International Taxation and FDI Strategies: Evidence From US Cross-Border Acquisitions

While there is a well-established body of empirical research documenting the negative effect of taxation on foreign direct investment (FDI), there is scant evidence on the extent to which international tax considerations (double taxation, international tax relief stipulated in bilateral tax treaties and the effect of withholding taxes) affect the role of taxation for FDI, and how tax issues differ according to the investment strategies—‘horizontal’ and ‘vertical’—pursued by %multinational firms. This paper addresses these issues. Using data on US acquisitions over the period 1995-2005 in 18 OECD countries, it is shown that international tax relief plays a critical role in determining the impact of taxation. Regardless of the type of investment strategy, the significantly negative effect of corporate taxes disappears when accounting for the tax credits stipulated in bilateral tax treaties. It is also shown that there is considerable heterogeneity of the impact of sales taxes across investment strategies. High administrative burden to comply with taxation always reduces a country’s appeal as target for FDI.