Tax Arbitration and Foreign Direct Investments: A Comparison between Developed and Developing Countries

• In Event: Tax Policy and MNE Investment

Abstract

Tax arbitration — an alternative dispute resolution mechanism conducted through independent arbitrators to reduce tax uncertainty — has become a major focus of recent regulatory efforts to tackle growing cross-border tax disputes. Until now, we have little insight into potential consequences of tax arbitration efforts and their impacts on overall economic activity. We investigate whether tax arbitration globally is associated with foreign direct investment (FDI), using the staggered adoption of bilateral tax arbitration clauses under tax treaties over the period 2003 to 2020. Country-level analyses based on OECD development rankings show that investments from developed countries into developing countries sharply increase after the adoption of bilateral tax arbitration clauses. The effect is driven by inflows into middle-income developing countries and less pertinent into low-income countries. Additional firm-level evidence tracing historical ownership data suggests that the increase in investments is partly attributable to tax arbitration encouraging mid-sized and private (unlisted) multinationals to establish subsidiaries in developing destination countries. Overall, our findings provide novel evidence on the investment response to tax arbitration, informing policymakers about the effectiveness of tax arbitration clauses in attracting investment and the importance of considering economic environments when designing tax policy.

Author

• Xixi Zhang, IESEG School of Management