"Tax Sparing" and Direct Investment in Developing Countries

Abstract

This paper analyzes the effect of and performance of foreign direct investment (FDI). sparing foreign investment income to permit investors to receive the full benefits of host country tax reductions. For example, Japanese firms investing in countries with whom Japan has agreements are entitled to claim foreign tax credits for income taxes that they would have paid to foreign governments in the absence of tax holidays and other special abatements. Most high-income capital-exporting countries grant "tax sparing" for FDI in developing countries, while the United States does not. Comparisons of Japanese and American investment patterns reveal that the volume of Japanese FDI located in countries with whom Japan has than what it would have been otherwise. In addition, Japanese firms are subject to 23% lower tax rates than are their American counterparts in countries with whom Japan has agreements. Similar patters appear when with the United Kingdom are used as instruments for Japanese sparing influences the level and location of foreign direct investment and the willingness of foreign governments to offer tax concessions.