Tax Effects on Foreign Direct Investment

Virtually all governments are keen to attract foreign direct investment (FDI). It can generate new jobs, bring in new technologies and, more generally, promote growth and employment. The resulting net increase in domestic income is shared with government through taxation of wages and profits of foreign-owned companies, and possibly other taxes on business (e.g. property tax). FDI may also positively affect domestic income through spillover effects such as the introduction of new technologies and the enhancement of human capital (skills). Given these potential benefits, policy makers continually re-examine their tax rules to ensure they are attractive to inbound investment. Tax policies may also support direct investment abroad, as outbound investment may provide efficient access to foreign markets and production scale economies, leading to increased net domestic income.

At the same time, governments continually balance the desire to offer a competitive tax environment for FDI, with the need to ensure that an appropriate share of domestic tax is collected from multinationals.

But while tax is recognized as being an important factor in decisions on where to invest, it is not the main determinant. FDI is attracted to countries offering: access to markets and profit opportunities; a predictable and non-discriminatory legal and regulatory framework; macroeconomic stability; skilled and responsive labour markets; and well-developed infrastructure. All of these factors will influence the long-term profitability of a project.

Policy makers face many complex issues and questions in this area, such as: How sensitive is FDI to taxation? How does tax planning factor in? What are the main policy considerations guiding the taxation of inbound investment, and outbound investment? How have countries responded to pressure to reduce taxes on FDI? This Policy Brief looks at recent OECD work on these issues.