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Faculty of Finance and Accounting

Finance and Accounting

MASTER THESIS

The Impact of Double Tax Treaties on Foreign Direct Investments in the Southeast Asia Region

Author: Bc. Trang Hien Cao

Supervisor: Ing. Jana Tepperová, Ph.D.

Academic Year: 2019 - 2020

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Declaration of Authorship

The author hereby declares that he compiled this thesis independently, using only the listed resources and literature, and the thesis has not been used to obtain a different or the same degree.

The author grants to University of Economics in Prague permission to reproduce and to distribute copies of this thesis document in whole or in part.

Prague, 3^rd May 2020 Trang Hien Cao Signature

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Acknowledgements

I would like to express my gratitude to my Thesis Advisor Ing. Jana Tepperová, Ph.D. for her guidance and support in completing my Master Thesis. I would also like to extent my

gratitude to the University of Economics Prague for providing me with the access to

academic and research resources through the University Library. Lastly, I would like to thank my friends Giang Hoang and Marcial Lagos, who helped me tremendously with the

technicality of my econometric model.

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Abstract

This paper has examined the effectiveness of Double Tax Treaties (DTTs) as a tool to attract Foreign direct investment (FDI) in the economies of the ASEAN region. The topic has been studied in several empirical studies and research, however, the result is still inconclusive, and the literature on this particular region is limited, hence, this study aims to contribute to a more effective and efficient decision-making process of regulators regarding the relationship between DTTs and FDI in ASEAN countries. In this paper, the author used the panel data method and a set of data covering the period 1988 – 2018 on the ten ASEAN countries to test the correlations between five control variables – GDP, population, trade openness, number of yearly new DTTs concluded, and accumulated number of DTTs of the source country – and the dependent variable – FDI inflows into the source country. The empirical study shows that new DTTs signed by ASEAN countries with their economic partners have significant positive impact on the FDI inflows into these countries. However, the accumulated DTTs a country has in effect exert negative impact on the FDI inflows into an ASEAN country, due to the diminishing in value of DTTs over time.

JEL classification C5, H2, H3, H7

Keywords Double Tax Treaties, Foreign Direct Investment, Developing Countries, Panel Data

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List of Tables

Table 1: FDI flows in CLMV countries, 2015 – 2018 (in millions of dollars and per cent) Table 2: Total accumulated number of DTTs in force in ASEAN countries

Table 3: Control variables and data sources Table 4: Descriptive statistics

Table 5: The effects of explanatory variables on FDI inflows in ASEAN countries (Model 1) Table 6: The effects of explanatory variables on FDI inflows in ASEAN countries excluding Cambodia and Singapore (Model 2)

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List of Figures

Figure 1: FDI restrictions are associated with a lower stock of FDI per capita

Figure 2: FDI inflows in ASEAN region in period 2010 – 2018 (billions of dollars and per cent) Figure 3: Total FDI share of ASEAN countries period 1970 – 2018

Figure 4: New Double Tax Treaties in Force by Year

Figure 5: GDP growth of Vietnam in period 1985 – 2018 (in billion USD)

Figure 6: Foreign direct investment net inflows in Vietnam 1970 - 2018 (BoP, current US$) Figure 7: FDI inflows by economic sector, 2017 – 2018 (millions of dollars and percent) Figure 8: The development of tariff rate in Vietnam (2000 – 2017)

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I. Introduction

Nowadays, the key element of globalization for almost every country is foreign direct investment (FDI) that has generated a significant part of the global economic growth, especially in

developing countries. The importance of this cross-border investment is even more crucial to developing economies such as those in the Southeast Asia region, because these countries largely rely on FDI for financial resources, which otherwise, would not be sufficient if only provided by domestic investors. Therefore, over recent decades, many countries, especially the emerging economies, have been employing the strategy for economic growth, whereby, attracting FDI is one of the most important elements.

As the efforts to attract foreign capital inflow, governments worldwide have been taking several actions including changes to domestic law and regulations, adoption of bilateral agreements such as trade agreements reducing tariffs, investment protection agreements, and double taxation treaties (DTTs). Among these agreements, DTTs and their the effectiveness on attracting FDI inflows are one of the most commonly discussed among both academic and economic

researchers. The main purpose of DTTs, as the name suggests, is to avoid the issue of juridical double taxation, which arises when both the source and the residence jurisdictions claim their taxing right on a single income, which can be personal income or corporate income, but in this paper, the author will focus on the corporate income taxation. Double taxation can have severe negative effects on cross-border investment flows, exchange of goods and services, movement of labor and capital, hence, DTTs play an important role in enhancing the investment climate and encouraging economic activities across countries. Unfortunately, the costs to negotiate and conclude DTTs are enormous, especially to developing countries who have restricted financial resources. A part of costs arises from administrative resources for the negation process.

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However, the main concern is the significant loss of tax revenues of the capital importing countries after concluding a DTT, because its mechanism to eliminate double taxation is to shift the taxing right of almost all income from the source country to the residence country.

Consequently, this has become a controversy and raised a debate question in the field

international finance that is whether the costs of DTTs could be outweighed by these treaties’

anticipated benefits.

As the importance of FDI is increasing, it is increasingly important to understand the

relationship, if at all, between the changes in FDI inflows and the number of DTTs from the perspective of a capital importing country. There have been a significantly amount of empirical research and studies on this subject, yet, the results are inconclusive. Therefore, the purpose of this paper is to contribute to the current research on the topic whether by concluding more DTTs, a capital importing country can attract more inward FDI, which can be useful for the policy- making process. The author will focus on the sub-region of Southeast Asia, which, in this paper, is referred to as ASEAN or the Association of Southeast Asian Nation that was established in 1967, due to the lack of literature on this topic for the sub-region , (eria.org, 2017). Particularly, the author will examine the correlation between the development of FDI and DTTs, and a few other control variables using the panel data method, with a set of data about 10 countries in ASEAN, within the period from 1988 to 2018. After conducting the empirical tests, the author found a significantly positive correlation between the number of DTTs, both newly signed in a given year and accumulated number, and the amount of FDI inflows into ASEAN countries.

The remaining parts of the paper will be structured as follow: literature review to provide readers with background understanding on FDI and DTTs, and existing studies on the same topic, but for different regions; based on the literature review, two hypotheses are constructed; in the next part,

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the method to test these hypotheses will be explained; after the tests are carried out, the author will analyze the results and conclude the research paper.

II. Literature Review

A. The Theory of Foreign Direct Investment 1. Overview

A formal definition of foreign direct investment (FDI) by the UNCTAD is that FDI is a long- term investment reflecting a lasting management interest and control (usually 10% of voting stock) in an enterprise locating in an economy other than that of the foreign direct investor. Such investments can in be in forms of either ‘greenfield’ investment, where the parent company establishes a new subsidiary facility in a foreign country, or merger and acquisition (M&A), which refers to an acquisition of existing operations rather than a new investment, (UNCTAD, 2007).

