Foreign Direct Investment under Oligopoly: Profit Shifting of Profit Capturing?

In this paper a model of taxation of foreign source corporate income is developed, when the output market is not competitive. Profit shifting policies, similar to those in the new trade literature, are also present in the case of foreign direct investment (FDI). There are, however, important differences to the new trade theory since in case of FDI (i) corporate taxation and double taxation relief are the policy instruments rather than output/revenue taxes, (ii) countries are not symmetric in the sensee that the host country has the first right to tax the multinational's profit and the home country reacts to this by providing double taxation relief, and (iii) output but not corporate taxation is specific to strategic industries. It is argued that (a) variants of a tax credit are analogous to export subsidies, (b) when the home country operates a tax credit system the host country's incentive to capture profits by raising its tax is bounded under imperfect competition, (c) the home country should imitate the host policy wehen the host country offers a tax holiday, and (d) in the presence of non-competitive sectors double taxation relief is a good instrument to target strategic industries.