World Investment Report 1998:
Trends and Determinants

Chapter III
Investment Policy Issues

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(...) It is generally accepted that one of the most important effects of tax treaties is the legal certainty they provide to investors, in both the home and the host countries. Regardless of any changes affecting a host country’s tax system, foreign investors cannot be taxed beyond the levels allowed by a treaty. This effect is less comprehensive in the home country. In reality, certain changes in the home country tax system can affect the investor regardless of the existence of a treaty. For example, if the treaty provides for the credit method, a general increase in the corporate tax rate in the home country will also affect a resident deriving foreign-source income, regardless of the treaty. However, the exemption method, if adopted in the treaty, could not be modified at will by the home country.

Tax treaties can have development implications and cannot, therefore, be fully separated from the context of various monetary, fiscal, social and other policies of contracting parties. When the parties are at the same or a similar level of development, the gain or loss of revenue resulting from reciprocal flows of investment does not have the same significance as when the parties are at different stages of development. The presumption of symmetries of gains and losses underlying tax treaties between countries at the same level of development is not applicable for countries at different stages of development. The loss of revenue may have a different “value” for a contracting party, depending on its level of development. For this reason, it could be argued that any eventual reduction in tax revenue from locally produced income should be offset by an increase in investment and technology flows. Since income flows are generally from developing to developed countries, a pattern of tax treaties in which the source country gives up revenue more often than not will not involve the rough symmetry of sacrifice which it might in tax treaties between developed countries. It should also be noted that developing countries, in their domestic laws, often introduce measures aimed at the alleviation of the tax burden of foreign investors, through a variety of tax incentives including income-tax exemptions, reduction or exemption of export proceeds, and reduction or exemptions of individual income taxes for foreign personnel. The benefits of these tax incentives for investors may exceed those resulting from tax treaties. These benefits are, however, offered unilaterally rather than in the context of an international agreement and it may be that foreign investors will value more highly the benefits of more modest reductions or exemptions given in the context of tax treaties with the attendant advantages of stability, transparency and certainty of treatment. From the perspective of host countries, having a smaller share of revenue, as a consequence of concessions offered either in domestic legislation or in the context of a tax treaty, could be (though it need not be) compensated for by increased flows of capital and technology into their economies as the result of an improved climate for FDI.

A number of different views have been expressed on the role that the tax factor plays in attracting or inhibiting FDI (Plasschaert, 1994, pp. 46-47). Although this factor remains subsidiary to other factors, it is also generally accepted that, with the removal of barriers to FDI, taxation may gain more importance in investors’ decisions. Long-term investors may attach more importance to the general features of a country’s tax system than to its temporary incentives. In considering the role of the tax factor in attracting or inhibiting FDI, it may be important to distinguish the significance of incentives from that of other features of the tax system such as stability, transparency and certainty of treatment. Still, other things being equal, the tax factor could play a determining role in the choice of an FDI location and this in turn could give rise to a tax competition for investment (OECD, 1998b) (box III.12). (...)