to play by the rules.”

He also advocates the rationalization of public spending, which includes reducing the bloated number of civil servants (about 300,000) and fighting effectively against smuggling and the grey economy, whose size is estimated at 50 percent of GDP.

“Without a comprehensive approach, the IMF’s recommendations will remain a dead letter,” Chammas said.

Daher, for his part, was surprised that the IMF has not addressed the issue of standardizing the tax number to all Lebanese taxpayers (both nationals and foreigners) to facilitate traceability, or digitizing government services, without which the best efforts to reorganize will fail.

“If it does not have the means to catch tax evaders, the state will once again be tempted to punish those who play the game to make ends meet,” Daher said.

This article was originally published in French in L'Orient-Le Jour. Translation by Sahar Ghoussoub. 

The International Monetary Fund finalized a report in November and made it public in January, in tandem with the passage of Lebanon’s budget for 2022.Entitled “Lebanon: Technical Assistance Report on Putting Tax Policy Back on Track” and accessible via the IMF website, the report details, in about 80 pages, the organization’s advice from experts on the direction Lebanon should take in...