The tax incentive regime in Honduras

Honduras has a long history of providing generous tax incentives to firms and consumers, primarily as part of an effort to attract foreign direct investment. The government of Xiaomara Castro, president of Honduras since January 2022, has made reforming the tax system in order to reduce the country’s use of exemptions and other concessions a key priority. 

The Honduran tax incentive structure has been a key feature of the country’s development model and has long roots: since the 19th century, governments in Honduras relied on land concessions and later, tax incentives, to attract foreign investment, and to facilitate the extraction of natural resources. A range of special regimes have been introduced since the 1970s, including the ZOLI (‘free zones’ which provide various tax and customs concessions for commercial and industrial activity largely but not necessarily exclusively for export), ZIP (‘free zones’ which provide various tax and customs concessions for industrial activities exclusively for export) and RIT (which allows duty free imports for use in the production of exports by businesses not benefiting from other special regimes). See https://www.cni.hn/language/en/regimenes-especiales-2/ for further details/.

The exemptions can be generous: for example, businesses in ZOLI are exempt from local taxes, corporate income tax, and indirect taxes related to import and export operations, while those in ZIPs benefit from corporate income tax exemptions for 20 years and from local tax exemptions for 10 years. Moreover, the number of special regimes has been expanding over time, with 18 different regimes in operation as of 2022, each with different sets of benefits and different time-frames. And special regimes set to expire have been extended, often far into the future – for example, the ZOLI regime was meant to come to an end in 2019, but was extended until 2047.

The generosity and proliferation of special regimes in Honduras contributes to the fact that the country has one of the highest levels of tax expenditures in Latin America – 6.8% of GDP in 2019, of which expenditures related to income tax (both corporate and personal) amounted to 2.2% of GDP (Campois Vazquez, 2022). Tax exemption credits were equivalent to almost 50% of tax liabilities for the top 1% of corporate income taxpayers by income, compared to between 0 and 10% of liabilities for the smallest 90% of corporate income taxpayers. Evidence on the impact of these tax incentives on employment is limited, but jobs in businesses benefiting from special regimes are often of low quality, with the average monthly salary being $350. 

Looking ahead, the government of Honduras has set out concrete plans to rationalise corporate income tax expenditures. The ‘Tax Justice Bill’ submitted to the National Congress in April 2023 will, among other things, abolish 10 incentive regimes, including the ZOLI and RIT, grandfathering the provisions for existing beneficiaries. In their place, two new regimes will be enacted: ‘Zonas Francas’, which are free trade zones providing exemptions from income, sales and customs tax for a period initially lasting five years and extendable up to a maximum of ten years following evaluation of performance; and ‘RINDE’, which will provide subsidies for permanent jobs and accelerated depreciation for a period of five years. The new regimes are therefore more strictly time-limited and begin a move from profit-based to cost-based incentives. Better systems for controlling and monitoring exemptions and tax incentives, including exemptions granted at customs will be important. So too, will better communication between government departments within Honduras and with other governments, where investors and taxpayers are based. With this in mind, the ‘Tax Justice Bill’, when passed, will also repeal bank secrecy laws, create a registry of final beneficial ownership, and enable exchange of tax-related information with other signatory countries of the Convention on Mutual Administrative Assistance in Tax Matters. 

Fully achieving the changes the government of Honduras wishes to see will take time: they are not just about changing the operation of the tax system, but also mean re-thinking the development model pursued for decades by Honduras. Businesses benefitting from existing special regimes often have contracts with the government, setting out their benefits, for a period of time, so cannot be moved to new regimes overnight.

The experience of Honduras therefore illustrates the challenges that can arise in tax systems dominated by special regimes and widespread tax exemptions: such regimes and exemptions may proliferate as incumbents lobby to extend benefits due to expire, and other businesses and sectors lobby for their own benefits (de la Feria and Walpole (2020));  and it is difficult to reform regimes when benefits are ‘set in stone’ through investment contracts/agreements. While evidence suggests that investment-based incentives can boost investment and productivity among qualifying businesses (Liu and Mao, 2019 ), the granting of tax incentives following lobbying may also contribute to misallocation of capital across businesses and industries, reducing economy-wide productivity (Arayavechgkit, 2014 ). Moves towards investment-based incentives, available on a  time-limited basis and/or at a lower level of generosity more widely across the economy, may therefore help improve both the equity and efficiency of Honduras’s tax system.