Abstract
Many multinationals divert Foreign Direct Investment (FDI) through conduit countries that have a favorable tax treaty network, to avoid host country withholding taxes. This is referred to as tax treaty shopping. The Netherlands is the world’s largest conduit country; in 2009, multinationals held approximately €1,600 billion of FDI via the Netherlands. This paper uses microdata from Dutch Special Purpose Entities to analyze geographical patterns and structural determinants of FDI diversion. Regression analysis confirms that tax treaties are a key determinant of FDI routed through the Netherlands. The effect of tax treaties on FDI diversion partly arises from the reduction of dividend withholding tax rates, which provides strong evidence for tax treaty shopping.
Similar content being viewed by others
Notes
Between the ultimate home and host countries, FDI may be diverted several times.
The UK and Japan recently switched from credit to exemption systems for foreign dividend income, but many structures set up in response to past tax rules are still in place.
Investment treaties can also be an important secondary consideration when fiscal reasons are the main driver for FDI diversion and various conduit countries offer similar tax benefits.
Calculated as €1,918 bn of conduit entity FDI assets minus €327 bn of securities issued to finance FDI; the latter follows from €435 bn of total securities issued by conduit entities minus €108 of debt securities issued to finance portfolio assets. This is consistent with the reported €1,650 bn of conduit entity FDI liabilities. Source: DNB, http://statistics.dnb.nl, Tables 9.1, 12.10, and 12.14 (accessed 19 Sept. 2011).
For conduit entities with the same ultimate parent, these criteria apply to the cluster as a whole.
This is a commercial database that integrates data from national company registers. Ultimate parents are defined as companies that own an SPE through shareholdings of more than 50 % at each step in the ownership chain and that are not known to be majority owned by another company.
The large share of direct parents in the Netherlands Antilles is partly due to historical reasons. The number of ultimate parents in these countries is overstated due to incomplete ownership data.
Also in contrast to investment statistics, capital or loans provided by Dutch SPEs to their foreign parents are counted as positive assets, because this describes SPE positions in the most useful way.
WHT data based on 170 countries for which data were available. Most countries and tax treaties define various rates. This study uses the maximum rate for large nonfinancial parent companies that hold a controlling stake in the host country entity, are not owned by a government, and are not subject to antiavoidance provisions or based in a tax haven. Furthermore, for normal host countries, it disregards special rates for companies operating in a particular zone or industry. For tax haven host countries, in contrast, it uses the special rates for international financing companies, if applicable.
Some SPEs have negative balance sheet positions. These reflect a negative valuation of investments on the assets side or negative net worth reported as negative equity on the liabilities side, for example. The matrix calculations include rules to prevent attribution of positive assets to negative liabilities (as a negative proportion) and vice versa.
Avoidance of capital gains tax on the potential future sale of a foreign subsidiary can also be a reason for diversion of equity investments.
If both measures would be included simultaneously, the effect for country pairs where the host country has the lowest tax rate would be modeled largely independently from pairs where the home country has the highest rate. This would not provide useful information about overall tax strategies.
This is especially relevant for joint ventures between companies from different countries.
The main results of OLS regressions are not materially different, though.
As far as possible, these matrices attribute equity assets to equity liabilities and loan assets to loan liabilities to reflect SPE structures more accurately. Most SPEs have one main origin country for each type of liabilities.
Most regressions use the square roots of these shares to match the transformation of the dependent variable.
Examples are total outward FDI stocks of Bermuda and the Netherlands Antilles as of the end-2007, for which UNCTAD reports €0.1 billion and €0.7 billion, respectively, whereas the sum of bilateral inward FDI stocks reported by OECD partner countries is €14 billion and €68 billion, respectively.
For the selection of applicable tax rates, see footnote 10.
For example, consider a host country with 20 % WHT on dividends paid to nontreaty countries, which include the home country. The Netherlands has a tax treaty with the host country, which reduces this 20 % rate to 10 %, and also with the home country, which reduces the standard Dutch dividend WHT from 15 % to 5 %. This reduces total WHT from 20 % to 1−(1−0.10)(1−0.05)=14.5 %.
The base company benefit may also capture structures involving a Dutch cooperative or a direct US parent that uses so-called tick-the-box regulations to create hybrid entities. Such structures can avoid Dutch WHT and home country taxation even if profits are distributed upward.
