Bilateral Tax Treaty and Taiwan’s FDI Activity
Wen-Chieh Jack Wu∗
Preliminary Draft

Abstract
Bilateral tax treaties, an important method of international tax cooperation, haverecently drawn more attentions. Recent literature began to study the impact of tax
treaty on FDI. Most theoretical work has begun to assume the tax treaty promotes FDI.
However, previous empirical studies provide little evidence to support that bilateraltax treaties increase FDI activity in USA and other developed countries. Unlike mostcountries in the world, signing bilateral tax treaty is also a possible way of increasing
international recognitions for Taiwan. Unfortunately, Taiwan has not successfully
signed tax treaties with major economies in the world. This paper discusses thepattern of Taiwan’s tax treaty formation. We find that the Taiwan was not pursuing astrategy of having tax treaties with countries that had the largest FDI activity with the
Taiwan. In addition, by simply observing the FDI records, we do not find strong
evidence for that bilateral tax treaty promotes FDI activity in Taiwan. An econometricanalysis will be done in order to correctly measure the impact of tax treaty on
Taiwan’s FDI later.

Keywords: Bilateral Tax Treaty, Double Taxation, Tax Evasion, FDI∗

Associate Professor, Department of Public Finance, National Chengchi University, Taipei, Taiwan;
email: jackwu@nccu.edu.tw
11. Introduction
Bilateral tax treaties1, an important method of international tax cooperation, haverecently drawn more attentions. The primary goals of a tax treaty are to reduce
problems of both double taxation and tax evasion. Moreover, tax treaties can be used
to coordinate tax definitions and jurisdictions across countries (Davies, 2004). In
general, most tax treaties follow the recommendations of OECD model2 or UN
model3 tax agreements. The earliest version of the UN model created in 1980 to alarge extent followed the 1977’s OECD model, but both still have significant
variations in tax definitions4. The variation led the UN to revise its model treaty inorder to be closer to OECD’s model treaty, which has become the most popular model
agreement for both members and non-members such as Taiwan.
There currently exist thousands bilateral tax treaties worldwide. The number oftreaties has been steadily rising. Table 1 summarizes the numbers of treaties major
economies of the world have already signed up to the year 2007. Both France andUnited Kingdom are top two countries following by Germany, Canada, Belgium,
Switzerland, and Netherlands. Nordic European countries such as Sweden, Norway,
and Denmark have also concluded a significant number of tax treaties. Surprisingly,
two biggest economies in the world, USA and Japan, do not sign as many treaties as
what we expected. The U.S. started its earliest tax treaties in the 1930s and has so far
signed treaties with 64 countries.5 Similarly, Japan has only concluded 46 income tax
treaties.6 Asian NIEs including Korea, Singapore and Hong Kong have relatively
smaller numbers of treaties. For instance, Korea only concluded 26 income tax
1

Davies (2004) mention these tax treaties go by several names including double taxation agreements,
capital tax treaties, and treaties covering the taxation of investment and income.
2
OECD published the 1977 “Model Double Taxation Convention on Income and on Capital” byrevising its 1963’s darft. The model has been revised in 1992, 1994, 1995, and 1997.
3
OECD model was more appropriate for negotiations between developed countries, but less suitablefor developing countries. In 1968, the Ad Hoc Group of Experts on Tax Treaties between developed
and developing countries were created by the UN Secretary-General. The Expert Group published its
first UN “Model Double Taxation Convention between Developed and Developing Countries” in 1980.
4
For instance, regarding the definition of “permanent establishment”, the OECD model treaty suggests
a 12-month duration criterion whereas the UN model treaty recommended a 6-month guideline.
5
The U.S. has experienced three major waves of tax treaty negotiations. The first wave of
post-WWII saw the U.S. complete treaties with its major economic partners such as western European
countries, Japan, and Canada. The second wave of the 1980s focused on a group of developing
countries including both China and India. The recent wave, beginning in the early 90s, added manyof the former Soviet Union. (Blonigen and Davies, 2004)
6
Japan has mainly signed treaties with Asia Pacific countries and European countries. Asia Pacificcountries include: Australia, Bangladesh, Canada, China, Fiji, India, Indonesia, Korea, Malaysia,
Mexico, New Zealand, Pakistan, Philippines, Singapore, Sri Lanka, Thailand, Vietnam, Russia, andUnited States. European countries have Austria, Belgium, Brazil, Bulgaria, Czech, Denmark, Finland,
France, Germany, Hungary, Ireland, Italy, Luxembourg, Netherlands, Norway, Poland, Romania,
Slovak, Spain, Sweden, Switzerland, Turkey, and United Kingdom. The rest of treaties include: Israel,
Egypt, South Africa, and Zambia.
2

treaties7, whereas Singapore has 54 treaties. Moreover, Hong Kong has only signed
three treaties with China, Belgium, and Thailand. In contrast to little Asian tigers,
those big states including China, India, and Russia began their treaty negotiations
relatively late, but they have quickly caught up with other major economies. For
instance, China began to negotiate its first bilateral tax treaty with Japan in 1981, but
it has quickly signed bilateral tax treaties with more than 80 countries8 for avoiding
double taxation and preventing tax evasion. India and Russia also have 75 and 69
treaties respectively.
Based on the observations from the previous paragraph, we find the tax treaty seems
more popular in Western and Nordic Europe than in the rest of the world. Moreover,large-size countries in the developing world tend to sign more tax treaties. Several
remarks from Hines and Willard (1992) can be possibly used to explain thisphenomenon. By analyzing the pattern of tax treaty formation, they find a country’s
history matters on the formation of tax treaty because the large number of treaties
sharing colonial ties. This may explain why France, UK, Netherlands, and Spain haverelatively more tax treaties. Moreover, they conclude the country size has a positive
impact on the number of treaties a country has. This can be evidenced by the numbersof treaties those big developing countries such as China and India have had. Lastly,
they addressed that government policies play important roles on signing bilateral tax
treaties. A country with low inflation and high tax policies tend to have more treaties.
This argument is consistent to our findings that Western and Nordic European
countries with high taxes have signed more treaties.
Compared to major economies in the world, the diplomatically isolated island state
Taiwan had not been successful in signing bilateral tax treaties with major partners.
Taiwan signed its first ever tax treaty with Singapore in 1981. Unfortunately, it took
another 14 years to sign the second treaty with Indonesia in 1995. According to the
Taiwan’s Ministry of Finance, by the year 2005, Taiwan has effectively concluded 16
comprehensive income tax treaties and 12 international transportation income tax

