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TRM 54 Financial Management in Tourism Enterprise PROFILE OF INVESTMENT INCENTIVES

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TRM 54 Financial Management in Tourism Enterprise PROFILE OF INVESTMENT INCENTIVES 85 PROFILE OF INVESTMENT INCENTIVES

PROFILE OF INVESTMENT INCENTIVES

TRM 54 Financial Management in Tourism Enterprise PROFILE OF INVESTMENT INCENTIVES 85 PROFILE OF INVESTMENT INCENTIVES

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PROFILE OF INVESTMENT INCENTIVES

Tourism is an effective instrument of economic development and is capable of delivering numerous benefits to a country or region. These benefits include the creation of employment, foreign exchange earnings (particularly hard currency), revenues from fiscal sources and additional superstructure, infrastructure, and amenities established to encourage and support a tourist industry. In addition, tourism can raise educational standards, act as a catalyst in bringing reward pride in culture and crafts, and conserve heritage and historic buildings as well as wildlife, flora, and fauna.

However, in order to attract tourism investment to a particular location, it is often necessary to enhance its attractiveness by offering a variety of incentives to investors. Such incentives normally fall into three categories: financial incentives, quasi-financial incentives and fiscal incentives. In addition, the provision of other incentives such as financial aid towards retaining workforces in declining industrial regions may be necessary.

Over the past decade, capital grants have become an increasingly favoured form of incentive package. This trend can be explained by a number of factors including simplicity and flexibility. In Europe, their compatibility with European Commission coordination requirements is an added consideration.

At the same time, there has been a decreasing emphasis on loan-related subsidies and fiscal concessions, and the introduction of a wide range of new measures (not specifically tourism-related incentives) aimed at developing the business environment more generally.

PURPOSE OF INVESTMENT INCENTIVES

When applied to tourism development, investment incentives can be said to have three main purposes:

To accelerate the realization of development in order that governments may enjoy the resultant benefits of tourism development economic, environmental, social, and political sooner. While incentives may not necessarily be required to bring about the eventual realization of a project, they will indirectly assist in the decision-making process if another destination initially has a higher development priority for the private sector, or they may assist in completing the financing of a project, or merely demonstrate a commitment on the part of government to the future of the tourism sector in that region.

To remove or overcome those obstacles preventing a private sector developer satisfying the profit motive. Investment incentives thus assist in generation of profits at a level sufficient to meet corporate objectives.

To discriminate in favour of particular locations, types of development, or products. Investment incentives can be used to discriminate positively in favour of particular types of development or certain locations, so making projects of other types, or in other location which are not favoured, less attractive to the private sector.

Greece’s previous incentive legislation (Law 1262/1992) was perceived to have contributed to both the industrial decline of the country as well as the development of a low quality tourism sector. Accordingly, current (1993) legislation is specifically aimed at accelerating industrial investment and initiating a

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reduction in the rates award for tourism projects, relative to manufacturing (under both the financial and fiscal packages). Administrative controls over the tourism sector are now reinforced, although rates

of award for high quality tourist accommodation and for support services for the tourism sector have

been increased. Measures such as these are used extensively to rejuvenate depressed areas, or to achieve a balanced supply of tourist facilities.

In Ireland, Bord Failte administers three grant schemes on behalf of the International Fund for Ireland.

One of the purposes of the fund is specifically to assist lower-grade hotels (grade B and C) and

guesthouses to improve the physical standard of accommodation and guest facilities.

In Portugal, under the SIFIT scheme, spas were always eligible for a higher rate of award range, irrespective of locations. In favouring specific locations, government will have regard to any existing infrastructure, and to the expense of installing infrastructure facilities where none exists generally to a prerequisite for obtaining private sector investment.

The European Community has recognized the role tourism can play in developing the economies of less- favored regions, as well as its role and importance in strengthening the cohesion of the Community by contributing to a faster rate of economic growth in priority objective regions. The Community discriminates in favour of the less-favored regions through a number of funding schemes, and these are discussed in more detail later in this chapter.

For the purposes of this paper investment incentives are categorized into four separate headings:

financial, quasi-financial, fiscal and others. While their application and effect will differ according to the category, the end objective of each is to encourage development which would not otherwise have taken place.

EXAMPLES

1. Government Financial Incentives

Grant Aid

Government financial aid to tourism projects can either be in the form of a grant (in cash or in kind) or a loan. Grant aid is considered to be the best method of ‘seeding’ tourism projects, as it has an immediate effect upon the realization of a project. Many tourism projects, particularly hotels and leisure centers, require a large up-front investment in fixed assets before operation can commence, and servicing this investment can have a serious effect upon cash flow in the early years of a project. Grant aid can have a dramatic effect of developing tourism.