Cross-border investment or FDI, especially by transnational corporations, is considered a key driver in today’s globalization, especially, it is vital to the growth of the developing economies in Southeast Asia region. The critical role of FDI in Association of Southeast Asian Nations

(ASEAN) is due to the importance of inflow capital essential for the development of an economy, which otherwise, would not be sufficient if solely provided by domestic investors within a developing country. Therefore, many countries, including the ASEAN cluster, have been seeing attracting FDI as one of the most important elements in their strategy for economic growth over recent decades.

2. FDI liberalization in ASEAN

Since its establishment in 1967, the ASEAN sub-region has been one of the most successful developing regions in terms of export-led development and become a leading destination for

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inward FDI in certain sectors (i.e. manufacturing) for at least three decades. Unlike other FDI determinants such as market size or geography, the factor that can be easily influenced by the government is economic reform and selective trade liberalization to open more sectors to foreign investment, to provide incentives for exports, and strong investment protection for foreign investors. Even though this integration is still on going, these countries have been negotiating free trade and economic partnership agreements, both individually and collectively under the name of the ASEAN region. However, as the investment liberalization is merely partial openness towards targeted investors, especially the export-oriented ones, 6 out of 10 ASEAN countries are still among the ten most restrictive economies to FDI, according to the OECD FDI Regulatory Restrictiveness Index, (OECD, 2019).

The FDI policies of ASEAN is significantly diverse among the member states. Singapore and Cambodia are greatly open to foreign investors, even when compared to OECD countries.

Vietnam and Brunei Darussalam are moderately open under the above mentioned index, and the remaining six are the most restrictive to FDI, especially in the service sectors, among 60

countries covered in the index, (OECD, 2019).

The key event that led to or accelerated some of the economic reforms within the region was the Asian Financial crisis in 1997. Other factors influencing the pace and timing of the reforms are the accession to international trade or economic organizations such as the WTO (in case of Vietnam, Lao PDR and Cambodia), as well as the pressure from increased competition for FDI among the peer countries. Overall, these reforms are crucially important for the development of inward FDI of ASEAN countries, as they have had a great impact on FDI performance.

Evidently, the most open economies like Singapore and Cambodia receive the highest

investment relative to their market size, whereas the most restrictive economies like Myanmar

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and the Philippines have been historically worst performers in attracting FDI. The figure below demonstrated the association between FDI restriction/openness level and stock of FDI per capita of 10 member states of ASEAN, (OECD, 2019).

Figure 1: FDI restrictions are associated with a lower stock of FDI per capita

Source: OECD, 2019 3. The Volume of FDI in ASEAN (at the latest update)

In general, Asia is the world’s largest FDI recipient region, accounting for 39 percent of the global FDI inflows in 2018 increased from 33 percent in 2017. While the FDI inflows have declined substantially (by 13 percent in 2018 comparing to 2017) worldwide, the flows to Southeast Asia have rose by 3 percent reaching an all-time high level of $154.7 billion, which marks the third consecutive year of growth of FDI in the subregion. As the result, the share of ASEAN in global FDI flows increased from 9.5 percent in 2017 to 11.5 percent 2018. The rising trend of the subregion is thanks to the strong performance in sectors such as manufacturing and services, finance, retail, wholesale trade and the digital economy. The major contribution to the total FDI inflows is from the increase in inward FDI in Singapore, Indonesia, Vietnam and

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Thailand. Additionally, the robust investment from other Asian economies, especially the strong intra-ASEAN investment contributed significantly to the trend, (UNCTAD, 2019).

The outlook of FDI flow into ASEAN is quite positive as it is expected to continue following its upward trend, which is driven by the great progress in regional integration, ‘dynamic industrial development’, new opportunities thanks to the shift of production and manufacturing activities from China, and the improvement in the regional investment environment. Additionally, several multinational companies have expressed interests and indicated plans to invest in and expand their operations into the ASEAN region in the near future, (asean.org, 2019). Below is the figure illustrating the trend of FDI inflows in ASEAN between 2010 and 2018 in billions USD and as percentage of global FDI inflows, (UNCTAD, 2019).

Figure 2: FDI inflows in ASEAN region in period 2010 – 2018 (billions of dollars and per cent)

Source: ASEAN Secretariat, ASEAN FDI Database

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a. FDI in six Member States

This section will discuss the highlights in FDI inflows in the six advanced Member States of ASEAN, including Singapore, Indonesia, Thailand, Brunei Darussalam, Malaysia and the Philippines.

Figure 3: Total FDI share of ASEAN countries period 1970 - 2018

Source: Worldbank, 2019

• Singapore

Singapore is currently the largest FDI recipient in ASEAN region, with total inward amount of

$78 billion in 2018, which is an increase of 3 percent from 2017. The region receives the majority of its investment from the EU countries, especially the Netherlands and the United Kingdom. The main driving force behind this growth in FDI was the robust investment in services such as financial services, wholesale, retails and real estate. Aside from the service sector, there was also a substantial rise of 94 percent in cross-border M&A activities, which were worth $19 billion in 2018, and were mainly from the real estate industry, energy and finance

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industries. The two mega-deals that generated most of the investment are one by Nesta

Investment (China) acquiring Global Logistic Properties for $11 billion, and the other onw done by Global Infrastructure Partners (the United States) acquiring Equis Energy for $5 billion, (UNCTAD, 2019).

• Indonesia

The second country in terms of attracting FDI inflows in the ASEAN region is Indonesia, with the capital inflows growth of 7 per cent to $22 billion in 2018, of which, the intra- ASEAN investment, especially from Singapore, made up to more than 50 per cent of the flows. Another important factor contributing to the record inflows is the substantial increase in investment from China and Japan, mainly in sectors such as manufacturing, real estate, infrastructure and the digital economy. Furthermore, in 2018, the major infrastructure projects in cooperation with foreign enterprises, like the Jakarta Light Rail Transit, were finished and in put to use.

Additionally, an important FDI attracting element of not only Indonesia, but the entire ASEAN region, is the ‘Special economic zones’ (SEZs), (asianbriefing.com, 2019). These SEZs are known as the cornerstone to encourage more FDI and to consolidate the emergence of ASEAN as a power trading bloc. SEZs can be in multiple forms including industrial parks, special export processing zones, innovation areas, or technology parks. In Indonesia, new SEZs such as Galang Batang and Sei Mangkei, similarly to other SEZs within the region, are significantly contributing to the country’s FDI inflows, (UNCTAD, 2019).

• Thailand

In the early years of the decade, the country was not performing well, yet since 2017, it has shown an outstanding increase in inward FDI, which later grew by 62 percent up to $10 billion in

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2018 – the steepest recorded growth of Thailand. The upward trend suggests that the country has been recovering well from its rough start in the early 2000s. This strong growth was contributed to greatly by the inflows from Asian investors such as Japan, Hong Kong and Singapore.