7

Asia Pacific countries include: Australia, Brazil, Canada, Chile, Japan, Kazakhstan, Malaysia, Malta,
Mexico, Myanmar, Nepal, New Zealand, Philippines, Singapore, Sri Lanka, Thailand, and UnitedStates. Others include: Belgium, Croatia, Egypt, France, Germany, Ireland, Israel, Morocco, Norway,
Sweden, Switzerland, and Turkey.
8
They are Armenia, Austria, Australia, Belarus, Belgium, Brazil, Bulgaria, Canada, Croatia, Cyprus,
Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Iceland, India, Israel, Italy,
Jamaica, Japan, Korea, Kuwait, Latvia, Lithuania, Luxembourg, Macedonia, Malaysia, Malta,
Mauritius, Mongolia, Netherlands, New Zealand, Norway, Pakistan, Papua New Guinea, Poland,
Romania, Russia, Singapore, Slovenia, Spain, Sudan, Sweden, Switzerland, Thailand, Turkey, Ukraine,
United Arab Emirates, UK, USA, Uzbekistan, Vietnam, former Yugoslavia, etc.
3

agreements9. Taiwan has signed international transportation income tax agreementswith major trading and investment partners such as USA, Japan, EU, and Canada, but
it is still required a lot of efforts to seek the opportunities of signing comprehensive
income tax treaties with these major economies. Moreover, due to political reasons,Taiwan is almost impossible to sign a formal tax treaty with China, which has close
trade and investment relationships with Taiwan.
Some believe that tax treaty not only can avoid the double taxation and tax evasion
problems, but also can promote the foreign direct investment (FDI) through a lower
effective tax rate. They believe the reduction on maximum allowable withholding
taxes on remitted income based on the tax treaty would lead to a lower effective tax
rate. A large empirical literature summarized by Gordon and Hines (2002) and de
Mooij and Ederveen (2003) links lower effective taxes to greater FDI.
As a matter of fact, the dramatic increase in foreign direct investment (FDI) has beena global trend. According to both EIU and CPII (Columbia Program on International
Investment), the global FDI increased by 22% between 2005 and 2006. The top ten
countries in the global ranking of FDI in the next five years (2006-2010) are as
follows: USA, UK, China, France, Netherlands, Germany, Canada, Belgium, Hong
Kong, and Spain. Other major Asian countries are ranked as follows: Singapore (13),India (19), Korea (25), Japan (27), and Taiwan (40). Taiwan is not a major FDI
country in Asia, but she has also followed this global trend. Both inbound andoutbound FDIs have been increasing. For instance, according to the data provided by
Ministry of Economic Affairs, we find the Taiwan’s outbound FDI to the rest of theworld excluding China went up by 14.43%, whereas the outbound FDI to China went
up by 35.81% between 2006 and 2007.
Previous studies have mainly focused on the effects of various factors such as
bilateral investment treaties (e.g. Hallward-Dreimeier, 2003) and taxation (e.g. de
Mooij and Ederveen, 2003) on foreign direct investment. However, there is relatively
little literature exploring the impacts of bilateral tax treaties governing the taxation of
FDI activity. Most theory work has begun with the assumption that treaties encourage
FDI (Davies, 2004). The empirical literatures, however, find little evidence thatbilateral tax treaties increase FDI activity (Blonigen and Davies, 2000; Blonigen andDavies, 2004; Davis, 2003). In addition, some studies (e.g. Blonigen and Davies,
2004) even find the old treaty has a positive effect on FDI, while the new treaty has anegative impact on FDI.
9

See Table 2 and Table 3.
4

There are several possible arguments for this insignificant effect of treaty. First, theproblem of double taxation can be alleviated unilaterally just as well as throughbilateral treaty, so the actual intent of treaty is to reduce tax evasion. Therefore,
treaties may reduce the incentives of FDI (Dagan, 2000). Second, the primary goal of
tax treaty is toward reducing tax evasion rather than promoting FDI (Gravelle, 1988).
Third, reducing withholding taxes does not necessarily translate into lower effective
taxes (Hartman, 1985). Based on these arguments, therefore, tax treaty does notnecessarily promote FDI.
Unlike most countries in the world, Taiwan is a diplomatically isolated country thathas a political tension with Asia’s rising power China. For Taiwan, signing tax treaties
is not only for purposes of avoiding double taxation and tax evasion, but also forinternational recognitions. Therefore, Taiwan has not been pursuing a strategy ofsigning treaties only with those countries that have large trade and FDI with Taiwan.
They also sign treaties with countries that have diplomatic relationships with Taiwan.
Though it may not be the only reason, but it is widely suspected that Taiwan could nothave successfully signed treaties with major economies mostly because of China
factor. Due to the same reason, Taiwan does not have treaties with both China andHong Kong, either. Though there are no treaties between these three places, Taiwan’s
outbound FDI to China and Hong Kong (SAR) has been constantly rising. As a matterof fact, Taiwan can avoid the double taxation on incomes derived in China and Hong
Kong unilaterally according to the Statue of Cross-Strait People Relation. In otherwords, Taiwan’s investment in China is no longer subject to double taxation problem.
However, Taiwan still cannot solve the tax evasion problem under the circumstance of
having no tax treaties between two sides. Since Taiwan is so unique and different
from other countries in terms of signing treaties, we were wondering if the causal
relationship between tax treaty and Taiwan’s FDI activities would be similar to theone in other countries. Therefore, the goals of this paper are to investigate the patternof Taiwan’s bilateral tax treaty formation and to analyze the relationship between tax
treaties and Taiwan’s FDI activities. This paper is organized as follows. In Section 2,
we give an overview of bilateral tax treaty including its principles, model tax treaties,
primary functions, and benefits and costs. Section 3 discusses Taiwan tax treaties
comprising of its history, urgently needed treaties, withholding taxes on remitted
incomes, and practical cases of application. In Section 4, we present the data of
Taiwan FDI activities. Section 5 analyzes the causal relationship between tax treaty
and FDI activities. Finally, Section 6 concludes.

