The Effect of Double Taxation Treaties on Attracting Foreign Direct Investment: A Review of Literature

Abstract

Double taxation treaties are enacted with the aim of eliminating double taxation. Furthermore, these treaties help less developed countries attract foreign direct investment (FDI) and reduce and eliminate double taxation. Numerous studies have revealed the positive impact of implementing double taxation treaties on attracting FDI to developing countries. Implementing double taxation treaties does not happen overnight. In fact, LDCs have expended years of effort and scarce resources to negotiate, implement, and conclude these treaties with developed countries. Furthermore, LDCs lose out on potential tax revenues. These treaties often favor residence-based taxation over source-based taxation. The lost tax revenues and capital invested in negotiations with developed countries, in addition to other implementation costs, can only be justified if the expected benefits of foreign direct investment (FDI) outweigh these costs. This paper critically reviews the literature on the impact of implementing double taxation treaties on attracting FDI to developing countries. This review is supplemented by a summary of economic models used by policymakers to analyze the potential tax impact on FDI decisions.