- Reuters / Aly Song
- Roughly 40% of foreign direct investment is “phantom capital” being used to avoid or pay lower corporate taxes, according to a new study by the IMF and University of Copenhagen.
- While foreign direct investment can be beneficial to economies hosting money, using shell companies to pay lower taxes is “financial and tax engineering,” according to the study.
- Tax havens like Luxembourg hold the majority of phantom foreign direct investment, the study found.
- Read more on Markets Insider.
About 40% of all foreign direct investment is “phantom capital” that’s being used by multinational firms to pay lower corporate taxes, according to a new study by the International Monetary Fund and the University of Copenhagen.
That’s about $15 trillion globally – or roughly the size of annual gross dometic product for China and Germany combined, the study showed. Phantom investment has picked up in the last decade, expanding to 40% of all FDI from 30%. That growth rate is faster than global GDP over the same timeframe.
FDI, defined as “cross-border financial investments between firms belonging to the same multinational group,” can be hugely beneficial to countries, the study said. Countries even have policies to attract it because of its ability to drive integration, stimulate growth, create jobs, and boost productivity in local economies.
But phantom FDI – or investments that pass through empty corporate shells that don’t do any real business – is “financial and tax engineering,” blurs statistics, and makes it difficult to understand the true economic integration, the study said.
The vast majority of phantom FDI is being held in well-known tax havens. Luxembourg and the Netherlands hold nearly half, the study showed. Add in Hong Kong, British Virgin Islands, Bermuda, Singapore, the Cayman Islands, Switzerland, Ireland, and Mauritius and more than 85% of phantom FDI is accounted for.
Some countries attract phantom FDI, even luring foreign investment by offering benefits like low or no corporate tax rates. This is because even if shell companies pay little taxes and have few employees, they still boost local economies by buying tax advisory, accounting, and other financial services.
They also pay registration and incorporation fees. In the Caribbean, these fees account for most of GDP, along with tourism.
But overall, heavy investment in foreign empty shells could indicate that both domestically controlled and foreign multinationals are trying to avoid paying taxes, either to the host economy or the home economy.
“Unsurprisingly, an economy’s exposure to phantom FDI increases with the corporate tax rate,” the study said.