5

2.

Bilateral Tax Treaty

2.1.

Principles of Tax Treaty

There are two principles of international tax treaty: source principle and residence
principle. Under the source principle, a State can claim to levy a tax on income
because of its relationship to that income. However, the source of income issometimes ambiguous as some of assets and activities generating income are locatedin more than one State. Under residence principle, a State can claim to levy a tax onincome because of its relationship to the person (party) deriving the income. Ideally aState can levy a tax on the worldwide income of its residents based on the residence
principle. However, this is practically difficult to do unless it has reliable information
about the amount of income they have earned abroad. If an income is derived within
its territorial boundaries, a State can claim to levy a tax on the income earned by aresident based on both source and residence principles, but can only claim to levy a
tax on the income earned by a non-resident based on source principle. On the other
hand, a State can only apply residence principle to levy a tax on income derived by aresident who conducts activities outside its territorial boundaries. Generally speaking,a territorial system (source principle only) often fails to tax foreign source income.
This failure undermines the fairness of tax system and provides residents with tax
incentives of investing abroad. Therefore, the number of States using a territorial
system10 has diminished.
2.2. OECD and UN Models
There are two basic models for tax treaties: OECD model and UN model. OECD’s
fiscal committee published a report entitled “Draft Double Taxation Convention on
Income and on Capital” in 1963. The revision of the 1963 draft had led to the “Model
Double Taxation Convention on Income and on Capital” published in 1977. This
1977 model became the worldwide standard for tax treaty negotiations. As a matter offact, the OECD model was designed to match needs of developed countries, but wasless suitable for developing countries. Therefore, UN launched its first tax treaty
model named “Model Double Taxation Convention between Developed andDeveloping Countries” in 1980. Both OECD and UN models are to a large extent
similar, but there still exist several significant differences. For instance, there exist
differences on the definitions of permanent establishment, taxable profits, andwithholding taxes on remitted incomes. The OECD model requires the duration of 12
10States continuing to use the territorial system include Bolivia, Costa Rico, El Salvador, Guatemala,Hong Kong, Kenya, Malaysia, Nicaragua, Panama, Paraguay, Singapore, and Uruguay.
6months, while the UN model requires the period of six months before permanentestablishment is considered to present. The OECD model states that only profits
attributable to the permanent establishment may be taxed in a state where thepermanent establishment is situated. However, the UN model addresses that all profits
including profits directly attributable to Permanent Establishment, and profits fromsales and business activities through Permanent Establishment, are taxable. Unlike
OECD model, the UN model does not specify rates of withholding taxes on dividends,
interest and royalties. These rates are supposed to be determined through bilateralnegotiations. The OECD model defines that the royalties only comprises of industrial
royalties, and cultural royalties. In addition to the OECD definition, the UN model
also includes leasing income in the category of royalties. The UN model authorizes
the source state a limited taxation right on the royalty payments, while the OECDmodel only grants the residence state of royalty recipient the exclusive taxation right.
2.3.

Primary Functions of Tax Treaty

A primary goal of a tax treaty is to remove the obstacles that double taxation presents[OECD, 1997]. Blonigen and Davies (2004) summarized four primary functions of atax treaty. The first function is “standardizing tax definitions and solidifying the tax
jurisdictions of treaty partners”. All modern tax treaties use permanent establishment11
as the main instrument to establish taxing jurisdiction over a foreigner’s income in thehost country. If countries differ in definitions of permanent establishment, the problemof double taxation arises. Therefore, it is necessary to standardize tax definitions andjurisdictions to reduce the double taxation. The second function for tax treaty is to
reduce transfer pricing and various forms of tax avoidance. Tax treaty promotes theexchange of tax information between treaty partners. The third goal of tax treaties isto prevent treaty shopping12. Recent treaties have primarily focused on this problemof treaty shopping (Ault and Bradford, 1990). This also promotes some countries torenegotiate its older treaties. The final function of tax treaties is to affect the actual
taxation of multi-national enterprises (MNEs). They can affect the actual taxation of
MNEs through rules affecting double taxation relief and withholding taxes. For
instance, following OECD model treaty, tax treaties specify that both countries must
offer either foreign tax credits or exempt foreign-earned profits from domestic
taxation. In addition, the tax treaties often reduce maximum allowable withholding
11

The OECD model treaty sets forth the general definition of a permanent establishment as a fixedplace of business through which the business of an enterprise is wholly or partly carried on. The termof permanent establishment includes a place of management, a branch, an office and a factory.
12
Although there are many variations in the regulations regarding treaty shopping, the most common
rules restrict treaty benefits if more than 50% of a corporation’s stock is held by a third, non-treaty
country’s residents (Doernberg, 1997)7

taxes on dividend, interest, and royalty payments.
2.4. Benefits and Costs of Entering Into a Tax Treaty
Blonigen and Davies (2004) summarize the benefits and costs of entering into a tax
treaty. One of benefits is that more overseas incomes are repatriated to the homenation, since a tax treaty can reduce the overseas taxes. The lower overseas taxes canthen promote a more efficient allocation of global investments. At the same time,
costs of entering into a tax treaty incur because tax treaty reduces the tax rate on
inbound investment and then reduces tax revenues for the home nation. Anotherbenefit of entering into a tax treaty is that treaty can promote investment by reducing
uncertainty about the overseas tax environment. On the other hand, however, a treaty
which reduces the ability to transfer price and encourages the exchange of tax
information lowers the incentive to invest. Therefore, tax treaties may reduce FDI
activity if some firms engage in FDI simply to minimize taxes.

3.

Taiwan’s Tax Treaties

3.1.