This is an approximation only, which disregards WHT and assumes that a multinational repatriates equal pretax profits from host countries with lower and higher tax rates than the home country. Half of the benefit is attributed to each type of host country.
Europe is defined here as all EU countries plus Norway, Iceland, Switzerland, Croatia, Bosnia–Hercegovina, Serbia and Montenegro, Albania, and Macedonia.
The 2007 CPI covers 179 countries, but none of the eight major tax haven islands. For these jurisdictions, corruption is set to zero, because it is very unlikely that protection against corruption is a reason to divert tax haven investments through the Netherlands.
At the end of 2007, total FDI diverted via Dutch SPEs was approximately €1,400 billion. The observations in the dataset add up to €864 billion, or roughly 60 % of the total, because they exclude FDI assets attributed to unknown liabilities, roundtripping FDI, and smaller SPEs. Total diverted FDI included in the regressions is further reduced to €563 billion, because FDI into tax havens is disregarded, for €110 billion of diverted FDI corresponding data on nondiverted FDI are unavailable, and tax or control variables are missing for some minor countries.
All estimated effects reported in the text are evaluated at mean values of the regression variables, taking into account the tobit estimation method and the transformation of the dependent variable. The effects refer to the expected share of diverted FDI unconditional on this expected share being greater than zero. The difference with conditional effects is not substantial.
References
Avi-Yonah, R. S. (2009). Double tax treaties: an introduction. In K. P. Sauvant & L. E. Sachs (Eds.), The effect of treaties on foreign direct investment (pp. 99–107). Oxford: Oxford University Press.
Baistrocchi, E. A. (2008). The use and interpretation of tax treaties in the emerging world: theory and implications. British Tax Review, 4, 352–391.
Barthel, F., Busse, M., Krever, R., & Neumayer, E. (2010a). The relationship between double taxation treaties and foreign direct investment. In M. Lang et al. (Eds.), Tax treaties: building bridges between law and economics, Amsterdam: IBFD (pp. 3–18).
Barthel, F., Busse, M., & Neumayer, E. (2010b). The impact of double taxation treaties on foreign direct investment: evidence from large dyadic panel data. Contemporary Economic Policy, 28(3), 366–377.
Blonigen, B. A., & Davies, R. B. (2008). Do bilateral tax treaties promote foreign direct investment? In J. Hartigan (Ed.), Handbook of international trade (pp. 526–546). Boston: Blackwell Publishers.
Collins, J. H., & Shackelford, D. A. (1998). Global organizations and taxes: an analysis of the dividend, interest, royalty, and management fee payments between U.S. multinationals’ foreign affiliates. Journal of Accounting & Economics, 24(2), 151–173.
Coupé, T., Orlova, I., & Skiba, A. (2008). The effect of tax and investment treaties on bilateral FDI flows to transition countries. In 9th annual global development conference, Brisbane, 29 Jan 2008.
Desai, M. A., Foley, C. F., & Hines, J. R. Jr. (2003). Chains of ownership, regional tax competition, and foreign direct investment. In H. Herrmann & R. Lipsey (Eds.), Foreign direct investment in the real and financial sector of industrial countries (pp. 61–98). Heidelberg: Springer.
DNB (2009). Stagnation at bank SFIs, growth in activities of other SFIs. DNB Statistical Bulletin, 14–19 Sept. 2009.
DNB (2010). EUR 90 billion in income channeled through dutch SFIs. DNB Statistical Bulletin, 25–28 Dec. 2010.
Dolan, D. K., & Walsh Weil, M. F. (1995). Use of holding companies in international tax planning. Taxes, 73, 873–888.
Egger, P., Larch, M., Pfaffermayr, M., & Winner, H. (2006). The impact of endogenous tax treaties on foreign direct investment: theory and evidence. Canadian Journal of Economics, 39(3), 901–931.
Fortanier, F., & Van Tulder, R. (2007). Bilateral investment treaties and foreign direct investment. Paper presented at AIB Conference, Indianapolis, IN, June 2007.
Grubert, H., & Slemrod, J. (1998). The effect of taxes on investment and income shifting to Puerto Rico. Review of Economics and Statistics, 80(3), 365–373.
