Business issues Bulletin 47254 Lao PDR THE BUSINESS INFORMATION CENTER AT THE LAO NATIONAL CHAMBER OF COMMERCE AND INDUSTRY No. 7 December 2008 Toward a Unified Investment Promotion Law Further enhancing the investment climate for growth Introduction Figure 1: Approved and Implemented Foreign Investment 2001 to March 2008 The first foreign investment law in Lao PDR was promulgated in 1989 following the government's adoption 3000 250 2,670 Approved FDI of the New Economic Mechanism reforms in the mid 1980s. 2500 191 200 Implemented FDI In 1994, the law was amended to include provisions to 178 2000 161 allow for 100% foreign-owned businesses and to broaden 143 170 150 Number of Projects the range of sectors open to foreign investment. The first 1500 1,245 1,137 100 domestic investment law was promulgated in 1995 to 1000 80 64 771 57 provide a framework for promoting investment by Lao- 533 628 500 466 449 50 299 393 owned businesses. )noillimDSUni(stnemtsevnI 13393 155 194 0 5454 0 tcejorpforebmuN Following a second round of revisions to the legal 01 02 03 04 05 06 07 08 Year (unil March) framework for investment in 2004, there are currently two Source: Ministry of Planning and Investment laws governing domestic and foreign investment, namely the Domestic Investment Promotion Law and the Foreign As seen in Figure 2 below, the largest percentage of Investment Promotion Law. Box 1 provides a timeline of the approved FDI since 2000 has been channeled to power development of the legal framework for investment in the generation projects followed by the agriculture, mining, and Lao PDR. The Government of Lao PDR is currently revising industry and handicraft sectors. its legal framework for investment to further streamline procedures to reduce administrative burdens on investors. Figure 2: Approved Foreign Investment by Sector This Business Issues Bulletin highlights the major issues 2000 to March 2008 affecting the legal framework for investment and provides recommendations for reforms to streamline the role of the government in investment approval and strengthen its role in investment promotion and generation. Box 1: Timeline of investment laws in Lao PDR Foreign Investment Domestic Investment 1989: Foreign Investment Law, No.07/PSA, dated April 19, 1989 1994: Foreign Investment 1995: Domestic Investment Law No.01/NA, dated March Promotion and Management Source: Ministry of Planning and Investment 14, 1994 (Amendments to FIL Law No.03/95/NA, dated Oct. 1989) 14, 1995 2004: Foreign Investment 2004: Domestic Investment Promotion Law, no.11/NA, Promotion Law, No.10/NA, dated October 22, 2004 dated October 22, 2004 This bulletin is published with support from IFC-managed MPDF, a private sector Investment Situation in Lao PDR development initiative in Vietnam, Cambodia, and Lao PDR, whose donors are Australia, Canada, Finland, IFC, Ireland, Japan, New Zealand, the Netherlands, Norway, Sweden, Asaresultofanumberofmeasurestakenbythegovernment and Switzerland. The "Business Issues Bulletin" provides those interested in business issues with to encourage foreign investment since the late 1980s, a short summary and analysis of a particular topic affecting the business environment in foreign direct investment (FDI) inflows have expanded Lao PDR, and exposure to different opinions held by various stakeholders on the topic. and account for a higher share of total investment. Figure The statements and opinions presented here are only meant to provide additional 1 shows the flow of approved and implemented FDI from reference material and do not reflect official opinion of the Lao National Chamber of Commerce and Industry (LNCCI) or IFC. 2001 to March 2008. Readers are welcome to copy and distribute the information contained in this bulletin provided acknowledgement is given to LNCCI/IFC as the source. Data from the same period indicate that Thailand is at the Key Areas for Reform top of the list in terms of approved investment by country followed by Vietnam, China, France and Japan. However, Recognizing the need to address these issues and as investment from China has increased rapidly during challenges, the Government of Lao PDR has decided to recent years, it will soon outpace Thailand as the largest prepare a new unified Law on Investment Promotion.As the investor. government prepares this new law, there are several key areas for reform that should be addressed. These include: Figure 3: Approved Foreign Investment by Country of Origin 2000 to March 2008 1) Unification of two existing laws on investment ­ Based on international and regional good practices, investment laws should focus on applying a common set of rules that focus on the type of investment activities rather Japan $423m than on the nationality of the investors. The fundamental France $443m goal behind this practice is to ensure a level playing field for all investors regardless of their nationality. The new Vietnam $575m law under preparation addresses this issue and will be China $1,285m the first unified investment law the Lao PDR has ever issued. Thailand $1,381m 2) Harmonization of procedures for business entry ­ As $0 $200 $400 $600 $800 $1,000 $1,200 $1,400 commonly known, a wide range of rules collectively Source: Ministry of Planning and Investment affect and regulate investment in a particular country. Issues and Challenges Oftentimes, many of these rules lie outside the