Historical BackgroundIn addition to avoiding double taxation and tax evasion problems, another function ofsigning tax treaties with other countries is to help Taiwan, a diplomatically isolatedisland state, pursue its international identity. Taiwan signed its first tax treaty with
Singapore in 1981. After the Taiwan/Singapore treaty, Taiwan faced difficulties incompleting tax treaty negotiations with other countries. It took another 14 years for
Taiwan to successfully sign the second tax treaty with Indonesia. However, it was amilestone to Taiwan. Since then, Taiwan has signed comprehensive income tax
treaties with another 17 countries (see Table 2). Besides Singapore and Indonesia,
Taiwan has also signed treaties with other three ASEAN countries including Vietnam,
Thailand, and Philippines. Though Thailand and Philippines treaties were signed in
1999 and 2002 respectively, they have not been effective yet. In order to gaininternational recognitions, Taiwan signed tax treaties with several countries such as
Gambia, Swaziland, Macedonia, Senegal, and Paraguay because they were Taiwan’s
allies at that time, but not major trading or investment partners. As a matter of fact,
these treaties have never been applied to real cases.
Unfortunately, only few industrialized countries including United Kingdom,
8

Netherlands, Belgium, Sweden, and Denmark in European Union, and Australia, New
Zealand in Pacific Rim have signed treaties with Taiwan. Taiwan’s other major
trading partners such as USA, Canada, Japan, and Germany (or EU) alternatively
signed double taxation agreements on international transportation incomes with
Taiwan instead of signing a comprehensive income tax treaty (See Table 3). The
urgently big goals of Taiwan’s Ministry of Finance are to eventually signcomprehensive income treaties with these major partners. Moreover, Taiwan urgently
needs to sign the bilateral tax treaty with China and Hong Kong in order to solve theserious problem of tax evasion.
3.2.

Taiwan’s Urgently Needed Treaties

USA and Canada
The Ministry of Finance recently claimed that Taiwan is expected to sign tax treaty
with the USA in one or two years following a recent call from the Director of
American Institute in Taiwan. There are two major reasons for both sides to speed up
signing tax treaty. First, Taiwan recently began taxing foreign stockbrokers on theircommission incomes received from Taiwanese enterprises and foreign film supplierson their royalty incomes. Second, based on so-called “alternative minimum tax”, theMinistry of Finance in Taiwan will begin to impose a 20% tax on overseas incomes
earned by Taiwanese residents that exceed US$30,000. These new tax policies
urgently need both countries to exchange information regarding overseas Taiwaneseincomes derived in USA and American incomes derived in Taiwan through tax treaty.
These reasons are also applicable to the Canadian case. Taiwanese government began
talks with Canadian government over signing tax treaty about 10 years ago.
However, the biggest obstacle for signing tax treaties with both USA and Canada has
been from a significant number of overseas Taiwanese living in North America.
Their main argument is the treaty would force them to expose the details of theirwealth and assets. According to the Ministry of Finance, Taiwanese government has
kept making efforts to convince overseas Taiwanese to accept the tax treaty policy.
European Union
Historically EU was not a major trading/investment partner of Taiwan. This could
probably explain why Taiwan has only signed tax treaties with 5 European Union
member countries. All of these treaties were signed after 2000. Netherlands andSweden signed treaties with Taiwan in 2001 following by United Kingdom (2002),
9

Belgium (2004), and Demark (2005). After joining WTO, Taiwan has made efforts on
improving her relationships with EU countries. All of other 21 EU members,
especially Germany, France, and Spain are most wanted by Taiwanese government.
Japan and Korea
In Asia-Pacific region, Taiwan has successfully signed treaties with major partners inSoutheast Asia and both Australia and New Zealand, but she faces tremendous
difficulties for signing treaties with her important neighbors: Japan and Korea. There
are many possible reasons, but it is widely believed that the China factor is also amajor obstacle for Taiwan to sign treaties with both Japan and Korea. As a matter offact, mutual economic activities between Taiwan and these two Asian economic giants
are numerous. A significant number of Japanese and Korean are deriving incomes in
Taiwan. It is supposed to be important for these countries to find effective ways toreduce opportunities of double taxation and tax evasion. Japan has signed tax treaties
with all major Asian countries except Taiwan, and so does Korea. To my knowledge,
both Japan and Korea have not started to negotiate with Taiwan regarding the treaty
yet. Taiwan has to make more efforts on completing this difficult task.
China and Hong Kong
Due to political issues, Taiwan is very difficult to sign official tax treaty with China
and Hong Kong, but there actually exists a mechanism preventing Taiwanese income
derived in China and Hong Kong from double taxation problem. According to thestatue of Cross-Strait People Relation, incomes and profits derived in China can be
tax deductible in Taiwan if they can provide documentations indicating their tax
payments in China. Moreover, individual incomes derived in Hong Kong is not
subject to Taiwan’s income tax and business profits derived in Hong Kong can be tax
deductible according to the statue of Hong Kong/Macau Relation. The double taxation
problem is no longer a big issue, but the tax evasion problem still cannot be avoided
due to being lack of tax treaty between Taiwan and these places. Up to now, Taiwan
has not officially opened her door to Chinese investors, so signature of tax treaty
between two sides is not really an urgent task for Chinese government. However,these investment restrictions are expected to be lifted in the future. Once Chinese
businesses invest more and more in Taiwan, signing a tax treaty or quasi-type of tax
treaty between two sides will become necessary if both double taxation and tax
evasion problems would like to be avoided.

10

If Taiwan will possibly sign the quasi tax treaty with China or Hong Kong in the
future, it may optionally follow the model treaty between China and Hong Kong.
Hong Kong and China originally signed a memorandum for avoidance of double
taxation in 1998, and then officially signed an agreement on the arrangement foravoidance of double taxation and tax evasion between Mainland China and Hong
Kong SAR” in 2006. They basically follow the OECD model tax treaty. Most treaties
between two formal countries cover both regular incomes/profits anddividend/interest, but the China/Hong Kong memorandum originally only covered
regular incomes/profits and did not form the information exchange mechanism. The
new agreement had covered dividend and interest and formed the informationexchange mechanism. They used the word “arrangement” instead of “treaty” in order
to distinguish from other formal treaties between two countries. In addition to thisarrangement, they also signed transportation income treaty.
3.3.

