Attracting inbound foreign direct investment (FDI) by multinational corporations has long been an important objective of many governments in developing and transition economies. In view of the perceived benefits of FDI and of its sensitivity to taxes, many such governments offer tax holidays and other tax incentives for multinational corporations.
The effectiveness of these measures depends in crucial respects on the tax regime prevailing in the multinational corporation’s home country (where the parent firm is headquartered). The benefit it receives from the tax holiday may be fully or partly undone by higher taxes owed to the home country. This is because the lower tax paid to the host country (where the multinational affiliates carry out business activity) lowers not only the local affiliate’s tax liability, but also the tax credit available to the parent in its home jurisdiction for taxes paid abroad.
As multinational corporations care about their combined tax liability to both governments, the developing country’s aim of attracting more FDI will be frustrated, as a tax incentive would only benefit the treasury of the home country, without benefiting the multinational corporation.
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