Does withholding tax on interest limit international profit-shifting by FDI?

Abstract

Research background: Poland is a significant recipient of intercompany loans as a part of foreign direct investment (FDI) debt instruments reported in the Balance of Payments. Most of them  come  from  the developed West European  countries — Netherlands, Luxembourg, France, Ger- many, and Belgium. Igan et al. (2020) confirm debt-based FDI inflows to emerging markets had a higher impact on the industries’ growth in the pre-crisis period 1998–2007 than after (till 2010). Purpose  of  the  article: We  aim  to  identify withholding  tax  (WHT)  impact  on  intercorporate loans inflow to Poland and analyse the relationship between trade credit and intercompany loans  to assess the importance of the profit-shifting role of FDI after 2010. Methods: To reflect the impact of withholding tax and trade credit on inter-company loans (in-ward debt-based FDI) in 2011–2017 to Poland, we use Arellano-Bond and random effects panel model estimators. The estimated specification  is derived  from the knowledge-capital model and includes two types of capital: Human and physical. Findings & value added: We show that WHT on interests reduces profit-shifting by multinational companies’ intercompany lending to Poland. But intercompany loans are positively related to foreign trade credit. Unlike in the case of total FDI inward to Poland (Cieślik, 2019), we identified that vertically integrated multinational enterprises are more likely to provide loans to Polish firms. This  study  is  the  first  to  confirm  that withholding  tax  of  interests  reduces  international profit-shifting by FDI and to provide evidence on the relation-ship between  foreign trade credit and intercompany loans provided by multi-national companies.