Withholding Taxes on Remitted Incomes

Most treaties typically reduce maximum allowable withholding taxes on three typesof remitted incomes: dividend, interest, and royalty. In most existing treaties of theworld, the maximum allowable withholding taxes for treaty partners are ranged
between 0 and 15%. In the China/Hong Kong treaty, both sides provide different
policies on withholding taxes. Hong Kong’s maximum allowable withholding taxes
on dividend, interest, and royalty paid by Hong Kong companies to Chinese residents
are 10%, 7%, and 7% respectively. However, China does not specify the maximum
allowable withholding taxes on dividend, interest, and royalty paid by Chinesecompanies to Hong Kong SAR residents. Table 4 summarizes the maximum
allowable withholding tax rates on dividends, interests, and royalties paid by
Taiwanese companies to non-residents under Taiwan’s various tax treaties. In general,for non-treaty countries, Taiwan’s maximum allowable withholding tax rates on
dividends, interests, and royalties are all 20%13. Taiwan/Singapore treaty deserves
particularly to be mentioned. It was the Taiwan’s oldest treaty, but its conditions on
withholding taxes were the strictest ones. For instance, there are no reductions inmaximum allowable withholding taxes on dividend and interest incomes under the
Taiwan/Singapore treaty.14 The only reduction in maximum allowable withholding
taxes under Taiwan/Singapore treaty is on royalty incomes. The maximum allowablewithholding tax rate on royalty is 15%. Unlike Singapore, the maximum allowable13

For investments that are not approved officially, the withholding rate on dividend is 30% for
non-resident individuals and 25% for non-resident enterprises.
14
The aggregate of dividend withholding tax and corporate income tax on profits cannot exceed 40%of the taxable income from which the dividends are declared.
11withholding tax rates can be reduced by 5~15% for other treaty countries. The
common reduction rate in most of these countries is 10%.
3.4.

Practical Cases of Tax Treaty

Lien (2005) analyzed 49 randomly selected application cases from foreigners thatwere filed to Taipei National Tax Administration in both years of 2003 and 2004. 60%of these foreign services providers (profit/income receivers) are from Singapore thatis Taiwan’s first tax treaty country. Others include: 18% from UK, 12% from
Netherlands, 8% from Australia, and 2% from New Zealand. Services provided in thefinancial industry takes up about 30% of total applications, following by consulting
supports 20% and information technology 14%. Most of these service providers (say68%) appointed CPA firms to apply for tax treaty on their behalf. Others appointed
either law firms or service recipients to do so. More than half of service providers did
not send representatives from overseas to Taiwan. They mainly perform services
through internet and other methods. Among those providers (totally 17 cases)
dispatching representatives, there were 11 cases whose representatives stayed for lessthan a required length of duration for Permanent Establishment. There are 41% of
total applications that have two parties of contracts (service providers and service
recipients) belonging to the same conglomerate (multinational enterprise). The global
conglomerate may use the tax treaty to reduce total taxation burden. For instance,
assume a service provider in a treaty country such as Singapore provides services to a
Taiwan enterprise, and both service provider and receiver belong to the same global
conglomerate. Moreover, the permanent establishment is not detected and the income
is classified as business profit. After the application case is approved by Taiwan’s tax
bureau, this claimed business profit is not subject to the taxation in Taiwan, but only
to the taxation in Singapore. This provides a mechanism for the global conglomerate
to save tax payments.
After the screening test done by tax authority, the overall approval rate isapproximately 74% of total applications. It means claimed profits in the rest 26% of
total applications should be still taxed in Taiwan. The approval rate varies acrosscountries. Take both Singapore and UK as examples, 22 out of 29 Singapore cases
were approved, while 6 out of 9 UK cases were approved. As mentioned earlier, a
global conglomerate may take advantage of tax treaty for reducing its tax burden, so
the tax bureau may pay more attentions to these types of case. Therefore, almost halfof cases with both service providers and recipients in the same conglomerate weredenied.
12

4.

Taiwan’s Foreign Direct Investment

Taiwan used to be a country, which had more inward FDI than outward FDI, between
1950s and 1990s. It attracted net capital inflow during that period. Since the late
1990s, it has gradually become a country with net capital outflows (see Table 5). It is
now one of major source countries of FDI in several Southeast Asian countries15 andChina. Approximately 70% of the total approved outbound FDI flew to China in 2007.
Taiwan is ranked among top ten foreign countries investing in China. 16 It is widelybelieved that the officially approved amount of outward FDI from Taiwan to China issignificantly lower than the actual amount. As a matter of fact, it is very difficult toobserve the actual amount of Taiwan’s outward FDI to China. The official numbers
indicate that Taiwan’s approved outward FDI to China was almost double of her
approved outward FDI to the rest of the world in 2007, but the actual difference
should be much bigger.
Besides China, Caribbean islands, USA, Singapore, and Hong Kong are among top
destinations of Taiwan’s outward FDI by the year 2007 (see Table 6). Caribbean
islands have received the largest amount of Taiwan’s outward FDI, whereas USA has
received the most cases of Taiwan’s outward FDI during the period of 1952-2007. The
possible explanation for the large amount of Taiwan FDI flowing to Caribbean
countries is that a lot of Taiwanese businesses take advantage of low tax or tax freepolicy in Caribbean islands and use them as intermediary to invest in China. Hong
Kong is considered as another suspicious gateway for Taiwan’s outward FDI to China.
According to either official or unofficial estimates, China has recently become themajor destination of Taiwan’s outward FDI. By the year 2007, the top five provinces
that have attracted most of Taiwan’s FDI are Jiang-Xu province, Guang-Dong
province, Shanghai, Fu-Jian province, and Je-Jiang province (see Table 7).
Guang-Dong province has received the most cases of investment from Taiwan, while
Jiang-Xu province has accumulated the largest amount of Taiwan FDI in the past five
decades.