Moreover, the, the reinvestment from the multinational enterprises already present in Thailand, which doubled to $7.4 billion in 2018, also contributed significantly to the strong performance, (UNCTAD, 2019).

• Brunei Darussalam

The inward investment from traditional major investors, which are Malaysia and the U.K., to Brunei Darussalam has fell substantially by 96 per cent, to $21 million and -$343 million respectively. The same downward trend was observed in the oil and gas industry, with the amount of -$277 million. However, thanks to the increase in flows from Hong Kong that was a 42 per cent rise to $669 million, and the increase in investment in the manufacturing sector from

$493 million in 2017 to $701 million in 2018, in total, inflow FDI in Brunei Darussalam in 2018 is still recorded at a rise of $44 million compared to 2017, (asean.org, 2019).

• Malaysia

2018 was the second consecutive year that Malaysia experiences the downward trend in FDI inflows, of which the fall was recorded at 13 per cent to $8 billion. The lower inflows were mainly due to the decline in investment from other ASEAN economies of 79 per cent, as well as a substantial decline in investment in real estate, which reduced from $3 billion in 2017 to less than $1 billion in 2018. The only bright spots in Malaysia’s FDI weather were the doubled investment in the finance sector bringing it to a total of over $1 billion, and the increase by 2.7 times to $4 billion in the manufacturing sector, (asean.org, 2019).

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• The Philippines

Following the increases of 48 per cent and 24 per cent in FDI inflows in 2016 and 2017,

respectively, that of 2018 remain relatively flat at $10 billion. The rise in inward FDI from Hong Kong (by 2.5 times), from Japan (by 3 times), and the surge of FDI from China, which was a seven-fold rise, played a significant role in offsetting the substantial decline in investment from European economies that dropped from $2 billion in 2017 to $340 million in 2018. Further decline in inward FDI in the manufacturing sector, which was over $1 billion in 2017 and fell to

$193 million in 2018, was compensated by the moderate rise in the finance, real estate and other services sectors, (asean.org, 2019).

b. The CLMV countries

The combined investment flows into the CLMV countries (Cambodia, the Lao People’s

Democratic Republic, Myanmar and Viet Nam) remained strong, rose by 4 per cent in 2018 to an all-time high level of $23 billion, which represents 15 per cent of the total FDI inflows in

ASEAN. The record level of inflows in Cambodia and Vietnam was the crucial factor helping the sub-group reaching such strong level of investment. Vietnam, with the inflows exceeding $15 billion, was the third largest FDI recipient in ASEAN, after Singapore and Indonesia. On the other hand, the inward FDI into the Lao People’s Democratic Republic and Myanmar declined, yet remained at a high level. Multinational enterprises from intra-ASEAN countries and other Asian economies such as China, Japan, South Korea, continued to expand to these countries, mainly for the cost-effective reason, and in some cases, the effect of the trade tensions between the U.S. and China. The importance of Chinese investment has been consistent in the past years and becoming even more significant. Some of the major investment activities by Chinese

investors are relocating the labor-intensive operations, such as garment and footwear production,

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from China to CLMV region, participating in infrastructure development and several other activities under the influence of the Belt and Road Initiative. “In 2018, M&A sales to Chinese MNEs more than tripled, and the value of greenfield projects in ASEAN announced by Chinese MNEs increased five-fold”, (asean.org, 2019). The below table presents the data on FDI flows into CLMV countries in the period 2015 – 2018 as in USD as well as its share in the total ASEAN’s FDI inflows.

Table 1: FDI flows in CLMV countries, 2015 – 2018 (in millions of dollars and per cent)

2015 2016 2017 2018

Cambodia 1,701 2,280 2,732 3,103

Lao PDR 1,079 1,076 1,695 1,320

Myanmar 2,824 2,989 4,002 3,554

Vietnam 11,800 12,600 14,100 15,500

Total CLMV countries 17,405 18,945 22,530 23,476 CLMV share of FDI flows in ASEAN 14.7 15.9 15.3 15.2

Source: asean.org, 2019 4. The competition for FDI in ASEAN

According to several theoretical ad empirical studies, there is a common knowledge that FDI can bring in advanced technologies and managerial skills from multinational enterprises from the advanced source countries, to promote capital formation, economic activities and employment opportunities in the receiving countries, and thereby, enhances the economic growth of the receiving or the host countries. Therefore, a high level of inward FDI is associated with greater economic growth, which has resulted in increasing competition among developing countries to attract FDI inflows, (Sohn, 2016)

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ASEAN member states are no exception in this aspect. The main tools to attract FDI utilized by governments are Bilateral Investment Treaties, and Double Tax Treaties along with variety of tax incentives such as reducing corporate tax rates, tax holidays, loss carry-forwards, other rules that allow higher rate of depreciation of fixed assets, and so on, (unctad.org, 2000). For example, Singapore, which has been the leading FDI attractor in ASEAN, is known as the most free-trade and open-market economy in the sub-region. The country is also known for its unconventionally low corporate tax rate that is set at 17 per cent currently. Following the perceived success of this policy of Singapore, other ASEAN countries like Vietnam, Malaysia, Thailand, Indonesia and the Philippines have also reduced their corporate tax rates substantially. Within the period from 1998 to 2008, the corporate tax rate reduction in the ASEAN-6 countries reached more than 25 per cent, (Afrianto, 2018). There have been evidences suggesting that this competition among member states resulted in adverse implications, such as damaging their national tax revenues, promoting cross-border tax avoidance and evasion, and creating tax havens such as Singapore, (Maulia, 2017).

B. The Theory of Double Tax Treaties 1. The international double taxation problem

Due to the globalization of economies nowadays, the national taxation systems are no longer isolated and have the full control over the taxation of all economic activities occurring within the country juridical territory. In case of cross-border economic transactions and activities, to

maximize the tax revenue, a country often would like to tax worldwide gains and income of its residents, as well as those that arise within its jurisdiction, including income of non-residents. If all countries would apply such policy, the issue of juridical double taxation arises, where more than one country attempts to collect tax from the same income, hence, the income tax expense of

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businesses would become excessive and deterring to the process of globalization. There is another type of double taxation, which is economic double taxation where any income is taxed twice. One of the most commonly used examples is the taxes imposed on corporate profit, which is taxed corporate income, and subsequently, dividends yielded from the same profit is taxed as personal income. However, the focus of this paper is solely the juridical double taxation, where the conflict between countries is involved. The main question stemming from this issue of international taxation is: “Which personal income and corporate income can a country tax and to what extent?”, (Tepperova & Zidkova, 2017). The two essential principles that are used to determine the taxing right in this case are the ‘residency’ principle and the ‘source’ principle.

