Rwanda's standing as East Africa's most attractive foreign investment destination faces a serious test as Kigali moves to review tax exemptions to businesses amid concerns it is forgoing more revenues than any other country in the region in order to woo investors.

In a bid to improve its business environment and attract more investors, Kigali has over the years dished out a raft of tax exemptions, a level of generosity that experts are warning is denying the country revenue needed for growth.

A new report by ActionAid says estimates that Rwanda is forgoing at least 25 per cent of potential government revenue and 14 per cent of the country's annual budget in incentives and exemptions to businesses.

This translates into $224 million based on this year's Kigali budget of $1.6 billion.

Tax experts say the cost of tax incentives and exemptions provided by developing countries have been found to be high, while it is difficult to measure the benefits derived.

"A review of the tax incentives granted to foreign investors is necessary considering that this will be taking place six years after enactment of the Rwandan investment code," said Nelson Ogara, senior manager, tax services, at PricewaterhouseCoopers Rwanda.

However, Rwanda Revenue Authority director general Ben Kagarama projects a lower figure of 10 per cent or $160 million.

Mr Kagarama said the country will soon embark on a cost-benefit analysis to establish whether the government was getting a return from tax incentives given to investors.

"Relooking at our tax incentives is an issue we have talked about internally and externally. We are now considering it," said Mr Kagarama. "Balancing between the gains coming from the tax incentives given to investors and the losses arising from the forgone revenue is a tricky issue. But it is the high time we went back and estimated this."

Rwanda has the most generous provision of incentives in the EAC for both domestic and foreign investment, ActionAid researchers noted, which could potentially be seen as harmful taxes, distorting competition in the EAC.

EAC countries are considering harmonisation of taxes as the integration process gains more impetus. Mr Kagarama however said this does not necessarily mean that the member states would have to have identical incentives and exemptions.

Some analysts said Rwanda could claim that giving more generous incentives compensates for a disadvantaged geographical location, thus levelling the playing field with the other member states.

Rwanda has pegged its long term growth plan on foreign direct investment (FDI) inflows to key sectors of the economy, making the Action Aid finding an important legal and policy issue for the government.

A July 2011 International Monetary Fund report on Rwanda, shows FDI declined from $118.7 million in 2009 to $42.3 million last year.

This, analysts said, should prompt the government to roll out new strategies to woo more foreign investment. The Rwanda Development Board is targeting at least $500 million in new investments both local and foreign in 2011.

"There is a need to protect the tax base against sophisticated tax planning, that is businesses avoiding taxation by taking advantage of incentives and then moving when they are no longer entitled to them, " said the report, titled The Impact of Tax Incentives in East Africa- Rwanda case study, authored by Rwanda's Institute of Policy Analysis and Research (IPAR).

Among the key tax exemptions is one that exempts import of building and finishing materials that are not produced in Rwanda.

IPAR researchers said exempting the first Rwf 12 million ($20,236) of turnover from taxation for farmers may be considered over-generous.Non-farm small enterprises have to start paying tax when their turnover exceeds Rwf 1.4 million ($2,360) and a proportion with incomes below this threshold pay local taxes from which farmers are also exempt.

"Tax incentives will not result in direct benefits in the short-term but gradually the government benefits as companies begin operations and pay other taxes such as profit tax and consumption taxes," said Solomon Adede, deputy chief executive officer and head of finance at New Century Development Ltd, a construction firm that is building the Kigali Marriott, a five-star hotel.

The hotel project was granted a 15 per cent waiver on revolving taxes, a five-year guarantee on corporate taxes, a flat import duty of 5 per cent and exemption from Value added Tax.

Investor interest in Rwanda's economy is expected to start building up in second half of this year, with the National Bank of Rwanda projecting an upturn in key sectors such as agriculture and international trade.

The World Bank's 2011 Doing Business Report ranked Rwanda the second most pro-business reformer globally and 58th in terms of ease of doing business, up from 70th a year earlier, as radical reforms have made it easier for businesses to get credit, pay tax and deal with construction.

"Tax incentives are only one of many factors that investors consider when making investment decisions. Contrary to the critics' view that Africa is remaining underdeveloped in part because of tax incentives, there is no guarantee that because a government collects taxes the tax money will go to social spending," said Jacqueline Musiitwa, a lawyer who advises the government on investment issues.

According to the IMF, Rwanda's economy could grow by 8.5 per cent this year, though this would require additional investment of some $200-300 million or about 4-8 per cent of GDP annually over the medium term.

Statistics from the RRA show revenue collections shot up by 23.8 per cent to Rwf 476.9 billion ($802 million) last fiscal year compared with Rwf 385.2 billion ($649.5 million) in 2009.

The increment is partly attributed to a surge in imports and taxes levied on imports, which will help cushion against revenues lost as a result of cutting taxes on fuel.