The Effect of Double Taxation Treaties on Tax Relief and Foreign Firms’ Investment Flows (FDI): Evidence from Pakistan

Abstract

To increase inward foreign investment, policy makers increasingly resort to the ratification of double taxation treaties (DTTs). However, the effectiveness of DTTs in inducing higher FDI is still open to debate, as the empirical evidence of existing studies is anything but conclusive. This study analyzed the benefits of DTT to firms in terms of profits from dividend and capital gains, and whether or not these benefits lead to increase in foreign investment inflows. In contrast to earlier approaches, we used a firm specific dataset of bilateral FDI stocks. We also calculated the tax relief obtained by each firm due to DTT. And investigate whether these relief were significant factor in attracting FDI by those firms. We collected the consolidated tax data for a sample of 50 entities residing in Non-resident countries for the period of 2013 to 2017. 28 of them have Active income and 22 were Non-Active. Descriptive statistics, Correlation and regression test were used for the analysis of the data. Our results indicate that tax relief from dividend and capital gains due to DTTs is a significant factors in attracting FDI stocks. Moreover, increase in dividend and capital gain tax also seems to positively affect FDI. Furthermore, the relationship remained unchanged for active income and Non-Active income categories. Hence, in context of Pakistan, DTT seems to have a positive effect on FDI.

Keywords: Double taxation treaties, bilateral investment treaties, Foreign Direct Investment (FDI), Income Tax Act, Domestic laws, Pakistan, Tax Relief, Dividend, Capital Gain