The source principle holds that the income should be taxed in the juridical territory wherein it was originated, regardless of the residency status of the person generating the income. Whereas, the residence rule allows the country in which the taxpayer resides to have the taxing right regardless of the origin of the income, (Yue, 2019). Based on these principles, in order resolve the conflict in such situation, countries have been negotiating and drawing agreements regarding the right to tax, which are the constantly growing worldwide network of bilateral double taxation treaties. The elimination of double taxation, hence, the worldwide tax treaty network, is a crucial factor impacting the investment climate of countries due to its importance in investment flows, the exchange of goods and services, the cross-border movement of labor and capital, and intangible assets such as technology, (UN.org, 2020).

2. Overview, Definition and History of DTTs

To have a strong foundation for the interpretation of the purpose and motive of countries to negotiating and implementing DTTs despite of its enormous costs, it is important to have a thorough understanding of the nature of this kind of treaties and certain issues associated with

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DTTs. Generally, DTTs are titled as “Agreement Between [Country X] and [Country Y] for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income”. As the name suggests, DTTs serve two primary purposes: (1) to avoid the issue of juridical double taxation, and (2) to prevent tax evasion, which is more likely to happen when there is no bilateral agreement in place that allows more legal loopholes, see section 5 for

detailed discussion. Furthermore, these treaties are also aimed to prevent discrimination between taxpayers, to provide the legal certainty in international operations for businesses, and to attract foreign investment (Tepperova & Zidkova, 2017).

Concerns about international taxation had emerged in the nineteenth century and originally in the form of diplomatic treaties. The objective of these early treaties was primarily to prevent the discrimination towards diplomats of one country working in another. Later the objective was extended to cover the income taxation matter, as its importance was widely recognized in the twentieth century, (Arnold, 2015). The League of Nations in 1921was the first organization to commence the work to develop a model convention dealing with income tax and capital tax issues, which was finally completed in 1928, and further modified in Mexico and London in 1943 and 1946 respectively, (Smith, 1996). Based on this the precedent model developed between the period of 1928 to 1946, the Organization for Economic Co-operation and

Development (OECD) and the United Nations (UN) both developed their own models that have been widely used and are the source for more than 3000 tax treaties in force worldwide (Sauvant

& Sachs, 2009). The differences in the implication of these two models will be discussed in more details in section 4.

DTTs are negotiated under public international law and interpreted as well as governed by the Vienna Convention on the Law of Treaties to ensure the consistent interpretations by both

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contracting countries that may lead to either double taxation or double exemption. After the treaties are in force, countries frequently revisit the terms and renegotiate the existing treaties the reflect the constantly changing conditions of the global economy. Overall, the existing DTT network, which represent the general applicable rules governing all cross-border income

taxation, plays an important role in the international taxation regime, (Sauvant & Sachs, 2009).

3. The Mechanism of Double Tax Treaties

This section will discuss how a double tax treaty determine whether the residence country or the source country would have the taxing right and to what extent. In a broad outline, tax treaties are organized based on a “classification and assignment” system, which implies that the income in question is first identified and classified based on its characteristics, then the right to tax is assigned accordingly to one of the contracting jurisdictions. The income can be categorized into two types: (1) active income and (2) passive income.

Regarding active incomes, the underlying principle to assign the taxing right is that the taxing jurisdiction must have the primary economic nexus with the income that can be determined through the recognition of a ‘permanent establishment’. In particular, tax treaties shift the burden of taxation from the source to the residence country, unless the taxpayer has a permanent

establishment, i.e. some fixed base of operations either directly or through a dependent agent, to which the income is attributable within the source country. For example, investment income is eligible for a reduced rate of taxation or an exemption in the source jurisdiction. Independent personal income is also taxable by the residence jurisdiction unless the taxpayer has a fixed base of operations to perform his/her activities in the source country, (Smith, 1996).

On the other hand, the primary mechanism of taxing right assignment for passive incomes such as royalties, dividends and interests is a tax rate reduction or withholding at the source country.

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For instance, according to the U.S. model of double tax treaties, taxation imposed on royalties and interests are reduced to zero, and dividends, which are the only passive income eligible for source-based taxation, are taxed at a reduced rate in the source country, (Avi-Yonah, 2009).

In cases that the source jurisdiction has the right to tax, DTTs require that the taxpayer’s

residence jurisdiction must implement certain methods to avoid double taxation. The commonly used methods are:

• The exemption method: the residence jurisdiction exempts all foreign income and does not impose any taxation on it.

• The credit method: the foreign income is included in the tax base in the residence country, but taxes paid in the source country are deductible from the total tax payable

• The deduction method: the foreign income is included in the tax base in the residence country, but taxes paid in the source country are treated as one of the business’ expenses, (Tepperova & Zidkova, 2017).

4. The OECD versus the UN Model Tax Conventions

Some countries employ their own double taxation convention to negotiate DTTs with other countries, such as the U.S., New Zealand, etc. Besides, most countries have used the two most influential tax conventions as a starting point for negotiations of tax treaties, which are:

• OECD Model Convention on Income and on Capital

• United Nations Model Double Taxation Convention between Developed and Developing Countries, (UN.org, 2005)

Since the first Model Conventions created by the League of Nations were not unanimously accepted, the OECD has taken over and published a its first draft of a commonly accepted model

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treaty in 1963. The model treaty was revised in 1977 and 1992, and since, every few years with the most recent revision done in 2014 by the Committee on Fiscal Affairs (CFA), which operates through several working parties consisting of delegates and senior tax officials from the member countries. The OECD has 34 members including the major industrialized countries, hence, its model conventions favors the capital-exporting countries by requiring the source countries to shift the taxing right to the residence countries in most cases. This feature could be appropriate for cases where the trade and investment flow between two countries is relatively equal.

However, it may result in substantial loss of tax revenue for net capital-importing countries, especially those that are developing countries. As the result, in 1968, the United Nations

established the “United Nations Economic and Social Council (ECOSOC) of the United Nations Ad Hoc Group of Experts on Tax Treaties between Developed and Developing Countries

pursuant to its resolution 1273 (XLIII)”. The group created a “Manual for the Negotiation of Bilateral Tax treaties between Developed and Developing Countries” which resulted in the publication of the United Nations Model Taxation Convention between Developed and Developing Countries in 1980. The UN model convention was created following the OECD model, hence, these two models are similar and nearly identical in their contents, including the order of topics covered, provisions and their language. In fact, about 75 percent of the wording in any given DTT are identical with the actual words of any other DTT. Therefore, generally, these two model conventions are not seen as two entirely separate ones, yet the UN model is a

modified version that provides limited, but important adjustments to the OECD model, (UN.org, 2015).