scope of an investment law and are part of the legal framework Although the trend of investment approval and for business entry and operations. In the case of Lao implementation has increased steadily since 2000, a PDR, the business entry rules belong to the legal and number of outstanding issues and challenges can still be regulatory framework under the Enterprise Law. In observed, including: preparing the new Law on Investment Promotion, it is very important that the contents of the revised law are well · Need to enhance sustainable investment in more aligned with those in the Enterprise Law. Consistency is diversified sectors. As can be seen from Figure 2, needed to ensure that as per the Enterprise Law, only foreign investment in Lao PDR is heavily concentrated those business activities within the Conditional List in resource based sectors. It is very important for the issued under the Enterprise Law require prior approval government to encourage more investment in sectors from sectoral agencies before registration. All other such as manufacturing and services in order to achieve business activities should be allowed to proceed directly an appropriate level of diversification and create more to the Ministry of Industry and Commerce for business employment. The current investment laws tend to registration. target larger project-type investments rather than to promote firms to diversify in a wider range of business 3) LiberalizationofexistingFDIspecificrestrictions­Inorder activities. To this end, the legal framework plays an to improve the overall climate for foreign investment, the essential role in promoting an enabling environment for first step usually taken by governments is to liberalize business, for which Lao PDR is still ranked relatively various FDI specific restrictions. In the current legal low in the Doing Business Report of the World Bank framework of the Lao PDR, several restrictions on Group. The legal framework should aim to better ensure foreign investment exist, which create artificial barriers to equity, transparency, and predictability with adequate entry. Some of these include: i) a minimum requirement protections and guarantees in place for all investors. on foreign ownership in joint ventures (the current law requires foreign investors to hold at least a 30% share of · Need to harmonize legal framework for investment with any joint venture); minimum capital requirement (30% of related laws. The legal framework for investment needs total capital); and iii) local content requirements (such as to be aligned with recent improvements in other related maximum foreign labor of 10% or an obligation to give laws, such as the Enterprise Law, Taxation Law and priority to recruiting Lao nationals). These restrictions other sector-specific laws, as well as with international should be removed in the new law. and regional arrangements, including WTO accession and the ASEAN Free Trade Agreement. 4) Rationalization of current incentive regime ­ It is not uncommon that a country implements special measures · Need to enhance role of relevant government agencies in the form of incentives to encourage investors, in investment promotion. It is understood that the current especially tax incentives. During recent years, there has direction of the government and the Ministry of Planning been a debate concerning the effectiveness of using tax and Investment(MPI)is to move toward playing a greater incentives to promote investment, especially to attract role as an investment promoter than as a regulator. FDI. Such incentives usually come with substantial costs Despite this trend, the current legal framework for in the form of tax revenue loss, additional administrative investment focuses heavily on regulating and managing burdens, and the potential misuse of the incentive investment rather than strengthening the role of the regime for tax avoidance by non-qualified projects. It government in generating investment. This aspect of the has also been observed that tax incentives work best current legal framework needs strengthening in order only when they are applied to tax-sensitive projects. to create a better separation between regulation and Using tax incentives in other general projects, such as promotion. for resource-based industries merely results in a loss of 2 revenue since such investments would occur even in the governments as a promotional rather than regulatory absence of tax incentives. tool. This means that the law should focus principally on In comparison to other countries in the region, the laying down the rights of investors, protection measures, current tax incentive scheme of the Lao PDR is relatively and the special treatment available for those investors generous and should be rationalized. Investors in a meeting specific criteria. Good practice investment laws wide range of industries are provided with generous should outline key policy statements of the government tax incentives, including a profit tax exemption period with regard to the promotion of investment. These aim to followed by a reduced rate which lasts indefinitely. attract investors by helping to create a level of comfort These incentives are provided based on the expectation among them. or promise from investors, rather than on their actual In the current investment laws in the Lao PDR, many performance as measured by what they contribute to