Tax Arbitration and Foreign Direct Investments: A comparison between developed and developing countries

Given the increased tax complexity of international tax law, tax arbitration, the alternative dispute resolution mechanism by independent arbitrators, is a major focus of recent regulatory efforts to tackle increased cross-border tax disputes. However, the real consequences of tax arbitration are underexplored. I investigate the degree to which tax arbitration is associated with foreign direct investment. Using the staggered adoption of tax arbitration under tax treaties, I find that investments from developed OECD countries in developing host countries significantly increase following tax arbitration. The effect on developing host countries is driven by investments in middle-income developing countries with a per capita gross national income of 766 to 9,385 US dollars. I also find a significantly positive association between destination countries with non-IFRS standards and low institutional quality and the adoption of effective tax arbitration clauses. Micro-level evidence from historical ownership data suggests the increase in investment is partly attributable to tax arbitration inspiring multinationals, especially not very large multinationals, to establish subsidiaries in developing host countries. Overall, I provide novel evidence on investment response to tax arbitration, which is valuable for policymakers in designing tax policy to foster investments by accounting for the involved economic environment.