Competitiveness, Concession and the Cost of Capital in Barbados

Over the last week much has been said about the concession granted to Sandals Resort to operate the property known as Almond Casuarina in St. Lawrence Gap, Christ Church. I have taken some time to reflect on them before making comments past my initial reaction. The concessions granted have created quite a stir for two […]

By Colin Daniel - Principal, Strategic Consulting & Advisory Services

November 16, 2013

Over the last week much has been said about the concession granted to Sandals Resort to operate the property known as Almond Casuarina in St. Lawrence Gap, Christ Church. I have taken some time to reflect on them before making comments past my initial reaction.

The concessions granted have created quite a stir for two reasons:

  • The grant of duty free exemptions for food and beverage items
  • That these concessions extend for up to 40 years.

According to the letter issued on November 5, 2013 by the Minister of Finance the following concessions were granted:

a)   The waiver of all taxes, duties and other imposts on:

  • capital goods whether imported or locally sourced
  • all consumables for hotel operations
  • all food, alcohol and beverages

b)  All value added tax on services directly related to the construction or cyclical refurbishment of the property to Sandal’s standards

c)    Similar exemptions on vehicles for commercial use at the property

d)    Similar exemptions on vehicles and personal effects for expatriate staff.

e)    Further that these provisions will remain in effect for 25 years and then the taxes will be imposed at 50% of the rates in force for another 15 years thereafter.

It is important to note that no waiver was granted on the payment of corporation taxes. What we don’t know is if in addition to these concessions, if Sandals will also benefit from the concessions available under the Tourism Development Act. If these benefits are also extended they will further extend Sandals’ competitive edge vis a vis other hotel properties in Barbados.

First let us understand that while Sandals will not pay value added taxes on any of its capital and operating costs, its guests will continue to pay VAT on their accommodation and expenses, be it on hopefully a lower tariff rate due to the concessions granted. We should remember that the end user customer is the person who ultimately pays the full VAT on the goods and services sold.

To illustrate this, if Sandals was subject to VAT they may sell the services inclusive of $200 worth of VAT and be entitled to $150 of input VAT credits which they have paid to their suppliers. They would then be required to remit $50 in net VAT payable to the government. Hence the government would have collected $200 in total VAT between their suppliers and Sandals. In the proposed model, there is no input VAT payable by Sandals and the customer still pays VAT of $200. Hence there is no lost of income to the Barbados government, except that the taxable cost of services to the guest should be lower as a result of the duty free concessions.

The proposed strategy seems to be that if Sandals is able to lower its costs, it can offer its lower rates and experience higher occupancy levels thus increasing its total revenue. The government is therefore hoping that this will translate in higher VAT receipts from room revenue and other spending in the local economy at the highest VAT rate. It is a reasonable strategy to pursue.

There is effectively no loss of duties and VAT on the construction and capital expenditure of the hotel since these concessions would have been granted under the Tourism Development Act. With respect to VAT, the Barbados government would have ended up refunding the VAT incurred on the construction of the property. Under this model the government would not have to look for the money to repay Sandals if they decided to undertake any significant capital expenditure at Casuarina at this time.

We will hope that the concessions will result in the hotel turning as profit so that government will capture income taxes levied on the operating profits.

This transaction raises issues that Barbados suffers from two critical problems which impact our competitiveness; our high operating costs and our high cost of capital. Further, these two items are impacted by the embedded costs of funding the government of Barbados through a relative high rate of duties and VAT. On the other hand, our corporate taxes on resident companies are some of the most competitive in the region, with small business and manufacturing attracting a rate of 15% and a rate of 25% applies to other businesses. We have not used these tax rates as an effective policy tool to attract more regional and international companies to operate from Barbados. In order to leverage on this we have a lot of work to do on our marketing strategy as well as on our business facilitation policies.

There needs to be a fundamental policy shift in Barbados away from indirect taxes to direct taxation. The challenges with indirect taxation are twofold, it taxes production and hence creates a drag on business activity and secondly it drains cash from businesses before revenue is earned. In many cases, these taxes payments are funded from bank borrowings or in the case of start-ups and growing businesses from savings of entrepreneurs. This is one of the factors that increase the cost of capital in Barbados.

