49% of All US Foreign Direct Investment Went to Holding Companies

Foreign direct investments have been touted for improving the overall health of the global economy, especially for developed countries, by supporting innovation, job creation, and economic development.

There are obvious benefits of FDI to corporations – they can get access to foreign markets, take advantage of lower labour costs in other countries, and perhaps most importantly, avoid domestic tax.

Moneyzine.com reveals that holding companies around the world receive 49% of all US foreign direct investments. This accounts for $3.7 trillion of the total $6.4 trillion invested abroad.

FDI is on the rise – but there’s an imbalance

Since 1982, the US foreign direct investment rose by 166.8% from $580 billion to $6.4 billion.

A total of eight industrial sectors accounted for $6.3 trillion, or 97.5% of total foreign direct investment of $6.4 trillion. Top sectors include;

• Holding companies at $3.7 trillion (49%),

• Financial services at $1.1 trillion (16%),

• Manufacturing at $912 billion (14%).

More than half (61%) of direct investment went to European countries, followed by Latin America (16%), Asian and Pacific countries (15%), Canada (6%), and finally the Middle East and Africa, both at 1%. Top countries included the UK, the Netherlands, Luxembourg, Ireland, and Canada.

Investments to holding companies made up 60% of all investments to Ireland, 80% to the Netherlands, and a whopping 90% to Luxembourg. Investments in holding companies hold an overwhelming majority among the overall investments to these three countries.

All three of which are listed in the top 11 in the Corporation Tax Haven Index.

Profit shifting is the crux

A holding company is a business that holds securities and other financial assets of corporations, called subsidiaries. They own the right to control interest in said corporations and influence their management decisions. Holding companies are immune to any financial trouble their subsidiaries may go through, meaning that they are not affected by the losses should a subsidiary go bankrupt.

Historically, domestic businesses choose to move profits and business into foreign countries with tax incentives. Companies usually do this by moving profits into foreign holding companies.

Back in 2016, the IRS calculated that about $1.3 trillion in profits were held by foreign subsidiaries of US finance, insurance, and holding companies, transferred through foreign direct investment. As the figures show, the majority of FDI concentrates in low-tax countries like Luxembourg or the Netherlands.

According to the estimates of the Congressional Research Service, profit shifting incurs losses close to $80 billion every year in U.S. corporate revenue. Since the mid-1960s, US corporate tax revenues have declined substantially. In 1965, the revenue from corporate tax accounted for 3.9% of the overall GDP. By 2020, it dropped to roughly 1%.

It’s a global problem

The world’s 20 leading economies, a group also known as the G-20, came together about a decade ago to crack down on the issue of corporations shifting profits to low-tax countries. They drafted a 15-point action plan that included proposals like creating universal tax rules and preventing harmful tax practices.

It hasn’t worked out very well. According to Fortune’s estimations, the world’s biggest multinational businesses shifted 37% of their profits, amounting to $969 billion, to tax havens in 2019. This is up from about 20% in 2012 when G-20 leaders agreed to take action against profit shifting.

In 2019, the total global government tax loss was $250 billion. The US multinational corporations alone made up about half of it. The amount of corporate tax lost as a result of profit shifting climbed up to 10% from less than 0.1% back in the 1970s.

The loss of tax revenue due to profit shifting is nothing short of staggering. I believe these figures show the pressing need for the international community to increase their efforts in tackling multinational companies taking advantage of mismatches in international tax regulations.

Jonathan Merry, CEO of Moneyzine.com