C5. Fiscal Support

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Fiscal support	Tax reductions	Exemptions from corporate income tax
		Tax deductions
	Corporate tax rate relief
	Tax deferrals
	Tax credits
	Allowances

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Governments have the option to offer fiscal support for OFDI projects by reducing the tax burden on firms investing abroad. The kind of fiscal support a country can offer is dependent on its tax system, especially whether the government taxes companies and their foreign affiliates worldwide, or just in relation to activities in its own territory.

The territorial approach taxes only the income earned within a country, with foreign income exempt from taxes. This assures that corporate earnings abroad are only taxed once, i.e., in the host country, and therefore does not discourage the repatriation of overseas earnings. The territorial approach could already be considered a regulatory HCM, as it foregoes the possibility of taxing foreign subsidiaries of a company from the home country. The territorial approach could therefore be considered more supportive to OFDI than the worldwide approach, with companies investing abroad being advantaged if the foreign tax rate is below that of the home country.

The worldwide approach taxes all income of a company irrespective where in the world it was earned. Taxes would be due when the earnings are repatriated, creating incentives to re-invest earnings in the host or other foreign country, rather than repatriating them. The worldwide approach may lead to double taxation in host and home countries, though double taxation treaties or tax credit systems can be put in place that reduce the tax burden by the amount of tax incurred overseas. In such circumstances, the difference between the host and home country taxes can be levied upon repatriation of earnings should the home country tax rate be higher. The worldwide approach places investors at a competitive disadvantage compared to companies from countries with lower taxes or countries that have adopted the territorial approach. Fiscal HCMs are particularly useful when a country uses the worldwide approach, as they can be applied to the tax levied by the home government on the activities of enterprises and their subsidiaries abroad.

Most advanced economies, except the United States, adopt the territorial approach, while the worldwide approach is quite common among emerging economies (Sauvant et al. 2014).

There are various kinds of fiscal support:

Tax reductions can be offered to companies to exempt specific kinds of income from OFDI activities. These can come in two forms:

1. Exemption from corporate income tax in home country taxation, to exempt companies from specified taxes, such as on dividends. Some countries specify conditions for such exemptions, for example a minimum degree of share ownership in a foreign affiliate, or not applying the exemptions to dividends made in foreign tax-haven countries.
2. Tax deductions to reduce the tax burden on investors. For example, companies could be allowed to deduct costs or business expenses associated with OFDI from their income.

Corporate tax rate relief can be applied to specified types of companies or investments, and at particular stages of an investment. It normally reduces the tax rate by a specified percentage.

Tax deferral can be granted to specified companies and their investments, especially to defer tax payments on certain types of overseas income. Tax deferral generally occurs when companies are not required to tax foreign income until that income has been repatriated. This provides an incentive for MNEs to move operations to countries with lower taxes and accumulate earnings there.

Tax credits can be offered on specified kinds of expenditures related to an investment, such as investments in desirable activities, for example R&D or capital goods.

Allowances can be made to support specific types of investments or activities related to an investment.

Fiscal measures require alterations of tax laws, which should make their implementation and administration comparatively straightforward and not too costly. It should be kept in mind that fiscal HCMs reduce the tax earnings of countries (Sauvant et al. 2014).

Fiscal HCMs offer governments an opportunity to incentivise and support OFDI activities that promise to yield favourable home-country effects. They can focus on investment phases that are critical to the success of an investment (UNESCAP 2020).

Key insights

• The territorial approach to taxation is fiscally more advantageous to firms than the worldwide approach and can be considered itself a HCM.
• Governments can offer various tax incentives to promote desirable investment activities, including those that promise to generate home-country effects.
• As fiscal HCMs reduce the income from taxation available to the home country government, their benefits in terms of offering support to OFDI and the generation of home-country effects need to be weighed against the costs of lower government revenue.