As mentioned, the OECD model is favoring the interests of the capital-exporting economies, whereas, the UN model aims to maximize the benefits of the developing countries by allocating

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greater taxing power to the source countries while the residence countries have to provide tax credit for taxes paid overseas or tax exemptions. Therefore, countries determining which model to choose as the basis of the bilateral DTTs are considering between more and less taxing powers for the source state, (Lang & Owens 2014). The UN model benefits developing countries by imposing less restrictions on the right to tax of the source countries. For example, Article 12 – Royalties of the OECD model reduces the tax on royalties at the source country to zero, while that of the UN does not prevent such taxation. The UN model convention also allows higher tax rates for source-based taxation on other passive incomes such as dividends and interests, (Avi- Yonah, 2009). Another significant difference between the two models stems from their distinct definition and threshold for ‘permanent establishment’. Article 5(3) of the OECD model requires construction jobs, building sites and assembly projects to last at least 12 months to be considered as a permanent establishment. In contrast, the UN model reduces the threshold to 6 months in duration, allowing a more relaxing condition for source-based taxation. Moreover, the UN model also applies some expansions to the scope of permanent establishment (PE) such as restricting the category of independent agent, (Per Article 5(5), PE exists when “business activities are carried on through a dependent agent who habitually exercises an authority to conclude contracts on behalf of an enterprise”. Article 5(6) in the OECD model and 5(7) in the UN model neglect PE status in case of independent agent), (UN.org, 2014).

5. Taxation in the digital economy

Even though there is currently no common definition for the ‘digital economy’, it can be

generally described as a novel business model that’s utilizes cutting-edge technology, including the volume, speed and reliability of data transfer, in order to be able to operate without having a fixed taxable presence in the country where revenues arise, or the consumer market is located.

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This emerging economy is posing a new challenge to the existing bilateral tax treaties that do not provide sufficient guidance to such exceptional business models. The permanent establishment concept that is the key mechanism to decide the taxing right of the current DTTs is showing its inadequacies to deal with new challenges as it is being manipulated by some of the participants in the digital economy, (UN, 2017).

Facing the issues arising from the taxation of the digital economy, many countries, instead of re- negotiating their bilateral tax treaties with their counterparty or establishing an international consensus, have decided to enact their own legislation or ‘unilateral action’ to deal with taxation of the emerging economy. This approach has been first taken by developed countries, and over time, developing countries have also picked up on the trend and initiated their legislation to address this issue. Some of the unilateral actions taken by i.e. India, China, France, the U.K., Saudi Arabia, etc. to address cross-border digital corporate income tax are: (1) presumed

allocation of profits to a jurisdiction (using the existing permanent establishment approach, or by requiring registration by taxpayers in the country, where their significant economic digital presence is located); (2) imposing taxes based on the use of the country’s digital infrastructure;

(3) withholding tax on certain types of transactions. Despite of the borderless nature of most digital activities, countries, especially ones with large consumer markets, can achieve the right to tax through these policies without the need for physical presence of a business in their markets, (UN, 2017).

As the effort of creating an international framework to tackle the tax challenges of the digital economy, OECD/G20 Base Erosion and Profit Shifting (BEPS) Project, has recognized this as the one of its main focused areas and committed to produce Action Reports to properly address the issues. The 2015 BEPS Action Report 1 was focused on indirect taxes i.e. VAT and Good

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and Service Taxes (GST), and delivered recommendations such as implementing the destination principle and mechanisms for effective collection of VAT/GST as presented in the 2017 OECD International VAT/GST Guidelines. However, for direct taxes, the question of how taxing right should be allocated between jurisdictions for income arising from cross-border digitalized activities is still opened. There has been a number of options, yet, none of them were

recommended. The Action Report 1 has called for continued work in this area and planned to deliver recommendations in the next report by 2020, (OECD, 2019).

6. Advantages and disadvantages of DTTs a. Advantages

• Benefits contributing to the competitiveness of a country

The primary objective of DTTs is to reduce or to avoid the double taxation issue, which is identified as one of the major challenges to FDI inflow, and hence, the globalization process and economy boost, by ‘harmonizing tax definitions, defining tax bases, assigning taxation

jurisdictions, and indicating the mechanisms to be used to remove double taxation when it arises”, (Baker, 2012). Secondly, DTTs act as a clear legal guidance, especially by facilitating the information exchange clause in every tax treaty, which also plays an important role in

preventing tax avoidance (e.g. through profit shifting) and fiscal evasion to secure tax revenue of the country.

Another important assumed benefit of DTTs is to attract foreign direct investment. Some

researchers argue that the key benefit of DTTs stems from the reduction of withholding tax rates on source-based international capital income, which may substantially contribute to making a country become more attractive as an investment destination, (Braun & Zagler, 2014).

Furthermore, according to Sauvant and Sachs (2008), DTTs may help to reduce the premium

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required by foreign investors to compensate the ‘sovereign risks of rule-changing’ by the source country after the investment was made. By diminishing the sovereign risk concerns, DTTs can further increase the desirability of a country as an FDI destination, (Barthel, Busse, Krever and Neumayer, 2010).

• Benefits to foreign investors

From the perspective of transnational businesses, research shows that the most difficult places to pay taxes are smaller developing countries that are lack of appropriate tax administration and as a result, the certainty in tax treatment and procedures. The DTT network provides a clear commonly accepted international taxation guideline which helps to mitigate the ambiguity for foreign investors on their tax burden and obligation in a foreign country that significantly encourages overseas investment activities, (Ahmed & Giafri, 2015).

Another important assumption about DTTs is that similarly to Bilateral Investment Treaties, DTTs are often considered as an indicator that a country is actively welcoming foreign capital inflows that may implies further easing in investment policies and certain incentives for

investors, (Lang & Owens, 2014). Additionally, in case of developing countries, besides the legal and fiscal certainty that DTTs provide investors with, they also express an inviting signal or message to foreign investors that the developing country has acquired ‘international economic recognition’ that increases the legitimacy of a jurisdiction, and is willing to follow the

‘conventional international investment rules’ (Dagan, 1999 cited in Neumayer, 2007).

There is one more provision in DTTs that is considerably important to investors from abroad, especially, those who are looking to build new branches and subsidiaries as a part of their global operations in a new host or source country. The mentioned provision is the mutual agreement

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procedure, which is useful for taxpayers to achieve ‘advance pricing agreements’, by which the revenue authorities of both the source country and the residence country recognize a commonly agreed transfer price for transactions involving parts that are shared/transferred between the two jurisdictions. In case there is no such agreed price, there is a substantial level of risk of double taxation, as the two revenue authorities each allows distinct transfer prices leading to the

overlapping recognition of gain in both countries, (Barthel, Busse, Krever, and Neumayer, 2010 citing Lang, 2002).

b. Disadvantages

DTTs undoubtedly have various benefits as discussed above, however, they are also associated with extremely high costs, including costs to negotiate, and costs incurring after the DTT is in force. Firstly, regarding the costs related to the negotiation and implementation process, which is an excessively lengthy process and requires a great amount of administrative resources including financial and human resource. There are several steps or stages involved in entering into a tax treaty. After the negotiation between two countries has been successful, each state must ratify the treaty according to its own ratification procedures, only then, it is ready to entry into force. The implementation of these treaties involves making minor or major adjustments to a country domestic tax system. Once a treaty has been fully integrated into both countries’ tax law, it must be frequently interpreted and amended to respond to any new circumstances, (Arnold, 2015).

