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Are the FDI against corporate tax?

Small economies should avoid taxing the income obtained by foreign investors, in order to attract FDI decisions.

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Tax on firms’ profits is the eighth most important factor to bear in mind in an FDI decision, being less important than other factors such as political stability and the host country’s market size.

A result of the study by Simmons was the conclusion that the rate of tax on company profit is one of several relevant factors in FDI decision-making. In this connection, the size of the market in the host country being a more relevant factor to consider in FDI decisions than the corporate tax rate in force was also the conclusion of a study made by the consultants Ernst &Young.

Globally, from a perspective not restricted only to EU countries, industries tend to gather in one region, and that industrial agglomeration gives industrialized nations, core nations an advantage over others which they designate as peripheral. Being aware of this situation, the governments of industrialized nations can tax their industries at a higher rate than that levied by governments of peripheral nations, as long as that rate is not too high.

The greater economic integration can originate higher tax rates, contradicting the view of those who defend that economic integration leads to lower taxes, supporting that position on the assumption that if production factors remain identical, investors move industry to wherever has lowest taxes, which will lead countries to competing in a race to the bottom.

Regarding the impact of the tax rate on corporate income in FDI decisions, various authors conclude on a relationship between the two variables, in that a reduction in the tax rate has an effect of stimulating increased FDI.

Some studies find a relationship between certain other specific measures of fiscal policy (besides measures related to the tax rate) and FDI.

A low corporate tax rate alone is not enough to attract FDI if the remaining fiscal policy creates an unfavourable climate for attracting business, namely by creating unpredictability in the fiscal norms applicable, lack of transparency and ambiguity in fiscal decisions, tax evasion and fraud.

Fiscal rules that are designed specifically to attract foreign capital, namely fiscal ruling on thin capitalization are more important in affecting FDI decisions than fiscal policies changing statutory tax rates. In the same line as specific tax rules on thin capitalization affecting FDI decisions, Beuttner and others concluded that restrictions on tax deduction of interest, resulting from changes to fiscal rules on thin capitalization, have a negative impact on capturing FDI.

Fiscal norms in this area generally act towards limiting tax deductions of the interest paid by the financed body, in situations where there is evidence of formal or nominal undercapitalization.

Stowhase has made a study dividing FDI in two categories (production and services). The results obtained indicate, on one hand, that FDI in the productive sector is affected negatively by the effective tax rate and that FDI in the service sector is not affected by variations in effective tax rates.

On the other, FDI in the goods producing sector is not affected by variations in the nominal tax rate while FDI in the service sector is affected negatively by the nominal tax rate. The author justifies the relevance of variations in the nominal tax rate for FDI in the service sector by the use of mechanisms for transferring results in the service sector, whereby the multinationals operating in this sector try to shift profits to regimes with lower tax rates. Stowhase concludes in this connection that FDI in different sectors responds with different levels of elasticity to the fiscal incentives of the host country and that the FDI made with different objectives will respond differently to the different types of fiscal incentives, namely rules that allow rapid fiscal depreciation can be relevant for a certain type of FDI but irrelevant for another.

It is a common vector in studies in this area that the different types of investment respond differently to fiscal incentives. Besides this, it is noticeable that the type of  fiscal benefit affects different types of investment differently (e.g. a fiscal benefit that allows rapid depreciation of tangible fixed assets will only be relevant for FDI that presupposes investment in this type of asset).

The factors of attraction (exogenous variables – e.g. market size, proximity of the country to the source of investment) are the most important explanatory variables in FDI decisions.

In an extreme position of absolute supremacy of exogenous variables and ignoring host country policies, namely completely ignoring fiscal policy as a relevant factor in FDI decisions. In this argument helps the BRICs experience that managed to attract FDI even with complex and very unattractive tax regimes.

Despite some uniformity of opinion concerning the preponderance of exogenous variables, many studies recognize that host country policies (e.g. labour costs, tax burden, infrastructure, exchange and commercial policies) are also factors to bear in mind in FDI decisions. Fiscal policy is part of a State’s receiving policies, and in turn, receiving policies among them tax policy are also influenced by exogenous factors.

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