A grant scheme which, although introduced and ended over twenty years ago, demonstrates the

dramatic effort such schemes can have on hotel development, was the 1969 Development of Tourism Act in the UK. As part of this Act, the Hotel Development Incentive Scheme in England provided for a 20 percent grant for expenditure on buildings and fixed equipment subject to an upper limit of £1,000 for

each letting bedroom created. In development areas, the rate was 25 percent (with an upper limit of £1,250). Between 1968 and 1973, £43 million of grant aid money primed the pump and encouraged an investment by the hotel industry of over £300 million. Over 50,000 new hotel bedrooms were created in

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England and some 100,000 new bedspaces. Over 1,300 new hotels and extensions were built 180 of them in London. For many smaller hoteliers, the scheme was instrumental in changing the balance of their business.

A grant can be either discretionary, i.e. subject to the satisfaction of certain conditions in relation to

location, type or other factors and requiring approval from the funding authority, or non-discretionary, where conditions will also normally have to be met, but approval is not necessary. Non-discretionary grants can either be extremely effective in achieving objectives in a short time frame, as in the UK example above. A grant to a tourism project may be a cash payment which does not require a return, injection of an equity stake requiring profit share, or payment in kind, e.g. rent-free land, which would otherwise have had to have been purchased and therefore would have required capital outlay.

In Portugal, the Sistema de Incentivos Financeiros ao Investimento no Turismo (SIFIT) scheme operated

a capital grant, which aimed to make the regional economic base more dynamic by improving the

tourism supply, as well as an employment premium to help create jobs. The grant considered two

components:

A regional development component which varied by location 10 to 35 percent of eligible expenditure in zone 1, and 40 to 50 percent in zone 2 and for spas.

An employment premium, which also varied by location, and was a fixed amount per job created.

Within each range of grants for the regional development component, exact rates were set according to type of investment being undertaken. The maximum grant for the two components in combination was 60 percent of eligible expenditure, subject to a ceiling of 220 million escudos. The system was overt with no administrative discretion. Projects located within developed areas or those dealt with within the framework of specific regional development programs were excluded. The SIFIT was financed from the budget of Fundo de Turismo (30 percent) and from the European Regional Development Fund (ERDF) (70 percent).

Loan aid

Instead of, or in addition to, grant aid, but with the similar objective of reducing the requirement for a developer to raise finance from other sources, government can provide loan financing. The effect of a government loan upon a tourism project is entirely conditional upon the terms of the loan. A loan on the same terms as those offered by commercial sources does not affect the profitability of the operation of project, but it may remove an obstacle to development, i.e. the developer’s difficulty in raising finance from the private sector. However, in these circumstances, and in fact in all circumstances where governments give loan aid, the reason for the obstacle being present in the first place must be recognized and evaluated against the motives for promoting tourism growth. If the obstacle is a perceived country risk, then the government aid in this form should satisfy whatever motives are present, including any purely political motive, by demonstrating the government’s own confidence and commitment to the tourism sector.

If the obstacle preventing a developer from raising finance is doubt as to the financial viability of the

project itself, then government must consider whether it is prepared to jeopardize the economic motive

as fault on the loan may occur in order to satisfy another motive. For example, construction of a

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hotel project might be particularly costly in a specific location, although market demand might be able to support the project’s operation, the return on investment would be low. However, government might wish to promote the project to create employment, or to increase the opportunities for social tourism, to accrue the social rather than the economic benefits. By funding in this manner, government is tacitly accepting that default on the loan is possible, in order that its own social motive and the private sector’s profit motive can be satisfied.

Because of the risks involved in commercial loan funding, government loan finance is most commonly given to tourism projects at preferential rates. This can be in a number of forms interest relief schemes giving a lower interest rate, longer-term, longer-payment moratorium, reduced repayment in balloon funding all of which would be more favourable to the project than the terms available from the private sector sources.

Implication of Financial Incentives

The provision by government grant or preferential loan finance to tourism project is evidence of a commitment to tourism growth, and of recognition of the opportunity cost involved. A system of financial incentive which operates within the framework of tourism policy will recognize and evaluate the opportunity cost of grant and loan financing. The tourism policy will be formulated and will operate within the context of a broader economic plan (whether local, regional, or national) and therefore financial assistance given to tourism projects may have direct links to other sectors of the economy.

Administration of Financial Aid

The most easily administered form of financial aid for tourism projects is a non-discretionary grant. The awarding authority need only set the conditions for the grant, and ensure that the grant is used, and continues to be used, for the designated purposes. Discretionary awards require the interim process of deciding whether or not to award a grant, according to the applicable criteria, and therefore the exercise of opinions and public accountability, and also public pressure. Conversely, loan finance requires continued administration throughout the term of the loan.