DTTs, yet can be important factor of attracting FDI, are a relatively small factor overall. Hence, it is argued that the extensive negotiations consuming administration resources to achieve and implement a DTT are an distraction to tax authorities from their other priority, and some countries, especially developing ones, may not have the capacity in terms of both cost and administration for such actions, (Yue, 2019).

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Secondly, regarding the costs incurred after a DTT is in force, DTTs often result in potential loss of tax revenue for the source country, which is the main concern of tax authority regarding DTTs. As explained in section 3 and 4, the mechanism to avoid double taxation of DTTs is to shift the taxing right to the residence country in most cases. Even though the UN model

convention is favoring developing countries more by apply less restriction on the source-based taxation, it still evidently leads to the reduction in tax revenue of the source jurisdiction. In case the FDI patterns of two countries entering into a DTT are relatively symmetrical, typically for developed-developed country pairs, or, the total FDI outflow and inflow of a country are reasonably similar, this distributional issue would not be a great threat. However, developing countries, who rely significantly on FDI inflow, and have limited FDI outflow, suffer from this issue greatly. Dagan (1999) argues that DTTs serve a cynical goal to “redistribute tax revenues from poorer to the richer signatory countries”. According to IMF, based on rough calculations, the U.S. tax treaties with non-OECD country counterparts costed these countries approximately

$1.6 billion in 2010, (2014).

7. DTTs in ASEAN

Taxation undoubtedly is a crucial factor impacting the globalization and economic growth of countries in the ASEAN sub-region. Not only are there DTTs ASEAN countries have signed with countries from the rest of the world, there are also several DTTs signed intra-ASEAN that foster greater economic integration and cooperation within the region. Below is the figure illustrating the development of the annual total new DTTs entered into force in ASEAN from 1988 to 2019. The number has increased impressively, reaching an all-time high level of 24 new treaties in 1999. The existing network of 456 in force bilateral DTTs by 2019 in the ASEAN subregion alone shows that DTTs represent a vital part of international trade law.

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Figure 4: New Double Tax Treaties in Force by Year

Source: data collected by author from government websites of ASEAN countries

As discussed in the previous section, due to its main mechanism to shift the taxing right from the source jurisdiction to the residence jurisdiction, which leads to a significant loss of tax revenue for capital importing countries. In most case, developing countries are net capital importers, hence, DTTs may have even more severe adverse impacts on these countries. Therefore, it is crucial for the policy maker in the ASEAN sub-region to investigate the estimated costs and anticipated benefits prior to signing a new tax treaty. Only after reviewing carefully all the potential long-term advantages given the costs of giving up their taxing rights, they should decide whether or not to sign such bilateral tax treaties. The policy maker in ASEAN should be optimistic and confident prior to completing a DTT, that the expected additional inward

investment is likely to outweigh the associated reduction in tax revenues.

According to the below table, the countries that are most active in negotiating DTTs with other countries are Singapore, Vietnam, and Malaysia, and in contrast, the nations with the least DTTs are Cambodia, Myanmar and Laos.

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Table 2: Total accumulated number of DTTs in force in ASEAN countries

Countries Number of DTTs

Brunei 19

Cambodia 5

Indonesia 66

Laos 10

Malaysia 72

Myanmar 8

Philippines 50

Singapore 91

Thailand 61

Vietnam 77

Source: data collected by author from government websites of ASEAN countries C. Previous Research

1. Overview

There have been numerous studies on the relationship between the volume of DTTs and the development FDI in various regions or countries. Generally, the studies are divided into two groups based on their research approach. The first one is dyadic studies, also known as two-party studies “that track changes in bilateral treaty status and shifts in the amount of FDI on a

jurisdiction-by-jurisdiction basis”. The second group is monadic studies that are one-party

studies focusing on the absolute numbers of DTTs of the source or host country and its impact on FDI in this one country, (Barthel, Busse, Krever, and Neumayer, 2010).

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Due to the difference in their samples in terms of characteristics and size, dissimilar control variables, and methodological frameworks, the results of the studies are diverse and together, inconclusive to the research topic. According to Blonigen and Davies (2004), depending on the type of each DTT, and the fact that they are not equally enforced, the impact DTTs on FDI cannot be the same. The conclusions of these studies range from significant positive correlation between FDI and DTTs, to no association, and even a negative effect of DTTs on FDI. Despite of the controversial linkage between the two variables, countries have been continuously negotiating and ratifying DTTs. The increase of these agreements could be due to the existing evidence of their possible positive association with FDI presented by few studies. Additionally, developing countries tend to focus on these treaties as a mean to stay competitive against other countries within the region to attract more FDI. (Shah, 2011d). In this section, previous studies with different findings are categorized into three types that are those that found (1) a positive correlation between DTTs and FDI, (2) a neutral relationship or no correlation, and (3) a negative correlation between the two variables.

2. Impact of DTTs on FDI according to existing research a. Positive correlation

A study by Blonigen and Davies (2005) was the first research that provides robust empirical evidence of the positive relationship between DTTs and FDI. The research covered 23 developed source countries within the period 1982 – 1992 using OECD data. Interestingly, the authors concluded that old treaties had positive impact, while new treaties have negative – but

statistically insignificant – impact on FDI inflows. However, the research has certain limitations such as: (1) limited range of developing host countries no developing source countries were covered, (2) the restricted time frame leads to potential biasness in the sample as during the

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selected period almost three-quarter of the treaties covered were old treaties, leaving the few remaining being new treaties.

The second study that resulted in a positive relationship between higher FDI stocks and the existence of DTTs was carried out by Neumayer (2007). According to his study, developing countries that have signed more DTTs with major capital exporting countries benefit from an overall higher FDI inflow volume. The study was based on the fixed effects panel estimation technique using on annual data about the outbound FDI of the U.S. from 1970 to 2001. Another important finding in this research is that DTTs are only effective for middle-income developing countries but not for low-income ones in stimulating FDI inflows.

Similarly, Barthel, Busse and Neumayer (2010) have concluded that DTTs “are not only statistically significant, but also substantively important” in promoting FDI, with the effective rate of between 27 and 31 percentage points. In this paper, the authors claim to more provide more reliable output as their research was based on an extensive dyadic country dataset, which represents 105 countries – 10 developed countries and 84 developing or emerging countries over the period from 1978 to 2004.