15

Taiwan is the third largest source country of FDI in Thailand following top two countries: Japan andUSA. It is also the third largest investor in both Malaysia and Vietnam.
16
Taiwan is one of major source countries of China inward FDI. According to the data of first 11
months of 2007, Taiwan’s direct investment in China is US$1.434 billion. The top 10 source
countries during these months are Hong Kong, Virgin Island, Korea, Japan, Singapore, USA, Cayman
Islands, Samoa, Taiwan, and Mauritius. The details of Taiwan’s approved direct investment in China
are summarized in Table 5. It is widely believed that Taiwan’s direct investment in China is muchhigher than the official number. Many investments have been through those tax-free countries such as
Hong Kong, Virgin Island, Cayman Island, and Mauritius.
13Regarding Taiwan’s inward FDI, USA, Japan, and Caribbean islands have been top
three investors following by Netherlands, Singapore, United Kingdom, and HongKong. As shown in Table 8, in the past five decades, USA has accumulated the largest
amounts of foreign direct investment, while Japan has accumulated the most cases offoreign direct investment in Taiwan. At the moment, China’s capital is not allowed toinvest in Taiwan officially, but it is believed that its capital has been indirectly flowed
into Taiwan through Hong Kong and Caribbean islands.
5. The Relationship Between Bilateral Tax Treaty and Taiwan’s FDI Activity
5.1. Endogeneity problem
Bilateral Tax treaty and FDI may be endogenously related. A country may tend to sign
the tax treaties with other countries that had large FDI activities. On the other hand,bilateral tax treaty may promote FDI activity. It seems the endogeneity problem is not
significant in some countries such as USA. Blonigen and Davies (2004) find the U.S.
was not pursuing a strategy of signing tax treaties with countries that had the largest
FDI activity with the United States. They also find the old treaty has a positive effecton FDI, while the new treaty has a negative impact on FDI. Does this endogeneity
problem arise in Taiwan? We would like to answer this question by firstly examining
whether the Taiwan negotiate tax treaties only with the countries that had large andincreasing amounts of FDI activity. Table 9 lists all of Taiwan’s treaty countries forwhere they rank in terms of FDI Stock (outward or inward) with the Taiwan relative
to other countries, and how many countries that were ranked ahead of the country did
not have a bilateral tax treaty with the Taiwan. This table does not show that the
Taiwan was obviously pursuing a strategy of having tax treaties with only thosecountries that had large FDI stock with the Taiwan. For instance, several treaty
countries of the Taiwan had none or very little FDI with the Taiwan. The Taiwan
signed treaties with these countries simply because of diplomatic relationships.
However, the Taiwan also signed treaties with few countries that had significant FDI
activities with the Taiwan. Take the Taiwan’s first treaty country Singapore as theexample. By the end of the year 2007, Singapore became the 4th country for Taiwan’s
outbound FDI and the 5th country for Taiwan’s inbound FDI. Moreover, UK and
Netherlands are top countries that had large amount of inbound investments in Taiwan.
Taiwan has also signed treaties with other ASEAN countries because many overseas
Chinese from Southeast Asia invested in Taiwan and these countries such as Indonesia,
Malaysia, and Vietnam became major destinations of Taiwan’s FDI to Southeast Asia.

14

Table 10 lists several representative treaty countries of Taiwan and historical recordsof Taiwan’s outbound FDI to these countries over time. By simply observing thesenumbers, we find tax treaty seems only has a positive impact on Taiwan’s outbound
FDI to Singapore which is the Taiwan’s oldest treaty country. The effects of tax treaty
on other treaty countries are not very obvious. Though we have observed the trend of
Taiwan’s FDI activity before and after effective date of tax treaties in these treaty
countries, but it is difficult to conclude the real impact of tax treaties on FDI. We
know the FDI is affected by many factors. In order to estimate the impacts of bilateraltax treaty on Taiwan’s FDI activity correctly, we also have to control for theseco-founding factors of FDI such as country size, geographic location, taxation,bilateral investment agreement, economic indicators and so on. In the next section, we
will estimate the effect of tax treaty by using the econometric specification that
follows the CMM (Carr, Markusen and Maskus, 2001) specification adding treaty
variables. This econometric section will be completed after the Hitotsubashi seminar.

15

6.

Concluding Remark

Bilateral tax treaties, an important method of international tax cooperation, haverecently drawn more attentions. Recent literature began to study the impact of tax
treaty on FDI. Most theoretical work has begun to assume the tax treaty promotes FDI.
However, previous empirical studies provide little evidence to support that bilateraltax treaties increase FDI activity in USA and other developed countries. Unlike mostcountries in the world, signing bilateral tax treaty is also a possible way of increasing
international recognitions for Taiwan. Unfortunately, Taiwan has not successfully
signed tax treaties with major economies in the world. Up to date, Taiwan has only
concluded 16 tax treaties. The main goals of this paper are to introduce the pattern of
Taiwan’s tax treaty formation and to examine whether there is the endogenous
relationship between tax treaty and FDI in Taiwan. We find that the Taiwan was not
pursuing a strategy of having tax treaties with countries that had the largest FDI
activity with the Taiwan. In addition, by simply observing the historical FDI records,
we don’t find strong evidence for that bilateral tax treaty promotes FDI activity in
Taiwan. An econometric analysis will be required for estimating the impacts of tax
treaty on FDI correctly. We will continue this analysis in the future.

16

References
Ault, H.J. and Bradford, D.F. (1990), Taxing International Income: An Analysis of the
U.S. system and Its Economic Premises, Taxation in the Global Economy, Universityof Chicago Press.
Blonigen, B.A. and Davies, R.B. (2000), The Effects of Bilateral Tax Treaties on U.S.
FDI Activity, NBER Working Paper No. 7929.
Blonigen, B.A. and Davies, R.B.(2004), The Effects of Bilateral Tax Treaties on U.S.
FDI Activity, International Tax and Public Finance, 11, 601-622.
Carr, D., Markusen, J.R., and Maskus, K.E. (2001), Examining the
Knowledge-Capital Model of the Multinational Enterprise, American Economic
Review, 91, 693-708.
Dagan, T. (2000), The Tax treaties Myth, Journal of International Law and Politics,
Summer, 939-996.
Davies, R.B. (2003), Tax Treaties, Renegotiations and Foreign Direct Investment,
Economic Analysis and Policy, 33, 251-273.
Davies, R.B. (2004), Tax Treaties and Foreign Direct Investment: Potential versus
Performance, International Tax and Public Finance, 11, 775-802.
De Mooij, R.A., and Ederveen, S. (2003), Taxation and Foreign Direct Investment: A
Synthesis of Empirical Research, International Taxation and Public Finance, 10,673-693.
Doernberg, R. (1997), International Taxation in a Nutshell, 3rd edition. St. Paul:West
Publishing.
Lien, Y.P. (2005), A Study on Taiwan’s Tax treaty, Master Thesis, IMBA, National
Chengchi University.
Gordon, R. and Hines, J.R. (2002), International Taxation, Handbook of Public
Economics, volume 4, Elsevier.

