Global investment falters but tax havens prosper, U.N. finds

GENEVA Wed Jun 26, 2013 6:05pm BST

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GENEVA (Reuters) - Efforts to stop companies syphoning money through tax havens are failing and offshore centres increased their share of foreign direct investment (FDI) again last year, according to a U.N. report.

"Tackling offshore financial centres alone is clearly not enough, and is not addressing the main problem," said the annual World Investment Report, published on Wednesday by economic thinktank UNCTAD.

While investment sinks in many economies, one country is enjoying above all is enjoying a boom: the British Virgin Islands, with a population of 30,000, is now the fifth biggest recipient of FDI in the world, the report said.

The Caribbean archipelago welcomed almost $65 billion (42.4 billion pounds) of inward investment flows in 2012, just less than fourth-ranked Brazil, and 10 times the amount of FDI it received in 2006.

FDI flows to such offshore tax havens have soared in the past five years, rising from an average of $15 billion in 2000-2006 to $75 billion per year in 2007-2012, the report said.

"Tax haven economies now account for a non-negligible and increasing share of global FDI flows, at about 6 percent," the United Nations thinktank said.

Meanwhile, traditional FDI - cross-border corporate acquisitions and overseas expansions - has slumped.

Among the worst hit are rich euro zone countries such as Belgium, which attracted $103 billion in 2011 but lost money in 2012 as existing investors sold up. The Netherlands saw a similar but smaller reversal, while Germany's $49 billion haul of FDI in 2011 shrivelled to less than $7 billion in 2012.

Global foreign direct investment shrank by 18 percent to $1.35 trillion in 2012 and is likely to remain at a similar level this year, the report said. UNCTAD forecasts global flows of $1.6 trillion next year and $1.8 trillion in 2015.

In tax havens, the vast majority of FDI flows do not go into projects based in the country. Instead they are redirected back to the source country, a process known as "round tripping".

"For example, the top three destinations of FDI flows from the Russian Federation - Cyprus, the Netherlands and the British Virgin Islands - coincide with the top three investors in the Russian Federation," the report said.

That could mean that global FDI is actually even weaker than it appears, since a growing proportion is simply round-tripping.

Even more money is channelled through "special purpose entities" (SPEs). Firms set up these foreign affiliates for specific purposes such as managing foreign exchange risk or facilitating the financing of an investment.

Money flowing to SPEs in just three countries - Hungary, Luxembourg and the Netherlands - amounted to $600 billion in 2011, dwarfing the $90 billion of flows to tax havens.

Those countries' SPE flows were not counted as FDI in the report. However, the report said SPEs were gaining importance relative to FDI flows and anecdotal evidence showed that most of the money sent to SPEs was invested in third countries.

Still more tax is avoided through cross-border transfer pricing schemes, which companies can use to shift profits into low-tax jurisdictions and show apparent losses in high-tax markets, the report said.

Despite the OECD trying to stem the flow of FDI to tax havens, the overall flows to tax havens overall "do not appear to be decreasing", the report said, partly because big companies still needed somewhere to park their cash mountains.

"Efforts since 2008 to reduce flows to OFCs (offshore financial centres) have coincided with record increases in retained earnings and cash holdings," the report said.

Also, although big investors such as Japan and the United States had succeeded in cutting the amount of flows to tax havens, many non-OECD members had now taken their place, ensuring the flows to tax havens continued and grew.

The report called for a discussion of corporate tax rate differentials between countries, extraterritorial tax regimes and tax levied on repatriated earnings.

"Without parallel action on these fronts, efforts to reduce tax avoidance through OFCs and SPEs remain akin to swimming against the tide," the report said.

(Reporting by Tom Miles; Editing by Ruth Pitchford)

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