The research of Murthy and Bhasin (2013) has also confirmed the similar finding of a positive correlation, yet a slight one, between the two variables in India. The research method was fixed effects panel model with multiple control variables such as FDI, openness of the market, GDP per capita, and GDP. The study on the effect of DTTs on Japan outbound FDI in 13 Asian countries covering the period from 1981 to 2003 was carried out by Ohno (2010). Its result shows that among the DTTs that Japan has enforced during this period, newly agreed treaties have had “statistically significant long-term positive effects on the scale of investment”.

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b. Insignificant correlation

There are number of studies show no to insignificant effect of DTTs on FDI. For example, in the same research, Ohno (2010) also found that the DTTs that were revised during the same period did not show any significant effects on FDI. His argument was that as the DTT becomes older and/or needs to be revised, its significance and effectiveness are decreasing.

Coupé, Orlova and Skiba (2008) focused on the impact of both bilateral investment treaties (BITs) and DTTs on the FDI flows from Organization for Economic Co-operation and Development (OECD) into transition economies, including 17 source countries and 9 host countries over the period of 1990-2001. The authors have found positive impact of BITs on FDI flows, but no consistent results were found on that of DTTs, which means that economies which have signed DTTs with OECD countries will not receive more FDI inflows, while signing BITs exerts significant positive effect.

Similarly, two studies covering the sample of the U.S. investments, one by Davies (2003) and one by Davies and Blonigen in the following year have concluded that newly signed tax treaties and renegotiations had no positive effect on either inward or outward FDI in the U.S. However, it is important to note that the renegotiation of treaties, in case the mature investment patterns had been established, are often focused on the anti-tax avoidance and information exchange clauses, (Barthel, Busse, Krever, and Neumayer, 2010).

Baker (2014) also found that DTTs do not have significant impact on FDI inflows. However, the author argued that developing countries often are capital importers, hence, to be more attractive to investors to compete for the limited resources from overseas, they actively seek to sign DTTs.

Even though there is an inevitable cost of DTTs due to the reduction in the tax rate after the

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treaty is in force, “it is also true that in this way they can become hubs of inward FDIs”. Another argument was that there was evidence that there is no difference found between the taxes before a treaty is in place and after. Therefore, in such situation, it is not necessary to spend time and resources on achieving a DTT, (Baker, 2014).

c. Negative Correlation

Eger and colleagues (2006) presented an interesting finding of negative of DTTs on FDI based on their research covering 76 country pairs with tax treaties and 719 pairs without those. Their study evaluated the effect of tax treaties on outbound FDI from OECD countries during the period from 1985 to 200 using a two-step selection model. In the first step, the authors assess the propensity to enter a DTT of a specific country pair, then in the second step, they conduct a difference-in-difference propensity score matching estimation, with the dependent variable as the difference between the biannual average of FDI-log prior to the treaty and the two-year average after the treaty.

Millimet and Kumas (2009) claim whereas the theoretical literature suggests that DTTs can be FDI-inducing, this effect is quite fragile. The authors have challenged the previous research of Blonigen and Davies (2004) using the same set of data, but with the emphasis on the role of timing of the effects of DTTs. Their research shows that the newly established DTTs may have positive impact if the level of existing FDI in a country is low, but in case it is already high they may exert a negative impact on the FDI level.

Yue (2019) is currently the only existing paper on this topic with a focus on Southeast Asian countries. His study covered 10 Southeast Asian countries during the period 1989 – 2016 and used the panel data estimation method which distinguished between yearly newly signed DTTs and accumulated number of DTTs. He found that both variables do not have statistically

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significant influence on FDI inflows in these countries, of which new DTTs showed a positive impact, and accumulated DTTs have a negative impact.

III. Hypotheses

DTTs have several implications that may act as the motivation foreign investors to invest in a host country. These implications are both important in building the attractiveness for a country as a potential capital importer, as well as in offering incentives to encourage investors to choose the country as an FDI destination. However, the associated costs of these benefits are also an

important element to be considered prior to concluding a treaty. Beside the costs of financial, human and other administrative resources required to achieve a DTT, the usefulness of these treaties is frequently discussed by researchers. One of the key objectives of DTTs, as their name suggests, is to avoid double taxation, however, in the absence of a bilateral DTT, countries can still avoid this situation by having their unilateral exemption system or credit system.

Particularly, with the unilateral exemption system, the residence country will not collect tax on income earned in the source country. In case of a credit system, the residence country only collects the tax, if its tax rate exceeds the rate of the source jurisdiction, (Barthel, Busse, Krever and Neumayer, 2010). Therefore, it is crucial for policy makers to investigate whether the anticipated increase in FDI is worth all the costs, especially given that DTTs are not entirely necessary to solve the double taxation problem.

Even though the answer to the question whether DTTs strongly increase the volume of inward FDI in a source country or not is still inconclusive, there have a considerable number of studies being affirmative to the question. As discussed in the previous section, there a wide range of findings by various authors on this topic. The extreme diversity of the result of these studies are due to the fact that researchers have different pursue in their research leading to the use of

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dissimilar samples in terms of geographical factor, distinct control variables and different estimation methodologies. Since there have been only one study on this topic for ASEAN sub- region, given its significance to the economic growth of all the Member States, this study will serve as an additional contribution to the understanding of the extent by which DTTs are influencing FDI inflows into ASEAN. This study will be conducted using a sample of 10 ASEAN countries using different explanatory variables with a distinction between number of DTTs signed annually and accumulated number of DTTs for the whole studied period, which is from 1988 to 2018 that has not been covered by any precedent studies. To answer the research question of the paper that is “To what extent do Double Tax Treaties have an impact on Foreign Direct Investment in ASEAN Member States?”, the author will conduct an empirical research based on the two following hypotheses:

Hypothesis 1: The volume of FDI inflows increases significantly on a yearly basis due to new DTTs signed annually in ASEAN Member States.

Hypothesis 2: Even after years of being in force, DTTs continue to contribute significantly to the increase of FDI inflows, or in other words, the volume of FDI inflows into ASEAN is driven substantially by the accumulated number of DTTs.

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IV. Research Design 1. Test Design

a. Estimation Technique

Generally, when a study seeks to examine the relationship (or the lack of relationship) between two or more variable factors, which in this case are FDI inflows and numbers of DTTs, the researcher would use the technique ‘correlative analysis’. There are two types of variable in such tests that are (1) dependent variable, of which value is changed due to changes in the causation variable; (2) explanatory or independent variable that are known as the cause of the changes in the dependent variable. The variables used in this study will be discussed in detail in the next section. Due to the use of multiple explanatory variable in this study, it is suitable to use the type of correlative analysis known as ‘regression analysis’, so that the relationship between DTTs and FDI can be compared to that between other independent variables and FDI, (Barthel, Busse, Krever and Neumayer, 2010).