For the private sector developer, grants are also the easiest to administer, although the effect on cash flow of a grant or loan may both be favourable. Although grant is normally more attractive, both in cash flow terms and as no conditions apply which have not been satisfied at the outset, government loan finance in a project can provide ready access to additional capital funds should the project require assistance, and if government wishes to preserve its original investment.

The choice for government as to whether to give grant aid or loan finance to a specific project, or to tourism development in general, will be a political decision, influenced by many factors. Both require the availability of funds up-front, but while a grant to a project has a permanent opportunity cost, loan finance delays that opportunity until repayment is made. Loans are politically more widely acceptable, as the perceived direct cost to public funds will only be the preferential element of the loan, as opposed to the whole amount of grant, while the economic and social benefits will be very similar, for example employment opportunities, tax revenues, and provision of leisure facilities.

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The financial benefits of loans are also readily quantifiable, for example, the number of jobs created or the amount of tax revenue received: they are politically presentable and acceptable, and easily understood. Grants in kind the provision of land, the development of essential infrastructure carry the least risk of all forms of financial aid. State-owned land which is developed has a greater value than underdeveloped land, and the provision of infrastructure is the creation of social capital which contributes to the wealth of the country and aids further development.

2. Quasi-financial Incentives

Financial incentives in the form of grants and loans are best method of promoting and directing tourism development, by removing obstacles to project profitability. Paradoxically, those economies with immature tourism sectors which could most benefit from overall growth are often those with insufficient access to funds, and are therefore unable to offer assistance in a planned, comprehensive manner.

Such countries are often perceived by private sector funding sources as risk areas for investment, and therefore, regardless of project profitability, private sector developers can experience difficulties in project financing. In these circumstances, governments can provide loan guarantees to commercial funding sources, thus demonstrating their commitment to and confidence in the tourism sector, at no initial cost and, in most cases, no cost at all to public funds.

Alternatively, a government may choose to make a financial commitment by offering a loan subsidy, which finances the differential between the (commercial) rate of interest charged by lending institution, and a lower rate decided by the government (which may be fixed, or may be related to the flexible commercial rate).

Interest rate subsidies are available in Portugal. Loans are granted by the commercial banks to investors in tourism. The interest rate is negotiated with the bank of the investor, according to the market rate, and subsidized by the Fundo de Turismo. To date the majority of funds available under this scheme have been allocated to the development of hotel units, in response to the need to increase the number of accommodation units available some 8.8 million escudos (50.6 billion ecu) between 1988 to 1990 (nearly 70 percent of all subsidies allocated).

Eligible project types include the construction and set-up of hotels (three-to five star) and restaurants (first and second category; renovation, enlargement, and modernization of equipment at camp sites and hotels; partial or total modification of buildings of important architectural value; set-up of turismo de habitacao and tourism units inducing further development of rural and agritourism; and projects related to the promotion of tourism nationally and abroad, as well as professional training in the tourism industry.

When there is an element of foreign currency loan funding in a project, governments can offer a quasi- financial incentive in the form of an exchange rate guarantee. The exchange rate for loan interest and capital payments is fixed, and the government undertakes to relieve any adverse effects from exchange rate fluctuations. This form of incentive therefore alleviates one form of risk associated with tourism development in areas where exchange rate fluctuations can seriously affect profitability.

3. Fiscal Incentives

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Fiscal incentives can have the dual role of removing obstacles to project profitability, where this would otherwise be marginal, and of accelerating the development process by making the investment climate more attractive than in other destinations. Fiscal incentives can apply both to the development stage of

a project and to the actual operation of the facility. They can be specific to the tourism sector, or more

usually, are part of an overall economic policy and aimed at encouraging capital investment, and particularly at attracting foreign investment. In general, fiscal incentives preserve or increase profits during operation, although some are intended to reduce the initial construction cost through duty

exemption, etc.

A particular feature of most fiscal incentives, of both political and economic significance, is that the benefit to the developer often will not accrue until the project is profitable, and therefore (paradoxically) is no longer in need of assistance. A careful assessment of projects will identify those developments of marginal profitability for which a fiscal incentive will actually realize a surplus. Fiscal incentives can include the following:

Income tax reduction

Net operating loss carryover

Tax credit on interest on foreign loans

Real estate tax exemption

Preferential energy tariffs

Reduced importation duties on equipment

Tax credits on domestic capital equipment

Tax exemption on reinvested profits

Capital expenditure allowances

Because they generally have no significant effect upon the cash flow in the early years of tourism project (unless they can be used against profits generated by other activities), fiscal incentives are most commonly used in conjunction with financial incentives. The cost related to the provision of fiscal incentives is readily assessed, as they are specific, e.g. 50 percent profits tax reduction is easily measured. However, the benefits accruing to government (as opposed to the private sector whose benefits are equal to the cost to the government) are less readily measured. Where a grant or loan is offered, it is often the case that the projects would not have been realized without it, and indeed this may be a condition for obtaining the award. It is therefore appropriate for all the benefits accruing form the project to be directly related to the cost of the incentive. Such ease of measurement is not possible with fiscal incentives, and their cost must often be written off against more general benefits, such as reduced unemployment or increase per capita income, rather than against specific benefits.

