The Impact of Bilateral Tax Treaties on FDI Inflows: The Case of India

Abstract

Foreign direct investment (FDI) inflows are driven by both home country and host country conditions. It is for the host country to provide a conducive environment to FDI. Many developing Asian economies, including India, have redesigned their tax systems to make them internationally competitive. Bilateral tax treaties are seen as an instrument of policy that makes this possible. Tax treaties alleviate the problem of international double taxation. They create an environment of fiscal and legal certainty. This paper examines the FDI inflows to India from 14 countries that are major partners. With the help of panel data for the period of 1993-2007, this paper models the role of tax treaties in promoting FDI. A fixed effects (LSDV) model is developed that captures macro-economic factors and policy factors such as openness. We have also used Principal Component Analysis to augment the model’s analytical richness. The model estimates shows that FDI inflows into India have been growing due to macro-economic variables, and policy variables including tax treaties. The results show that FDI to India is driven by supply and demand determined factors. It is market seeking and efficiency seeking. It is facilitated by tax treaties. The introduction of the treaty has had a positive impact and FDI flows have jumped due to the treaty. We get largely significant results for the ‘age of the treaty effect’, it clearly shows that in the case of Mauritius, UK, Singapore, Switzerland, UAE and Italy FDI flows to India accelerated after implementation of tax treaties. There is very small but significant and positive effect of tax treaties.