In theory, foreign direct investment (FDI) flows in a straight line, from a company’s home country to the one where it is committing capital.
In practice, things look a little different. A mix of disparate tax systems, globe-spanning multinationals and historical legacies work together to enable companies to engage in FDI ’round-tripping’. The term makes it sound like capital is being moved around, only to end up back where it began. However, Daniel Haberly, a lecturer at the University of Sussex who researches the topic, explains that this commonly used term is actually a misnomer, as it implies that money is actually moving.
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For more than a decade, Haberly has been working on an FDI database that maps the sources and pathways of offshore investment. The initiative is one among many that have attempted to map the ultimate owners noted in official data behind offshore or ‘phantom’ FDI. In his paper, round-tripping is described as when “a country’s own firms and citizens use offshore structures to hold assets at home”.
associate professor in Human Geography. Credit: Daniel Haberly.
While FDI is commonly thought of in terms of greenfield projects, it also includes offshore FDI. This is the type of investment that is mediated through shell company structures in specialised offshore jurisdictions that have little to no relevance to productive activity. According to International Monetary Fund data, around two-thirds of global FDI flows originate or take place in jurisdictions where shell company structures are prevalent.
While engaging in round-tripping does not necessarily mean that a company is in breach of the law, these practices have been linked to a wide range of problems such as money laundering, tax avoidance and the funding of criminal groups.
Common practice
One commonly held assumption is that this practice is more prevalent in developing economies. However, in his research, Haberly found that this was not the case, and that developed countries have similar levels of round-tripping.
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By GlobalDataCountries with a political legacy of socialist structures have, on average, higher levels of round-tripping than both developed and developing countries. When the transition to privatisation began in places like Russia, there were no solid company laws, only nascent legal frameworks. “So, there was a search for more solid, especially common law jurisdictions, where things can be registered,” he says.
In China, for example, capital controls are prevalent for company listings. “Basically anything listed overseas usually needs to have some kind of offshore structure, which is sort of what drives most of the round-tripping there,” Haberly says.
A significant portion of recorded FDI inflows into China is transferred through the special administrative regions of Hong Kong and Macau. By managing investments in the mainland from these regions, Chinese companies have more flexibility and can gain preferential treatment through tax breaks and financial incentives.
Drivers for FDI round-tripping can differ by region. Before the US’ 2017 Tax Cuts and Jobs Act (TCJA), there had been a “big boom” of tax inversions from US companies, where they would shift their legal headquarters to lower-tax foreign countries such as Ireland. However, once the TCJA came into place and overhauled a lot of corporate taxes, the incentives and scope to do these inversions diminished.
On the other hand, round-tripping practices in Europe have grown alongside the expansion of private equity in hotspots like Luxembourg.
Implications for FDI data
Aside from the noted problems associated with using offshore jurisdictions, one of the biggest issues is that this practice distorts FDI data.
“Official data just doesn’t tell you what the world economy actually looks like – it is sort of a black box. It makes it really difficult to make policy decisions,” Haberly notes. “There are all these studies looking at what is the economic impact of FDI, and they are not even looking at whether this is actually real FDI […] It skews the entire understanding of how the world operates.”
There are also likely significant tax losses, which are harder to estimate. While some revenues could get recaptured at the household investor level, he says, developing countries are likely losing out even more as there is less capacity to ensure tax compliance.
While the research highlights the challenges of fully understanding the way FDI flows and operates, it is also an important step towards obtaining a clearer picture.
