According to a report released late last year, at least 40 percent of foreign investments are aimed at reducing taxes. These investments frequently lead to empty corporate shells that do not have any real business activity.
The report came from researchers at the University of Copenhagen and the IMF. It was released in September 2019, and the findings are still highly relevant. The researchers looked at foreign direct investment (FDI) and found some interesting trends. The researchers included Jannick Damgaard, Thomas Elkjaer, and Niels Johannesen.
Understanding Foreign Direct Investment
Foreign direct investment refers to cross-border investments that occur between firms that are in the same multinational group. An example would be when a foreign company opens a local factory.
Many countries around the world do their best to attract foreign investments, operating under the assumption that doing so will enhance the local economy. The recent report, however, indicates that this may not always be the case.
The Key Findings
The report in question found that an average of more than 25 percent of these FDIs is phantom. In other words, they have no impact on innovations and create no jobs or very few of them.
According to the report, a large proportion of the foreign direct investments sit in foreign shells that do not have business activity. The purpose is not economic growth for the local country or even business growth. Instead, these FDIs seem to be used for reducing the global tax bill that the company pays.
Consider the figures that the researchers include in their paper. The team found that phantom investments total $15 trillion globally. This figure is the combined annual GDPs for Germany and China, both of which are known as economic powerhouses.
The researchers estimate that nearly 40 percent of the global foreign direct investments are phantom. Most of these funds are in a handful of tax havens but most economies in the world host at least some of them. On average, phantom FDIs account for more than a quarter of the total flows.
Almost half of all global phantom FDIs are in the Netherlands and Luxembourg. The remaining half is mostly in five jurisdictions, as well as British Overseas Territories, such as Bermuda, the Cayman Islands, and the British Virgin Islands.
Why It Matters
The finding that there are so many phantom FDIs is particularly crucial given the benefits of traditional FDIs. Phantom FDIs take advantage of this reputation for benefits without providing any of them.
For example, 7.1 million workers in the United States had jobs with foreign companies as of September 2019, with average earnings of $81,000. Additionally, at the time, foreign-owned firms’ exports accounted for over a quarter of all American exports. Experts also agree that FDI improves innovation in the hosting countries.
Phantom FDIs Do Contribute Slightly
Although phantom FDIs do not have the same level of benefits as brick-and-mortar ones, they do still contribute to the local economy, although to a minimal extent. They will buy financial services, such as accounting and tax advisory services. They also pay fees for incorporation and registration.
Criticism of Phantom FDIs
Those who criticize these phantom investments point out that those minor benefits in terms of services purchased and registration or incorporation fees are outweighed by their potential harm. Using empty corporate shells conveniently situated in tax havens can potentially undermine tax collection. Critics say that this is the case in all types of economies, including developing, advanced, and emerging-market.
So far, there has not been any indication that countries will take action based on the results of this research. Still, it has provided tax haven critics with additional valuable data.
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