4.

Other Incentives

It

is appropriate in a chapter of this kind to touch briefly upon certain other factors which, although not

strictly investment incentives as they do not affect the cost, not directly the profitability of a project, are relevant to discussion of investment incentives and tourism development as they form part of investment climate. Experiences show that in some cases one or more of these factors have restricted

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tourism growth, or have even brought about a decline in the sector. A formal tourism policy would consider and evaluate these factor as they impact on the investment decision.

Training : are there sufficient trained personnel available to staff for a new tourism enterprise? Does the government provide training facilities and courses to increase the qualified workforce? Or are these additional costs to be borne by the project? In Scotland, the Highlands and Islands Development Board offers advice and financial assistance towards the cost of training programs. The scale of assistance varies but does not normally exceed 50 percent of the eligible costs.

Marketing : governments who wish to and who have the resources are always best able to promote a new destination. Is the tourism promotion effective?

Repatriation of earnings : are there restrictions on the international transfer of operating profits, capital gains, and expatriate staff salaries?

Access to materials : if the materials required for the construction and operation of a tourism project are not available locally, is it possible to import them?

Work permits : where there is a shortage of professional and technical skills locally, is it possible to employ and to retain foreign staff.

General attitude to tourism : despite the existence of a range of tourism investment incentives, do other factors indicate more negative attitude, for example excessive visa regulations, prohibitive transport costs, and inconvenient timetabling?

Of most importance is the economic and political stability of a destination. Although certain incentives can be offered to alleviate the effects of instability, or perceived instability, project profitability, although commercially attractive, may be insufficient to compensate for the risks involved in development.

ASSESSMENT

In addition to that review of an individual project which takes place prior to and as part of the decision whether to give that project specific tourism investment incentives, and additional also to the review of an individual project which takes place during its operational life (to insure that the incentive is applied for the purpose intended), there is the essential review of the entire spectrum of tourism incentive available, on a regular basis. This review will be seeking answers in a number of different areas, but in particular the following:

Are the tourism incentives contributing to and furthering the tourism policy within which they are intended to operate? In Greece, the failure of Law 1262/1982 is believed to have resulted in a low-quality tourism sector, with serious negative environmental and cultural impacts on the country.

Are the tourism incentives furthering and contributing to the profit motive of the private sector, and to what degree?

What are the costbenefit implications of the policy to give tourism incentives?

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How does the range of tourism incentives offered compare with those in other regions or countries?

What is the monetary amount of tourism incentives committed in the future, but not yet taken up (for budgetary purposes)?

Answers to questions such as these should enable government to refine both its range of tourism incentives and its tourism policy, to meet the changing needs of itself, its people, the private sector and, of course, to tourists themselves. While the review should take place on a regular basis probably no less than every two years it is important that stability is maintained, as a continuously changing tourism policy and range of tourism incentives (or changes in their detail or conditions) can be as (if not more) damaging than no policy at all. Where policies and incentives do change, private sector investors should receive forward assurance that incentives already granted to a specific project will not be reduced in quality or quantity as a result of a review.

CONCLUSION

It is possible that all countries of the world, from the most undeveloped to the most developed, have on

their statue books measures which are, or which can be, construed as being tourism investment incentives. The use to which these are put depends upon the existence and application of tourism policy, upon the maturity of a country’s tourism sector and other, less tangible factors, including political will.

It is certain that, as global tourism continues to grow at a rate matched by few other economic activities,

tourism investment incentives will continue to be an integral part of that growth initiating, promoting,

and directing. The effectiveness of incentives in performing these roles will depend upon the manner in which they are applied, either piecemeal or selectively, and the manner in which they are administered.

An investment incentive which is difficult to obtain due to the workings of bureaucracy (and all too often

a succession of government departments must be satisfied) can become a disincentive through the

effects of inflation and missed market opportunities. And a range of investment incentives which are available, but not attainable, ca be worse than no investment incentives at all. Private sector developers,

both domestic and international, can normally satisfy their profit motive elsewhere, and will do so in the face of claims of a political will to develop tourism, which is not supported by political action.

Focus on small business

In order to take advantage of appropriate tourism investment incentives, it is necessary for firms to familiarize themselves with the opportunities available under their national aid programs. For those firms looking outside their home country, an understanding of the policy objectives and funding decisions of that country, and the potential effect of financial investment incentives on their tourism project and business, is essential.