for interpretation of tax rules to both firms and tax administrators, creating opportunities for leakages and corruption.

South Asian governments frequently alter tax regulations. The changes may be minor, yet frequent amendments create uncertainty about tax regulations and make compliance more difficult. In all four South Asian countries income tax regulations are changed at least annually at the time new budgets are planned. In Bangladesh and Pakistan, the changes are much more frequent. In Bangladesh, 18 changes to VAT and 16 to income tax law occurred through issuing new Statutory Regulatory Ordinances _(_ SROs) in 2014.<sup>39</sup> The changes were even more frequent in Pakistan ‐ 20 and 16 changes to VAT and income tax laws respectively occurred through SROs over the same time frame.<sup>40</sup> Such frequent changes mean that taxpayers should continuously follow tax notifications published in the official Gazette to stay informed about their tax obligations. Unpredictable tax rules worsen the business climate and may deter potential investment.

Complex and frequently changing tax legislation is prone to abuse. For example, producers of goods subject to tax holidays (e.g. boilers in Bangladesh) may be manufacturing other items as well but shifting most of their profits to boiler production to qualify for tax breaks. Location‐based incentives are also prone to fraud as multi‐unit firms often divert profits through an entity that is eligible for tax holidays. A study on India found that businesses established front offices in Jammu and Kashmir that qualified for area‐based incentives while production happened outside the state.<sup>41</sup> The study also showed that multiunit firms outside the special economic zones took advantage of tax incentives by transferring profits to the units located in the zones.<sup>42</sup> Another common type of abuse of tax holidays for new firms is when existing businesses close and reopen their operations under a new name to extend the duration of tax exemptions. In countries with several VAT rates (particularly for related products) and multiple exemptions, firms may misclassify their products (mostly final goods) to reduce or avoid taxation. Monitoring compliance is particularly difficult when the same product is subject to different VAT rules depending on the end use (e.g. local cottonseed in Pakistan is exempt if used for sowing; dyes for handloom industry are exempt from VAT in Sri Lanka).

Enforcement of tax legislation with multiple deviations from general rules requires continuous monitoring to prevent leakages, increases information requirements of tax authorities and creates additional burdens for under‐resourced tax administrations in the region. It also hurts businesses. To enforce compliance, tax administrations require firms to keep elaborate records and may need to conduct frequent tax inspections and audits.<sup>43</sup> While tax compliance costs for business were not estimated in South Asia, they are likely to be substantial. Complex and frequently changing rules put small firms at a particular disadvantage as tax compliance has a large fixed cost component. Eichfelder and Vallancourt (2014) report that tax

> 39 Bangladesh National Board of Revenue. VAT SRO  http://www.nbr.gov.bd/SRO_vat.php?lan=eng and Income Tax SRO <u>http://www.nbr.gov.bd/SRO_income.php?lan=eng</u>

> 40 Pakistan Federal Board of Revenue. SROs/Notifications <u>http://www.fbr.gov.pk/SROS.aspx?view=SROs&ActionID=6&ArticleID=</u>

> 41 James, Sebastian. 2013. Tax and Non‐tax Incentives and Investments: Evidence and Policy Implications, World Bank, Washington DC

> 42 Ibid.

> 43 For evidence from global studies on the costs of administering tax incentives, see James, S. 2013

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