The Rise of Phantom FDI in Global Tax Havens – IMF F&D
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Bibliographic details
- Authors: JANNICK DAMGAARD, THOMAS ELKJAER, NIELS JOHANNESEN
- Published: September 1, 2019
Overview
- Empty corporate shells (special purpose entities) in tax havens channel large volumes of foreign direct investment (FDI) without substantive business activity, undermining tax collection in advanced, emerging market, and developing economies.
- FDI is defined as cross-border financial investments between firms belonging to the same multinational group; much of it is phantom—passing through empty corporate shells that carry out holding activities, intrafirm financing, or intangible-asset management.
Key findings
- Luxembourg, a country of 600,000 people, hosts $4 trillion in FDI, equivalent to $6.6 million a person.
- A new global study combining OECD FDI data with the IMF’s Coordinated Direct Investment Survey maps bilateral investment relationships and disentangles phantom FDI from genuine FDI.
- A few tax havens host the vast majority of phantom FDI:
- Luxembourg and the Netherlands host nearly half of the world’s phantom FDI.
- Adding Hong Kong SAR, the British Virgin Islands, Bermuda, Singapore, the Cayman Islands, Switzerland, Ireland, and Mauritius brings the total to 10 economies hosting more than 85 percent of all phantom investments.
- Globally, phantom investments amount to $15 trillion, the combined annual GDP of China and Germany.
- In less than a decade, phantom FDI has climbed from about 30 percent to almost 40 percent of global FDI.
- Most economies invest in and receive investments from empty corporate shells, with averages across all income groups exceeding 25 percent of total FDI.
- An economy’s exposure to phantom FDI increases with the corporate tax rate.
Mechanisms and drivers
- Tax-motivated financial and tax engineering shifts profits and investment through empty shells to minimize multinationals’ global tax bills, blurring traditional FDI statistics and the understanding of genuine economic integration.
- Examples of tax engineering:
- “Double Irish with a Dutch sandwich” involves transfers of profits between subsidiaries in Ireland and the Netherlands with tax havens in the Caribbean as the typical final destination.
- Policy strategies in some tax havens deliberately lure phantom FDI by offering benefits such as very low or zero effective corporate tax rates.
- Even when empty corporate shells have few or no employees and pay little corporate tax in the host economy, they still contribute to local economies through tax advisory, accounting, and other financial services, plus registration and incorporation fees; in some Caribbean tax havens these services account for the main share of GDP alongside tourism.
Trends in corporate taxation
- Ireland’s corporate tax rate has been lowered from 50 percent in the 1980s to 12.5 percent today; despite tax cuts, Ireland’s revenues from corporate taxes have gone up as a share of GDP due to a significantly expanded tax base from massive inflows of foreign investment.
- The global average corporate tax rate was cut from 40 percent in 1990 to about 25 percent in 2017, indicating a race to the bottom and pointing to a need for international coordination.
Macroeconomic and statistical implications
- Financial engineering by multinationals can inflate GDP and FDI figures in tax havens (example: Irish GDP growth of 26 percent in 2015 following relocation of intellectual property rights to Ireland).
- FDI positions have grown faster than world GDP since the global financial crisis, whereas cross-border positions in portfolio instruments and other investments have not.
- Better, adapted macroeconomic statistics are required to reflect a globalized world where intangible assets and digital services can be relocated or sold from tax havens without a physical presence.
Policy recommendations and data needs
- Better data are needed to understand where, by whom, and why $40 trillion in FDI is being channeled around the world.
- The new global FDI network provides a tool to identify host economies of phantom investments and their counterparts, offering clearer insights into globalization patterns and guidance for policymakers addressing international tax competition.
- International cooperation is essential to address taxation challenges in a globalized economic environment.
- The IMF has put forward various alternatives for a revised international tax architecture, ranging from minimum taxes to allocation of taxing rights to destination economies, reflecting emerging widespread agreement on the need for significant reforms.
Source: The Rise of Phantom FDI in Global Tax Havens – IMF F&D
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