In the majority of the previous studies on this topic, which were discussed in the Literature Review section, the authors chose to use the panel data estimation method, out of other

regression analysis techniques. This method allows users to observe the variables pairs of each jurisdiction over different time periods, which means that only the variations over time between country pairs are observed, but differences across these pairs are ignored, (Woodridge, 2012).

This technique also enables users to control for all unobserved (approximately) time-invariant factors influencing the dependent variable, which can be geography, language, climate, and cultural proximity in this study. Additionally, the research design of this paper is adapted from the study of Shah and Qayyum (2015) on the similar topic for the Latin American and Caribbean developing countries, in which the authors used the fixed-effect panel data model.

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b. Selection of Control Variables Dependent variable:

The only dependent variable that the author wants to study in this paper is the Foreign Direct Investment net inflows that are converted to current US Dollar (data retrieved in February 2019).

The FDI data covered is in 10 ASEAN developing countries (except for Singapore) for the time period 1988 – 2018, and retrievable in the World Bank data bank.

Explanatory variables:

Besides the number of new DTTs and accumulated number of DTTs, there are several distinct factors or so-called independent variables that can influence the development of the inbound FDI in a country. In this study, the author chooses to examine the effect of the 5 key explanatory variables on the movement of FDI in the 10 selected countries, which are described and their expected impact on FDI will be discussed below.

• The total GDP of the capital importing country converted into current US Dollars. It is natural to assume that the higher GDP and a high rate of growth of GDP of a country would indicate a high level of economic development and a large market size, hence, greater attractiveness of the source market. The host-country’s GDP is especially an important factor to attract FDI in case there is high trade barriers, where the only way to penetrate the domestic market is through FDI. Additionally, it is expected that a larger domestic market can attract more FDI as its production and consumption capacities are higher, which help multinational enterprises to regain their investment faster, and exploit economies of scale, (Vogiatzoglou, 2007 citing Navaretti & Venables, 2004).

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• Population of the FDI receiving country. In theoretical literature, the source country’s population reflecting its human capital is also an important attracting factor that shows the size of the market as well as the availability of the labor force. Mankiw et al, 1992 emphasized the importance of human capital in increasing the marginal productivity for economic growth, and, hence, it will be crucial to investors when assessing an investment destination.

• The degree of openness to trade or to foreign investors and international integration are especially crucial to FDI. This is due to a number of reasons such as that without the source country being welcomed of investors overseas, regardless of how attractive and prosperous it is, investors would not be able to export their capital and attend to the targeted local market. Additionally, multinational enterprises can more easily find the necessary imports such as raw materials or intermediate goods for the production in an opened economy than in an isolated one. Lastly, an economy with a high level of

openness to the global economy is likely to have a well-established distribution network, trade agreements and other bilateral investment policies that better facilitate the operation of multinational firms than a closed economy could, (Vogiatzoglou, 2007). The data of this indicator was recorded as percentage of total GDP.

• One of the key explanatory variables in this study is the number of new DTTs entered into force in the current year. Typically, the process of negotiating a DTT is consisted of three steps: (1) once the countries decided to start negotiating, they will schedule two rounds of negotiation in both countries and will provide signatures once an agreement is reached. After signing the agreement, each country must ratify the treaty based on its own procedure. The last step is to enter the treaty into force according to rules specified in the

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treaty (i.e. Article 29 in the UN Model), (un.org, 2015). Some studies on this topic

chooses to recognize a DTT based on its date of ratification. However, in this study DTTs will be recognized using the date that it was entered into force because the author believe that this is what investors would be interested in the most. Therefore, some DTTs that were signed or ratified in 2018 but not yet in force by December 2018, were excluded from this study.

• The remaining key variable is the accumulated number of DTTs. For example, if the number of DTTs in force in Brunei Darussalam in 1988 is two treaties, and in 1989 there were two new treaties, the accumulated number of DTTs in 1989 would be four. This variable will examine the effectiveness of the old DTTs on the development of FDI.

c. Sample

The sample used in this study consists of 10 countries in ASEAN, namely Brunei Darussalam, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam. The sample is observed in the time period from 1988 to 2018.

d. Data Source

The below table summarizes the different control variables used in this study, and the sources, which the author used to gather data of these variables.

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Table 3: Control variables and data sources

Type of variable Proxy used Sources

Dependent variable FDI net inflows (current USD) World Bank website Explanatory variables GDP of the source country

(current USD)

World Bank website, Governmental websites of countries

Population of the source country World Bank website

Trade (% of GDP) World Bank website

New DTTs in current year Governmental websites of countries

Accumulated DTTs Governmental websites of countries

e. Limitations of the Empirical Study

There are two main obstacles that the author encountered during the conducting process of this empirical analysis. The primary difficulty was the limitation of data, in particular, the economic data for the dependent variable and the first 3 explanatory variables for some ASEAN countries in certain years is missing, especially those from the year 1988 to 2000. The author had tried to look for the data in all possible credible sources such as the governmental websites and reports of the countries, the World Bank website, the ASEAN archive, etc., yet, could not retrieve a full set of data. This limitation may lead potential issues regarding the missing of variable that reduce the accuracy of the empirical analysis. Additionally, due to the difficulty in obtaining data, the possibility to have a wider time frame, and to include additional variables (i.e. education indicators to reflect the quality of the labor force) to increase the statistical power is greatly

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restrained. However, in case these missing variables are included in spite of the missing data, there will be a significant increase in the inclusion of dummy variables, which may assert even more adverse effect on the quality of the research than the issue of omitted variables.

f. Fixed-effect Panel Data Estimation Model

The panel data estimation model with a fixed-effect approach used to test the impact of DTTs along with three other explanatory variables on FDI in this study is adapted from Shah and Qayyum (2015) as follow:

Ln FDIjt = β1 Ln GDPjt + β2 Ln Populationjt + β3 Ln Tradejt + β4 Current year DTTsjt + β5

Accumulative DTTsjt + α0 + ξjt, where,

Ln FDIjt is the natural logarithm of FDI inflows to jurisdictions within the sample in million US Dollars for time period (t);

Ln GDP is the natural logarithm of gross domestic product in US Dollars;

Ln Trade is the natural logarithm of trade as the percentage of GDP;

Current year DTTs is the absolute number of DTTs signed in the current year;

Accumulative DTTs is the absolute accumulated number of DTTs signed till the current year.

The author converted the variable values to the natural logarithm because it is useful in reducing the skewness of the variables, which helps to increase the accuracy of the result by eliminating the extreme values or anomalous factors. Additionally, it allows an easier interpretation of the estimated coefficients, for instance, one can express the result as a one percent change in the explanatory variable results in a certain percent change in the dependent variable.