the provisions are heavily control-oriented including economy in terms of employment or the introduction of complicated screening procedures for entry, new technology. In addition, the current incentive scheme cumbersome monitoring schemes and reporting in the Lao PDR is too complicated and ambiguous (in requirements and include highly subjective government particular regarding the criteria for qualified investments authority to terminate the investment operations. While and the authority of different administrative levels to measures are needed in the law to approve investment grant incentives), causing significant administrative incentives and monitor compliance with the investment costs while leaving substantial room for discretion. In the incentive scheme, they should not be applied to the end, it is not clear whether the current scheme incurs business operations of investors that are not related more costs than benefits to the country. to the incentive scheme. Such provisions impose an 5) Dispute resolution mechanism ­ The current investment unnecessary burden on investors to report on business laws consist of provisions for dispute resolution that operations to MPI on activities which are better regulated refer to relevant local settings including Committee for by relevant line ministries. Promotion and Management of Investment (CPMI), the Economic Dispute Resolution Committee, and the Conclusion People's Court. However, mechanisms often relied upon by larger more sophisticated investors, such as A review of the investment laws in the Lao PDR issued international arbitration, are not explicitly mentioned since 1989 shows the intention of the Government to as options for resolving commercial disputes. Due to encourage private domestic and foreign investment and to uncertainty in the host country perceived by foreign continuously work on improving the related legal framework. investors, most foreign investment laws provide recourse The decision by the government to revise the two existing for dispute resolution via international arbitration investment laws shows its intention to further address mechanisms. remaining deficiencies and incorporate more international 6) Transitional provisions ­ Another area that needs to be norms and practices into a new unified investment law. strengthenedinthecurrentlegalframeworkforinvestment Improvements in the investment law and accompanying relates to the provisions necessary to ensure a smooth regulations are expected to have a positive impact on the and equitable transition process for incentives that were investment climate by providing a secure legal foundation granted under the earlier legal framework. Any changes for investment in the country, simplifying business entry to the incentive structure in the new law need to provide procedures, and clarifying the role of MPI as an investment clear provisions to ensure that after some transitional generator and facilitator. If effective reforms are achieved period, all investors will be subject to the same scheme. through the new law it will be a positive step for the country It is important to ensure that investors carrying out the in reaching its stated goal of attaining private investment of same business activities are not provided different 22% of GDP, maintaining economic growth of 7-8% and, incentives simply because of the regime that existed at ultimately to graduate from the least-developed status by the time of business start up. If the new law removes 2020. certain tax incentives that were provided under the old law without having specific transitional or grandfathering Viewpoints provisions, this would lead to inequity between existing investments and those that would be established under Whilerecognizingthecurrentincreaseininvestmentinlarge- the new law. scale projects in areas such as mining and hydropower, The new law should include appropriate provisions that it continues to be a top priority for the government to specify a reasonable approach and timeframe to adjust create an investment climate that also supports small tax rates to the levels provided under the new investment and medium enterprises, which are a major driver for promotion law. economic development and job creation. To achieve this 7) Emphasis on promotion and facilitation as key aspects of objective, the Government of Lao PDR has decided to the revised law ­ International experience suggests that revise the legal framework for investment by drafting a the regulation and promotion of investment need to be new unified investment law that aims to provide a secure treated as separate functions, which require a different legal framework that is comprehensive, transparent, and set of skills serving distinctive objectives. Recognition includes clear measures to protect investors and rationalize of this distinction should be appropriately reflected in the tax incentives. new investment law. Generally speaking, the design and use of investment Investment laws are increasingly being regarded by incentives in developing economies such as Lao PDR 3 are challenging tasks. They require balancing (i) effective Lao PDR has an opportunity to significantly improve on the targeting with (ii) equal treatment of competing enterprises current incentives component of the 2004 laws. The new and (iii) administrative efficiency, given the revenue needs law and its implementing decree