17

Gravelle, P. (1988), Tax treaties: Concepts, Objectives, and Types, International
Bureau of Fiscal Documentation Bulletin No. 522, 522-526.
Global Individual Tax Handbook 2007, Published by IBFD.
Hallward-Dreimeier, M. (2003), Do Bilateral Investment Treaties Attract Foreign
Direct Investment?, World Bank Working Paper No. 3121.
Hartman, D. (1985), Tax Policy and Foreign Direct Investment, Journal of Public
Economics, 26, 107-121.
Hines, J.R. and Willard, K.L. (1992), Trick and Treaty? Bargains and Surprises inInternational Tax Agreements, mimeo, University of Michigan.

18

Table 1: Number of Tax Treaties in the World’s Major Economies
Country

Number of Treaty

Country

Number of Treaty

Argentina

18

Netherlands

84

Australia

42

New Zealand32

Austria

75

Norway81

Belgium

86

Poland79

Brazil28

Portugal47

Canada86

Russia

69

Czech

71

Singapore

54

Chile

16

South Africa

61

China

83

Spain

70

Demark76

Sweden

81

Egypt

55

Switzerland

86

Finland66

Turkey64

France

118

UK

112

Germany

88

USA

64

Greece43

Taiwan16

Hong Kong

3

Hungary64

Iceland

29

India

75

Indonesia

56

Ireland44

Israel

41

Italy

80

Japan

46

Korea

29

Luxembourg

50

Malaysia

60

Mexico32

Source: Global Individual Tax Handbook 200719

Table 2: Taiwan’s Comprehensive Income Tax Treaties
Country

Diplomatic relation

Signing date

Effective date

Singapore

December 1981

January 1982

Indonesia

March 1995

January 1996

South Africa

February 1994

September 1996

Australia

May 1996

October 1996

New ZealandNovember 1996

December 1997

VietnamApril 1998

May 1998

GambiaYes

July 1998

November 1998

Swaziland

Yes

September 1998

February 1999

July 1996

February 1999

June 1999

June 1999

Netherlands

February 2001

May 2001

UnitedKingdom

April 2002

December 2002

January 2000

September 2004

June 2001

November 2004

April 1994***

ThailandJuly 1999***

Philippines

May 2002***

Belgium

October 2004

December 2005

DemarkAugust 2005

December 2005

Malaysia
Macedonia

Senegal

Yes/NoYes

SwedenParaguay

Yes

Source: Ministry of Finance, Taiwan

20

Table 3: Taiwan’s Tax Treaties on International Transportation IncomesCountry

Shipping/Air

Signing date

Effective date

CanadaAir

July 1995

July 1995

EU

Shipping

August 1990

August 1990

Germany

Shipping

August 1988

August 1988

IsraelShipping

June 1998

June 1998

Japan

Shipping & Air

September 1990

September 1990

Korea

Shipping & Air

December 1991

December 1991

Luxembourg

Air

March 1985

March 1985

Macau

Air

December 1998

February 1999

Netherlands

Shipping

June 1989

January 1988

Netherlands

Air

May 1984

April 1983

NorwayShipping

June 1991

June 1991

ThailandAir

June 1984

June 1984

USA

Shipping & Air

May 1988

May 1988

Source: Ministry of Finance, Taiwan

21

Table 4: Taiwan’s Withholding Tax Rates on Dividends, Interests, and Royalties
Dividends

Interests

Royalties

20/25/30

20

20

Australia

10/15

10

12.5

Gambia10

10

10Indonesia

10

10

10

Macedonia

10

10

10

Malaysia

12.5

10

10

New Zealand

15

10

10

Netherlands

10

10

10

Senegal

10

15

12.5

Singapore

40

40

15

South Africa

5/15

10

10

Sweden10

10

10

Swaziland

10

10

10

UK

10

10

10

Vietnam

15

10

15

Belgium

10

10

10

Demark10

10

10Without treaty
With treaty

Source: Ministry of Finance, Taiwan

22

Table 5: Taiwan’s Inward and Outward FDI (US$ 1000)

1952-1996

Approved
Inward FDI

Approved Outward FDI to
Non-China

24,721,779

12,420,173

1991-1996

Approved Outward
FDI to China
6,873,724

1997

4,266,629

2,893,826

1,614,542 (2,719,771)

1998

3,294,714

3,296,302

1,519,209 (515,412)

1999

4,185,403

3,269,013

1,252,780

2000

7,607,755

5,077,062

2,607,142

2001

5,128,517

4,391,654

2,784,147

2002

3,271,749

3,370,046

3,858,757 (2,864,301)

2003

3,575,673

3,968,588

4,594,985 (3,103,799)

2004

3,952,147

3,382,022

6,940,663

2005

4,228,067

2,447,449

6,006,953

2006

13,969,247

4,315,426

7,642,335

2,432,293

4,592,758

2,783,350

6,237,611

2006(1~10) 11,228,914
2006(1~8)
2007(1~10) 12,932,685
2007(1~8)

Source: Investment Commission, Ministry of Economic Affairs, Taiwan

23

Table 6. Taiwan Approved Outbound FDI by Area (Jan. 1952-Aug. 2007)
Area (Rank)

