Does Withholding Tax Reduce International Income-Shifting by FDI?

FDI instruments are used for income-shifting from firms located in countries with higher taxes to low-tax governments or tax heavens. Nowadays, the EU tries to eliminate such practices. We add to this discussion by studying whether withholding tax reduces income-shifting with the use of debt and equity FDI. Poland is the chosen setting. We use the Arellano-Bond dynamic panel-data estimator for an extended specification model derived from the knowledge-capital model with two types of capital: physical and human. We provide evidence that to reduce multinational enterprises’ income-shifting, the policymakers can increase WHT on interests. However, WHT on dividends seems inefficient, contrary to WHT on interests, as a rise in WHT on dividends motivates MNEs to provide debt FDI instruments instead of equity FDI. We identified that vertically integrated MNEs from countries with good quality governance and a better institutional environment are more likely to provide loans and other debt FDI to Polish firms. Horizontally integrated MNEs are more likely to withdraw debt FDI from Poland, while vertically integrated MNEs renew debt FDI in Polish firms.