can ensure that: and administrative capacities of the country. International · all concessional tax treatment can be subject to time experience shows that incentives are in many cases limits, with transition arrangements to ensure that redundant. Investors in some sectors would have come existing beneficiaries'benefits do not indefinitely outstrip regardless.Therefore,revenueislostwhichcouldotherwise those on offer to new investors and distort competition. have been used to improve basic infrastructure and support national skills development. · to access investment incentives, beneficiaries should be required to implement accounting standards that enable The new investment law needs to ensure that the proper assessment of entitlements and tax obligations. procedures for FDI entry are streamlined, foreign investors · there is no attempt to direct investors into costly use of are protected, a level playing field is provided to investors `local content' or to support `import substitution' ­ the regardless of origin, and the scope and type of incentives emphasis needs to be on international competitiveness. have the best chance of genuinely promoting investment in · there is continuing relief for exporters from the distorting sectors with a sustainable future in Lao PDR. They should effects of duties and taxes on their inputs. include investments with obvious spillovers to the broader economy. The incentives on offer should be timely in their · tax incentives in the form of tax holidays are withheld assistance and equitable in their accessibility. from sectors where there is an obvious strong natural resource basis for highly profitable investment. Some Mr. Houmpheng Souralay, Director General, risk sharing by government in the form of longer loss Investment Promotion Department, MPI carry forward provisions is more appropriate. · the case for retaining `investment zones' as a basis One of the objectives of the reform of the investment law for awarding bigger or smaller incentives has been in Lao PDR is to simplify the entry of foreign and domestic adequately considered. investments and leave the regulation of the business operation to the sectoral ministries. The concerns are that Ideally, reconfiguration of the incentives on offer would not all sectors have their own laws regarding the licensing be done with some idea of what current tax holidays and and regulation of business operations, or the existing laws indirect tax exemptions are costing. But reform is hampered refer to or reflect the rules or procedure defined in the by the fact that estimates have not been assembled of the existing foreign or domestic investment laws. As a result, fiscal impact of current concessions, many of which, like the the unification of the investment law should be the starting 20% profit tax rate, are of indefinite duration. The reform point for the reform of commercial laws and other laws task is also made harder because of the distorting effects related to investment to ensure consistency in the legal of some remaining high tariff rates on a few products framework of the country. not made in Lao PDR and a profit tax rate (35%) that is high by regional standards. While beyond the scope of Regarding foreign investment, the concerned government this legislation, medium-term reductions in these will ministries should consider including provisions related to help all investors and relieve the burden on incentives in freedom to choose Law of Contract, Dispute Settlement, encouraging investment." Accounting, Protection against Change in Law, and Stability of Fiscal Obligations. If Lao laws can not provide answers Mr. Ross Chapman, Investment Policy Expert to these issues, foreign investors may try to negotiate and conclude specific agreements with concerned government There is an urgent need for much better communication agencies regarding these matters. between key government agencies whose activities impact oninvestment:forexamplebetweentheMinistryofPlanning Mr. Sivath Sengdoaungchanh, Legal Expert and Investment and agencies within the Ministry of Finance on Commercial Laws such as the Taxation Department. Without improved coordination potentially beneficial reforms to the investment The existing legal framework for investment is not suitable law may fail at both the design and implementation level. to encourage significant investment. It is bureaucratic, Furthermore, a sequence of past changes in investment law control-oriented, and inefficient. In this regard, the Lao has left an uneven playing field that needs to be rectified. Government has realized that the law drafting committee of Changes to investment law between 1994 and the present, Ministry of Planning and Investment seems to be heading and to eligibility for tax holidays in particular, have left some in the right direction. I am hopeful that the overhaul of the businesses (for example foreign banks) on a `permanent' investment regime will provide a more open and investor- preferential profit tax rate of 20 percent, while others (local friendly environment, which will in turn improve the country's and foreign banks) competing with them are paying the full competitiveness, contribute to more growth and generate statutory rate of 35 percent. An urgent adjustment needs to employment. be made so all are competing on an equal footing. 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