Let’s look at the implication of VAT and duties on the costs of financing business. First all inputs into most business with exception of staff costs are subject to VAT and duties. While financial services are VAT exempt there are not zero rated and these services are priced to recover the cost of input VAT. If we assume that the duties and VAT account for 40% of non-staff related costs in Barbados, we see how these costs contribute to the amount of finance that have to be raised to fund operations. Further many non-retail businesses allow credit on sales to their customers, there is also an element of financing which must be used to pay VAT on sales before the money is collected from these customers.

Our current lending policies continue to be unattractive for capital intensive projects. Most commercial banks will not finance projects with amortization periods of more than 15 years and at rates lower than 7 percent. Typically, we are seeing amortization periods as low as 10 years for commercial relate estate with interest rates between of between 8% and 10%. This trend will continue as the economy continues to contract and banks seek to reduce their risk exposure. These lending policies, which may seem logical to our bankers, are in my view increasing the overall risk of default and bankruptcy in the economy.

We are seeing more businesses having problems with collecting outstanding receivable as sales volumes fall across the country. The knock-on effect is that companies are paying their staff and cost of financing leaving their vendors and the government to compete with what little funds they have left over at the end on the month. With increase pressure from vendors to service outstanding liabilities, most businesses are doing what they can to meet these obligations in order to obtain goods and services necessary to stay in business. Hence the Barbados government is one of the last one paid. When this happens, they then struggle to meet their own obligations to their vendors.

I would suggest, that in order to get our economy going, the two players that can do the most to provide relief in the economy are the government and the financial sector.

Government must review its tax policy and start to shift its dependency away from indirect taxes in order to create a climate where business profits can be generated. It can compensate for the loss in cash flow from duties by collecting corporation tax on monthly or quarterly at rate of 75% of the estimated tax payable for that period. This will allow for some smoothing of cash flow to the tax payer.

The Banking sector needs to extend the amortization period for commercial loans for up to 20 or 25 years even if the term of these loans is 3 or 5 years. This will reduce pressure on business cash flows and would allow them to better meet their commitments to their vendors as well as their statutory obligations. The increase ability to meet statutory obligations should ultimately increase cash flow to government which in turn will allow them to settle their obligations to the private sector.

The concessions to Sandals in fact appear to be good policy which needs to be extended the rest of the hospitality sector so that it can compete in the region effectively. Given that VAT is still payable by the hotel guest, I am not overly concerned with the length of the tax holiday as it relates to the consumables, food, alcohol and beverages. I am also not concerned with the tax holidays on the duties for capital works as they plan to construct additional restaurants and they would be entitled to access these benefits under the Tourism Development Act.

I am however concerned that after 47 years of independence we find ourselves having to offer concessions to attract investment to Barbados. I am concerned that we do not have an indirect tax policy with competitive rates of duty that would eliminate the Minister of Finance having to use his discretion to grant benefits of this nature. I am concerned that we have manufacturing and agricultural sectors that continue to need high tariff barriers in place for their survival.

I am concerned that we have a financial services sector that continues to generate significant profits which when remitted to their head offices reduce our foreign exchanges reserves. I am concerned that this takes place while they continue to restrict access to credit in our economy and promote financing for consumption rather than for business investment. I am concerned with a financial sector which is prepared to lend at 7% for 7 years to purchase a car which is a depreciable asset rather than to provide financing at 7% or 8% to SME’s which produce the most business activity worldwide and make a significant contribution to our GDP.

I am concerned that we have some in the public sector who seem to act as if government should not support the business sector and in doing frustrate policy makers as well as their public sector colleagues who are going out of their way to improve the business climate in Barbados.

I am concerned that we have people in the private sector that continue to criticize our neighbors in the public sector who labor in sometimes sub-standard conditions, with business processes best suited for the 19th Century, who are sometimes exposed to political interference from appointees who do not understand how the civil service needs to work. These public servants sometimes are surly and other times brilliant, we all have met both kinds. We have also met the same in the private sector.

We all must do our part to facilitate business and the improvement in the quality of life to all of us in Barbados. We have a lot of work to do. The government can accomplish this by addressing the anti-competitive nature of our indirect tax system and our banking sector by attending to the issues of accessing finance.

Let’s get to work.

Colin Daniel - Principal, Strategic Consulting & Advisory Services