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Cost of Capital for Cross-border Investment: The Fallacy of Estonia as a Tax Haven

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  • Seppo Kari
  • Ylä-Liedenpohja
  • Jouko

Abstract

The initial cost of capital of a foreign subsidiary, financed by its parent from abroad, is dependent on repatriation taxes and this also applies to all follow-up investments financed from marginal foreign profits, representing the required return on the initial investment. Only investments financed from intra-marginal foreign profits are independent of repatriation taxes, but their cost of capital depends inversely on the dividend tax of the home-country parent?s owners. We calibrate the cost of capital formulae to the Estonian and Finnish parameters of taxing international investment income. The calculations show that Estonian subsidiaries, which pay no tax on undistributed profits but a corporate dividend tax, offer tax benefits to their parents only in terms of intra-marginal profits.

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Bibliographic Info

Paper provided by Government Institute for Economic Research Finland (VATT) in its series Discussion Papers with number 367.

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Date of creation: 28 Apr 2005
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Handle: RePEc:fer:dpaper:367

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Keywords: Direct investment; tax incentives; corporate tax;

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References

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  1. Sinn, H.W., 1990. "Taxation And The Birth Of Foreign Subsidiaries," Papers 66, Princeton, Woodrow Wilson School - Discussion Paper.
  2. Boeri, Tito & Brücker, Herbert, 2001. "Eastern Enlargement and EU-Labour-Markets: Perceptions, Challenges and Opportunities," IZA Discussion Papers 256, Institute for the Study of Labor (IZA).
  3. Lindhe, Tobias & Södersten, Jan & Öberg, Ann, 2001. "Economic Effects of Taxing Closed Corporations under a Dual Income Tax," Working Paper Series 2001:16, Uppsala University, Department of Economics.
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  6. Seppo Kari & Jouko Ylä-Liedenpohja, 2004. "Effects of Equalization Tax on Multinational Investments and Transfer Pricing," Discussion Papers 337, Government Institute for Economic Research Finland (VATT).
  7. Seppo Kari & Jouko Ylä-Liedenpohja, 2002. "Classical Corporation Tax as a Global Means of Tax Harmonization," Discussion Papers 266, Government Institute for Economic Research Finland (VATT).
  8. Michael Funke, 2002. "Determining Taxation and Investment Impacts of Estonia's 2000 Income Tax Reform," Finnish Economic Papers, Finnish Economic Association, vol. 15(2), pages 102-109, Autumn.
  9. William Vickrey, 1939. "Averaging of Income for Income-Tax Purposes," Journal of Political Economy, University of Chicago Press, vol. 47, pages 379.
  10. Blanchard, Olivier & Jimeno, Juan F, 1995. "Structural Unemployment: Spain versus Portugal," American Economic Review, American Economic Association, vol. 85(2), pages 212-18, May.
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  14. Seppo Kari, 1999. "Dynamic Behaviour of the Firm Under Dual Income Taxation," Research Reports 51, Government Institute for Economic Research Finland (VATT).
  15. Tiiu Paas & Raul Eamets & Jaan Masso & Marit Room, 2003. "Labour Market Flexibility And Migration In The Baltic States: Macro Evidences," University of Tartu - Faculty of Economics and Business Administration Working Paper Series 16, Faculty of Economics and Business Administration, University of Tartu (Estonia).
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  20. Sinn, Hans-Werner, 1984. "Die Bedeutung des Accelerated Cost Recovery System fur den internationalen Kapitalverkehr. (The Significance of the Accelerated Cost Recovery System for International Capital Movements. With English s," Kyklos, Wiley Blackwell, vol. 37(4), pages 542-76.
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Cited by:
  1. Michael P Devereux, 2007. "Taxes in the EU New Member States and the Location of Capital and Profit," Working Papers 0703, Oxford University Centre for Business Taxation.
  2. Michael P. Devereux & Peter Birch Sørensen, 2006. "The Corporate Income Tax: international trends and options for fundamental reform," European Economy - Economic Papers 264, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.

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