# Tax treaties and foreign direct investment: a network approach

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## Abstract

Multinational investors often reduce tax on dividends by using indirect investment routes. This paper constructs a tax rate matrix to represent a real-world network of tax treaties between 70 countries and develops a computation algorithm to study the structure of tax-minimizing (direct or indirect) investment routes in the tax treaty network. The treaty shopping rate, defined as the difference between the foreign tax rates of the direct route and a tax-minimizing route, is about 3.66 percentage points on average. This paper also examines the relationship between FDI and the structure of tax-minimizing routes. Empirical results show that the existence of a tax-minimizing direct route is positively and significantly related to FDI. The inward FDI stock via a tax-minimizing direct route is about 2.14 times larger than the inward FDI stock via a direct route that is not tax-minimizing. By making a direct route tax-minimizing, countries can encourage FDI via the direct route and reduce treaty shopping.

## Keywords

Tax treaty network Tax-minimizing route Treaty shopping rate Foreign direct investment## JEL Classification

F23 H25 H87## Notes

### Acknowledgements

Author would like to thank Ron Davies, Woo-Hyung Hong, Maarten van’t Riet, Hyun Young You, and two anonymous referees for insightful comments. An earlier draft of this paper was presented at IIPF 2016 Lake Tahoe, NTA 2016 Baltimore, and Vanderbilt University. Author appreciates comments from the participants.

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