Kandev, M. (2009). Treaty shopping after prevost car: what does the future hold? Toronto: International Fiscal Association (Canadian branch).
Kingson, C. I. (1981). The coherence of international taxation. Columbia Law Review, 81(6), 1151–1289.
Lee, K. G. (2009). Improper use of tax treaties. UN Committee of Experts on International Cooperation in Tax Matters, New York.
Mutti, J., & Grubert, H. (2009). The effect of taxes on royalties and the migration of intangible assets abroad. In M. Reinsdorf & M. J. Slaughter (Eds.), International trade in services and intangibles in the era of globalization (pp. 111–137). Chicago: University of Chicago Press.
Neumayer, E. (2007). Do double taxation treaties increase foreign direct investment to developing countries? Journal of Development Studies, 43(8), 1501–1520.
OECD (1986). Double taxation conventions and the use of conduit companies. Paris: OECD.
OECD (2008). OECD benchmark definition of foreign direct investment (4th edn.). Paris: OECD.
Pistone, P. (2010). Tax treaties with developing countries: a plea for new allocation rules and a combined legal and economic approach. In M. Lang et al. (Eds.), Tax treaties: building bridges between law and economics (pp. 413–440). Amsterdam: IBFD.
Siegmann, T. (2007). The impact of bilateral investment treaties and double taxation treaties on foreign direct investments. (Working Paper No. 2008-22) University of St. Gallen Law Economics.
Thuronyi, V. (2010). Tax treaties with developing countries. In M. Lang et al. (Eds.), Tax treaties: building bridges between law and economics, Amsterdam: IBFD (pp. 441–456).
Van Os, R., & Knottnerus, R. (2011). Dutch bilateral investment treaties: a gateway to ‘treaty shopping’ for investment protection by multinational companies. SOMO, Amsterdam.
Wacker, R. (1993). Anti-treaty shopping restrictions in the new U.S.–Netherlands tax treaty. The Tax Executive, 45, 383–390.
Weichenrieder, A. J., & Mintz, J. (2008). What determines the use of holding companies and ownership chains? (Working Paper Series No. 803). Oxford University Centre for Business Taxation.
Weyzig, F., & Van Dijk, M. (2009). Incoherence between tax and development policies: the case of the Netherlands. Third World Quarterly, 30(7), 1259–1277.
Wilkie, K. (2010). Business monitor MA4: foreign direct investment 2008. London: Office for National Statistics.
Acknowledgements
The author thanks Ruerd Ruben and various others for valuable comments and Eric Neumayer for sharing data on tax and investment treaties. The author acknowledges financial support from SOMO (Centre for Research on Multinational Corporations).
Author information
Authors and Affiliations
Corresponding author
Additional information
Research for this paper was done when the author was working for SOMO.
Views expressed in this paper are solely those of the author.
Appendices
Appendix 1: Calculation of tax benefits
Dividend conduit benefit
If the home country exempts foreign dividend income:
and if the home country does not exempt foreign dividend income, but provides a tax credit:
with STR denoting the statutory tax rate on corporate income and
Base company benefit
If the home country exempts foreign dividend income: Benefit=0; if the home country does not exempt foreign dividend income, but provides a tax credit:
Mixing company benefit
If the home country exempts foreign dividend income: Benefit=0; if the home country does not exempt foreign dividend income, but provides a tax credit:
Appendix 2: Correlation matrix
See Table 8.
Appendix 3: Results of robustness checks
Table 9 presents the results of robustness checks for the regressions with tax treaty dummies. The results are briefly discussed in the main text. The first regression omits gravity variables. The second regression includes home country fixed effects and the third regression includes host country fixed effects. The fourth regression uses a linear dependent variable. Table 10 presents the same robustness checks for the regressions with strategy-specific tax variables. These are also discussed in the main text. The use of data for 2006 instead of 2007 (not shown) does not affect the results for general and strategy-specific tax variables.
Rights and permissions
About this article
Cite this article
Weyzig, F. Tax treaty shopping: structural determinants of Foreign Direct Investment routed through the Netherlands. Int Tax Public Finance 20, 910–937 (2013). https://doi.org/10.1007/s10797-012-9250-z
Published:
Issue Date:
DOI: https://doi.org/10.1007/s10797-012-9250-z