Center for Economic Studies and ifo Institute (CESifo), Munich
This paper explores the effects of tax provisions aimed at restricting multinationals’ tax planning on foreign direct investment (FDI). Using a unique dataset which allows us to observe the worldwide activities of a large panel of multinational firms, we test how limitations of interest tax deductibility, so-called thin-capitalization rules, and regulations of transfer pricing by the host country affect investment and employment of foreign subsidiaries. The results indicate that, compared with the unrestricted case, in the presence of a typical thin-capitalization rule, the tax-rate sensitivity of FDI is about twice as large. Moreover, introducing such a rule or making it more tight exerts significant adverse effects on the level of FDI in high-tax countries. Regulations of transfer pricing, however, are not found to exert significant effects on FDI.