Attachment_J_2_-_Fiscal_Leakages_Background_Document_(Sept_2017).pdf

DISCLAIMER: This is a background document prepared by DFID as convenor of the task team and does not represent a statement of UK policy

Fiscal Leakages Background Document updated September 2017

Issue and synopsis Fiscal, or revenue, leakages emerge due to the Paris Protocol agreement not being fully adhered to and because parts of the agreement are outdated. Both the Palestinian Authority (PA) and the Government of Israel (GoI) are affected by fiscal leakages but losses incurred by the PA are more significant since around two thirds of its trade is with Israel, while less than six percent of Israeli exports are going to the Palestinian territories. In addition, the issue is more pressing for the PA due to its ongoing fiscal crisis as it presently endures an annual financing gap estimated at between USD 580M by the IMF and the World Bank. Hence, it is in the interest of all parties to minimise these leakages and support a strong and fiscally healthy PA.

The World Bank report to the spring 2016 AHLC touched upon a number of fiscal leakages which it argued caused a significant loss of revenue for the PA. It was able to quantify some of the outlined losses under two main categories: 1) annual losses, totalling at the time USD 285.1m, including losses as a result of what the World Bank referred to as an ‘outdated’ handling fee; 2) losses as a result of revenues retained by GoI over the years, totalling at the time USD 291.6m. PA estimation of losses differs from the World Bank and GoI has disputed the Bank’s figures.

Priority fiscal leakages The PA has outlined five priority fiscal leakages that it seeks to resolve in the immediate term, including the overall improvement of the revenue clearance process that currently exists between the PA and GoI. The actions required are:

1) On VAT clearance mechanism (estimated annual losses USD 103.7m):

Creation and operationalisation of a joint electronic system to replace the existing paper-based clearance process. This will go a long way towards enhancing the flow of information between GoI and the PA and enhance efforts to reduce fraud.

PA to receive invoices from GoI of imported goods entering Gaza through Kerem Shalom Crossing. This will allow VAT for Gaza to be included in the monthly revenue clearance process. Additionally, such invoices will assist the PA to make more accurate estimations of owed revenues from VAT for goods entering Gaza and hence assist in combating fraud. GoI already collects such invoices but does not share them with the PA.

Continue GoI-PA bilateral dialogue on VAT issues.

2) On Allenby Bridge exit fees (estimated losses USD 12.2m for 2016 and USD 67m retained):

Regularise meetings of the joint team on Allenby.

GoI to restart regular monthly transfers of exit fees, as opposed to irregular ad hoc transfers.

GoI to provide a breakdown of what PA-owed money has been spent on in terms of infrastructure/crossing upgrade etc.

Agreement by GoI and PA, including enforcement of agreement, that any change in value of fees should be subject to bilateral agreement.

Continue efforts to enhance passenger exit by expanding operation hours, reducing waiting time, decreasing exit procedures and upgrading non-security related facilities. (NOTE: The Israeli border authorities initiated 24 hour operation of the Allenby Bridge crossing from 20 June to10 September 2017. They are expected to begin long-term operation of the crossing on a 24 hour basis starting 1 May 2018).

Garner commitment from GoI that any upgrade of facilities should be determined and approved by the PA.

3) On Handling fee (estimated losses USD 50.4m for 2016 as calculated by the difference between what GoI currently charges and what the World Bank believes it should charge):

Reduction of fee to a percentage commensurate with actual costs incurred by GoI, estimated by the World Bank to be around 0.6%.

Removal of handling fee on transfer of fuel taxes which the PA estimates is costing USD 32m annually.

4) On Health stamps and equalization levies (estimated combined losses totalled USD 35.2m for 2016 and USD 226.6m in retained revenues):

Begin regular monthly transfers of health stamps and equalisation levies, which were supposed to commence in October 2016 (post-signing of the electricity deal) but have not.

Detailed information to verify accuracy of transferred amounts provided by GoI.

5) On Transparency of clearance revenue transfer process:

Increase transparency of clearance revenue communication between GoI and the PA with clear indications of how figures for revenues and deductions are calculated.

Ensure that information is shared electronically and in an official manner.

DISCLAIMER: This is a background document prepared by DFID as convenor of the task team and does not represent a statement of UK policy

Other fiscal leakages While still important, resolution of these leakages is more complex and hence is subject to further analysis and studies. Due to the above, these leakages have not been prioritised at present.

1) Undervaluation of Palestinian imports from third countries:

Find an arrangement whereby Palestinian custom officials can inspect goods (NOTE: GoI and PA are continuing discussions on possible arrangements, including establishment of bonded warehouses and transfer of customs functions).

Ensure better enforcement at Israeli ports.

Enhance the use of a risk management system based on international best practices whereby falsely declared imports are automatically flagged for post-clearance audits by the PA.

Continue daily sharing of information by GoI on imports going to the PA from third countries.

Apply penalties for traders who falsify customs declarations.

2) Tax losses on indirect imports:

Enforce the final destination principle.

Prevent Israeli importers from reselling goods declared to Israel as the final destination in the OPTs.

Establish a joint electronic system for VAT – same ask as outlined under ‘VAT clearance mechanism’ above.

Apply penalties for traders who falsify documents, including VAT declarations.

3) Tax revenues in Area C:

Unrestricted Palestinian access and free economic activity in Area C.

Begin monthly transfers of taxes on Area C businesses. (NOTE: It is difficult to estimate actual amounts due to the lack of data.)

Transfer of retained revenues from taxes collected by GoI in Area C.

Regularising GoI-PA meetings A key important element towards resolving fiscal leakages is the continuation of regular political and technical meetings between GoI and PA officials. While a number of meetings at the decision-making level have taken place post-April 2017 AHLC, such meetings were recently halted.

