Why this book?
This book reviews the rationale for the tax sparing mechanism and analyses its effects within a framework of foreign direct investment (FDI) from China into EU Member States. The author argues that the tax sparing mechanism should not be regarded as a foreign-aid tool used by developed countries to help developing countries; it is, rather, a technique that should be used by both residence state and source state to achieve their different objectives in respect of FDI.
Tax sparing is a mechanism usually reflected in tax treaty provisions, whereby one state commits to crediting the taxes spared (i.e. not actually paid) in another. The spared taxes are the common link between the tax sparing mechanism and FDI, so the book focuses on them throughout, examining the following questions: Which state sacrifices its tax revenue to generate the spared taxes? Who benefits from the spared taxes? Why would contracting states agree to include tax sparing in their tax treaties? And how does the tax sparing mechanism preserve the effect of the spared taxes? The answers lead to the author’s findings:
First, the residence state is not alone in sacrificing tax revenue, as the source state also forgoes tax revenue to generate the spared taxes. Furthermore, the residence state can benefit from the tax sparing mechanism, given that the spared taxes preserved by the mechanism can enhance the competitiveness of its residents in overseas markets and can reduce the distortional effects on its residents’ decisions regarding the repatriation of profits.
Second, the tax sparing mechanism is a treaty technique, with both positive and negative effects. The necessity of adopting the tax sparing mechanism is rooted in the inadequacy of the residence state’s foreign credit method, which nullifies the effectiveness of spared taxes for foreign direct investors. The tax sparing mechanism can resolve this inadequacy by obliging the residence state to credit the spared taxes as if they had been duly paid in the source state.
Finally, as a policy suggestion, both residence state and source state should use the tax sparing mechanism in their tax treaties.
Reviewed by Niels Bammens Professor of Tax Law, KU Leuven.
"The strength of the book lies in its attempt to cast a new light on the tax sparing mechanism, i.e. to shift the debate away from a focus on foreign aid and towards a more comprehensive view in which that mechanism can be mutually beneficial for both treaty partners, irrespective of their development level. The arguments in favour of that view are well presented, thought-provoking and original. The author not only develops arguments based on legal reasoning, but also draws inspiration from empirical data, case studies and game theory. Moreover, the technical issues related to the application of tax sparing clauses are illustrated by calculation examples, and significant attention is paid to policy recommendations based on the research results."
This book is part of the IBFD Doctoral Series
Na Li is an Associate Professor at East China University of Political Science and Law (Shanghai). She is an attorney licensed to practise in China and the United States (New York State), focusing on cross-border investment and international taxation. Dr Li obtained a PhD from Vienna University of Economics and Business (WU) in 2015.