to abuse as older firms may attempt to close and reopen their operations to continue enjoying the benefits. Thus, the governments’ objective of encouraging new investment runs the risk of motivating firm reorganization and shrinking the tax base (for more information on the impact of tax incentives for new firms, see James, 2013 and Easson and Zolt, 2002).

Small firms are eligible for tax concessions throughout the region (Table 4) **.** In Bangladesh, firms with annual turnover below 3 million taka (USD 38,000) are exempt from corporate taxes.<sup>12</sup> In India, firms with annual turnover below INR 10 million (about USD 162,000) face an effective tax rate of 2.4% (they are allowed to declare taxable income at 8% of turnover, which is then taxed at a regular rate of 30%). In Pakistan and Sri Lanka, small firms are subject to reduced rates. However, firms that are considered “small” in these countries will not fall in this category in many developed states as annual turnover thresholds have been set at a rather high level. In Pakistan, “small firms” are those with the annual turnover of less than PKR 250 million (about USD 2.4 million) and fewer than 250 employees. Such firms are subject to a reduced tax rate of 25%.<sup>13</sup> In Sri Lanka, firms with annual turnover below LKR 500 million (USD 3.8 million) are taxed at a rate of 12% ‐ more than twice lower than firms with larger sales volumes.<sup>14</sup> The special treatment of small firms is often justified as a means to compensate for banks’ failure to provide loans to small business. Yet, such policy has a negative impact on productivity and competitiveness as it discourages firms from exploiting economies of scale and growing their operations. It also creates incentives for larger firms to break down their operations into smaller units to reduce tax burdens, which increases administrative costs for firms and reduces public revenue.

**Table 4. Special Treatment of Small Firms**

|**Country**|**Concessions for Small Firms**|
|---|---|
|Bangladesh|Firms with annual turnover below 3 million taka (USD 38,000) are exempt from corporate taxes|
|India|Firms with annual turnover below INR 10 million (USD 162,000) can declare taxable income at 8% of turnover,<br>which is taxed at the regular rate of 30%. Effectively, the tax rate for such firms is 2.4% of turnover.|
|Pakistan|Firms with annual turnover below PKR 250 million (about USD 2.4 million) and fewer than 250 employees are<br>subject to a reduced tax rate of 25%|
|Sri Lanka|Firms with annual turnover below LKR 500 million (USD 3.8 million) are taxed at a reduced rate of 12%|

Sources: Bangladesh Income Tax at a Glance 2014‐15; India Income Tax Act 1961; Pakistan Income Tax Ordinance Act 2001; and Sri Lanka Inland Revenue Act, No. 10 of 2006 Larger investments receive preferential tax treatment in Sri Lanka. Most manufacturing, agribusiness and certain service firms are subject to 4‐6 year tax holidays if they invest above USD 378,000. Longer tax holidays are available for select economic activities with investments above USD 2.3 million and the duration of tax holidays increases with the amount of investment. Firms investing above USD 18.9 million are eligible for 12 year tax holidays. This policy favors foreign companies, well established domestic investors and capital intensive firms. The benefits of this approach are not clear. Some fast growing firms (e.g. IT, financial, consulting and a number of other service companies) do not require a significant upfront investment. Furthermore, it is hard to judge whether five new investments below a certain threshold are less beneficial for the economy than one investment above such threshold.

> 12 Ibid.

> 13 Pakistan Federal Board of Revenue. Income Tax Manual. Part I. Income Tax Ordinance, 2001. Amended up to June 30, 2014.

> 14 Sri Lanka Inland Revenue Department. Inland Revenue Act, No. 10 of 2006, incorporating amendments up to April 30, 2013

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