Percent of All Cases

Percent of Total Amount

Caribbean

15.89%

37.50%

USA

41.14%

17.69%

Singapore

3.73%

7.46%

Hong Kong

8.07%

5.14%

Bermuda

0.82%

4.78%

Thailand

3.22%

3.74%

Malaysia

2.56%

3.20%

Vietnam

2.93%

2.75%

Panama

0.56%

2.32%

Japan

3.76%

2.16%

Samoa

2.45%

1.64%

Netherland

1.15%

1.63%

Philippine

1.45%

1.45%

Indonesia

1.67%

1.20%

UK

1.31%

0.98%

Canada

0.56%

0.69%

Korea

1.13%

0.48%

Australia

0.47%

0.31%

Germany

1.19%

0.29%

Nicaragua

0.23%

0.25%

Czech Republic

0.19%

0.18%

Brazil

0.11%

0.12%

El Salvador

0.20%

0.10%

India

0.24%

0.05%

France

0.33%

0.05%

New Zealand

0.06%

0.01%

Other Areas
Other European Countries

0.83%

0.88%

Africa

1.24%

0.79%

Other Latin America

1.10%

0.69%

Other Oceanian Countries

0.23%

0.62%

Other Asian Countries

1.12%

0.60%

Source: Investment Commission, Ministry of Economic Affairs, Taiwan

24

Table 7. Taiwan Approved Outbound FDI to China by Provinces(Jan. 1952-Aug. 2007)
Province

Percent of All Cases

Percent of Total Amount

Jiang-Xu

15.29%

31.77%

Guang-Dong

32.55%

25.86%

Shanghai

13.79%

15.14%

Fu-Jian

14.31%

7.63%

Je-Jiang

5.21%

6.88%

Bejing

2.99%

1.82%

Tien-Jing

2.38%

1.81%

Shan-Dong

2.46%

1.80%

Hu-Bei

1.40%

1.01%

Chung-Ching

0.50%

0.97%

Xi-Chuan

1.00%

0.82%

Liao-Ling

1.39%

0.80%

Jiang-Xi

0.55%

0.53%

Guang-Xi

0.61%

0.50%

He-Bei

0.81%

0.48%

Hu-Nan

0.81%

0.36%

An-Huai

0.51%

0.35%

Shan-Xi

0.15%

0.34%

Hai-Nan

0.94%

0.26%

Xi-Bei area

0.55%

0.20%

He-Nan

0.64%

0.17%

Hei-Rong-Jiang

0.30%

0.11%

Yun-Nan

0.29%

0.10%

Ji-Ling

0.22%

0.09%

Nei-Meng

0.06%

0.05%

Guei-Jou

0.22%

0.05%

Others

0.06%

0.11%

Source: Investment Commission, Ministry of Economic Affairs, Taiwan

25

Table 8. Taiwan Approved Inward FDI by Area (Jan. 1952-Oct. 2007)
Area

Percent of All Cases

Percent of Total AmountUSA

16.27%

19.55%

Japan

25.05%

16.58%

Caribbean

13.87%

16.09%

Netherlands

1.61%

15.47%

Singapore

5.08%

6.07%

UK

2.15%

5.15%

Hong Kong

12.99%

4.79%

Bermuda

0.47%

2.13%

Germany

1.83%

1.90%

Malaysia

3.17%

1.77%

Samoa

2.40%

1.26%

Philippines

1.11%

1.25%

Africa

0.93%

1.20%

Australia

0.87%

1.10%

Panama

0.27%

0.86%

Korea

1.99%

0.79%

France

0.83%

0.55%

Canada

1.35%

0.47%

Indonesia

0.61%

0.11%

Thailand

0.66%

0.08%

India

0.58%

0.05%

New Zealand

0.14%

0.03%

Brazil

0.12%

0.02%

Vietnam

0.19%

0.01%

Other Areas
Other European Countries

2.92%

2.01%

Other Latin America

0.78%

0.43%

Other Asian Countries

1.65%

0.16%

Other Oceanian Countries

0.10%

0.11%

Source: Investment Commission, Ministry of Economic Affairs, Taiwan

26

Table 9. Relative Rank of Taiwan Bilateral Tax treaty Countries in Taiwan Outward
and Inward FDI Positions
Country

Rank of Country in Terms of
Taiwan Outward FDI Stock

Rank of Country in Terms of
Taiwan Inward FDI Stock

Singapore

4th

(3)

5th

Indonesia

15

th

(8)

18th

South Africa

N.A.

N.A.

Australia

th

19

13th

New Zealand

27th

21th

Vietnam

9th

23th

GambiaN.A.

N.A.

Swaziland

N.A.

N.A.

Malaysia

8th

10th

Macedonia

N.A.

N.A.

Netherlands

13th

4th

United Kingdom

16th

6th

Senegal

N.A.

N.A.

SwedenN.A.

N.A.

Paraguay

N.A.

N.A.

Thailand

7th

19th

Philippines

14th

12th

Belgium

N.A.

N.A.

DemarkN.A.

N.A.

Source: Investment Commission, Ministry of Economic Affairs, Taiwan

27

Table 10. Taiwan’s Approved Outbound Investment by Treaty Countries(unit: US$1000)
Singapore

Indonesia

Malaysia

VietnamUK

Netherlands

Australia

~1979

4302

8835

3083

1437

110

*

896

1980

2794

120

*

*

*

*

*

1981

736

1960

*

*

2231

*

*

1982

96

8960

*

*

*

*

*

1983

909

*

3000

*

*

*

144

1984

209

4900

1216

*

*

*

134

1985

253

1000

*

*

891

*

7

1986

434

1780

*

*

*

194

217

1987

1301

950

5831

*

*

*

*

1988

6433

1923

2708

*

858

25

6134

1989

5209

311

158646

*

25

1440

*

1990

47622

61871

184885

*

11405

5893

1397

1991

12540

160341442011

17139

14572

6679

2440

1992

8790

39930

155727

20167

4435

9690

5426

1993

69473

25531

64542

158396237918

10383

63

1994

10073220571

101127108378

16952

271

23598

1995

31649

32067

67302

108146

8215

20410

314

1996

164978

82612

93534

100479

6128

217

14792

1997

230310

55861

85088

85414

13412

11113

23200

1998

158176

19541

19736

110078

9724

8574

2292

1999

324524

7321

13700

34567

10263

17800

21004

2000

219531

33711

19406

54046

31250

3245

10429

2001

378301

6124

45516

30911

29217

5797

2064

2002

25760

9163

31956

55192

43028

56421

6327

2003

121469583

154671633756

274817

15407

2004

204179311

113048389

19368432428815397

Source: Investment Commission, Ministry of Economic Affairs, Taiwan

28