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

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  • Kari, Seppo
  • 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.

Suggested Citation

  • Kari, Seppo & Ylä-Liedenpohja, Jouko, 2005. "Cost of Capital for Cross-border Investment: The Fallacy of Estonia as a Tax Haven," Discussion Papers 367, Government Institute for Economic Research Finland (VATT).
  • Handle: RePEc:fer:dpaper:367
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    References listed on IDEAS

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    1. Weichenrieder, Alfons J., 1998. "Foreign profits and domestic investment," Journal of Public Economics, Elsevier, pages 451-463.
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    Cited by:

    1. Huizinga, Harry & Laeven, Luc & Nicodeme, Gaetan, 2008. "Capital structure and international debt shifting," Journal of Financial Economics, Elsevier, pages 80-118.
    2. 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.

    More about this item

    Keywords

    Direct investment; tax incentives; corporate tax; International comparisons; Kansainväliset vertailut; Taxation; Verotus; Taxation and Social Transfers; Julkisen talouden rahoitus ja tulonsiirrot; H250 - Business Taxes and Subsidies including sales and value-added (VAT); H320 - Fiscal Policies and Behavior of Economic Agents: Firm; H870 - International Fiscal Issues; International Public Goods;

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm
    • H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods

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