We urge parties to resume MOF-to-MOF meetings as soon as possible. While there has been success in holding these in past months as well as technical meetings between officials, a more systematic and regular meeting schedule would help. Below is a suggestion on how a regular meeting schedule/structure could look like moving ahead:

MOF-to-MOF

• Meeting to occur regularly at a pace determined by both parties (suggested every 45 days)

• Meeting to outline agreements in principle on resolving outstanding issues

• Meeting to include formal minutes with clear action points

• Progress on action points to be reviewed in the next scheduled meeting

Technical Meetings

• Meeting to occur regularly at a pace determined by both parties (suggested twice every 45 days)

• Meeting to translate MOF-to-MOF agreements into technical action plans

• Technical action plans to include clear targets and timelines

• Meeting to include formal minutes with clear action points

• Progress on actions points to be reviewed in the next schedule meeting

DISCLAIMER: This is a background document prepared by DFID as convenor of the task team and does not represent a statement of UK policy

Progress and potential targets Since the issuance of the World Bank report on fiscal leakages, there has been some significant yet patchy progress on some files. The table below includes three columns. The first outlines key asks as it relates to each identified fiscal leakage. The second outlines progress since April 2017. The third suggests potential targets ahead of the September 2017 AHLC meeting.

Fiscal Leakage Key Asks Progress since April 2017 Possible targets for

September 2017

VAT Clearance Mechanism

Joint electronic system

GoI to share VAT invoices for Gaza with PA and include VAT revenues for Gaza in the monthly revenue clearance process

Agreement in principle to pursue a joint electronic system for VAT

GoI vision for a joint system presented to the PA, but not accepted

PA vision for a joint system submitted to GoI

GoI is still considering means to share VAT invoices for goods entering Gaza through Kerem Shalom crossing

Agreement and plan of action to implement a joint electronic system

Agreement from GoI to share invoices of imported goods from Kerem Shalom Crossing with the PA and include VAT revenues in clearance process

A list of technical assistance needs from the PA to facilitate an expedient implementation of a joint electronic system

Allenby Exit Fees Regularise meetings of the joint team on Allenby

Regular monthly transfers of fees

Breakdown of what PA-owed money was spent on

Change in fee value subject to bilateral agreement

Passenger experience continues to be improved

Upgrades subject to bilateral agreement

In September 2017, GoI transferred USD 1.5 million to the PA for exit fees – yet it is still unclear for which period as GoI didn’t provide the PA with associated information

Transfer of fees continues to be irregular and ad hoc

No progress on retained money, fee value, and crossing upgrade

Joint team on Allenby has met a number of times

The OQ is discussing a comprehensive package of proposals to resolve passenger experience and crossing upgrade with the PA and GoI

Agreement to bilaterally approve fee changes

Agreement to seek PA approval for use of Palestinian share of fees

Regularise and systemise monthly transfer of fees as clearly outlined in the Paris Protocol

Agreement to continue improving passenger experience with clear targets and timelines

Joint team to continue to meet regularly to push for resolution of pending critical issues

Handling Fees Reduce fee to 0.6%

Remove handling fee on fuel taxes

GoI officially opposes renegotiating the handling fee, which entails reopening PP, but has exhibited willingness to consider workarounds

Calls to remove handling fee on fuel taxes remain unanswered

Agreement for de facto revision of handling fee to make commensurate with actual Israeli costs

Agreement to waive handling fee on fuel taxes

Health Stamps and Equalisation Levies

Begin monthly transfer of fees as part of the revenue clearance process

Retained money from September 2016-March 2017 transferred

Retained money from April- September 2017 still pending

Despite repeated commitments, monthly transfers since March 2017 have not commenced

Provision of detailed information on health stamps to verify amounts transferred

Transfer dues retained since April 2017

Regularise monthly transfer of dues and the associated information thereafter as stipulated in the PP

Undervaluation of Palestinian imports from third countries

Agree on arrangement allowing Palestinian custom officials to inspect imported goods

Ensure better enforcement at Israeli ports

Continue daily GoI reporting on Palestinian imports from third countries

Enhance the use of a risk management system for post-clearance audit

GoI and PA in ongoing discussions on possible arrangements, including transfer of customs functions and GoI proposals for bonded warehouses

OQ preparing a needs assessment to address customs reform and transfer of customs functions

Progress on this tied to ongoing discussions

DISCLAIMER: This is a background document prepared by DFID as convenor of the task team and does not represent a statement of UK policy

Tax losses on indirect imports

Enforce the final destination principle

Prevent sale of goods imported to Israel (as final destination) in the OPTs

Establish a joint electronic system for VAT

Apply penalties for traders who falsify documents, including VAT declarations

GoI and PA in ongoing discussions on possible arrangements, including bonded warehouses and transfer of customs functions

Progress on this issue tied to ongoing discussions

Transparency of clearance revenue transfers process

Increase transparency of clearance revenue communication between GoI and PA

Breakdown of figures for revenues and deductions to be included in monthly revenue clearance slips

Ensure information is shared electronically and in a manner suitable with standard government-to-government communication

No progress to report

GoI official responsible for monthly slip voiced openness to explore means of improving clearance revenue communication

Agreement to increase transparency of clearance revenue communications

Tax revenues in Area C Unrestricted Palestinian access and free economic activity in Area C

Begin monthly transfers of taxes on Area C businesses

Transfer of retained revenues from taxes collected by GoI in Area C

No progress to report

Accurate estimation of revenues is difficult due to a lack of data

GoI considers all requests relating to Area C will require political decisions

Progress on this issue may be tied to the wider political process and hence will take more time to resolve.