[Research Contribution] Tax Incentives and FDI Attraction: Recommendations for the Application of Global Minimum Tax

27 February, 2025

Keywords: Tax incentives, FDI, Global minimum tax rule

Employing an empirical model, a research team from the University of Economics Ho Chi Minh City (UEH) explored the impact of tax incentives and other non-tax factors on the ability to attract FDI inflows in developing countries in Southeast Asia and discussed necessary adjustments in tax incentive policies to adapt to the context of applying global minimum tax rules in Vietnam. The study contributes to clarifying the role of tax policies and also provides a comprehensive view of solutions to attract FDI inflows and to promote economic development in the new context.

Research context

Along with domestic capital, Foreign Direct Investment (FDI) is considered an important driving force for economic development in developing countries. Therefore, in addition to increasing domestic strength, developing countries are implementing various economic policies to attract FDI inflows.

In particular, tax incentives play a major role in FDI attraction strategies. In fact, many countries tend to use tax incentives as an important tool to enhance competitiveness in attracting Multinational Enterprises (MNEs). Meanwhile, many MNEs take advantage of these incentives to implement Base Erosion And Profit Shifting (BEPS), greatly affecting the national budget.

One effort to limit BEPS is the formation and the implementation of the global minimum tax rule. In 2024, the global minimum tax rule was started to be implemented. The emergence and the application of the global minimum tax rule in general is posing great opportunities and challenges for many developing countries. It is noteworthy that the effective tax rates in many developing countries are currently much lower than the global minimum tax rate of 15%. This raises concerns regarding the impact of the global minimum tax rule on the investment decisions and operations of multinational corporations. Therefore, the application of the global minimum tax rule requires countries to carefully consider the balance between the interests of the relevant parties.

In a broader view, the effective implementation of this rule is not only a purely economic issue but also involves many social and political factors. Accordingly, governments need to comprehensively assess the negative and positive impacts of implementing this rule, including the impacts on the investment environment, budget revenue and national economic development strategy.

The relationship between tax incentives and the ability to attract FDI

At the national level, investment is the core foundation of economic activities. One of the main activities of economic development is to promote enterprises to carry out investment projects. For this reason, economic growth theories emphasize the importance of investment capital for the economy in countries. Along with domestic investment capital, FDI capital flows contribute significantly to the economic development of some countries, especially developing countries. Accordingly, factors affecting the ability to attract FDI capital flows have become a topic of interest to many scholars. In this study, the research team focused on analyzing the role of tax incentives on the competitiveness of attracting FDI in developing countries and discussed adjustments to tax incentives in the context of applying global minimum tax rules. The research rationale mainly came from the urgency of the practical context. According to international tax theory, investment decisions of multinational corporations should be based on considerations of other factors, instead of just focusing on the benefits of tax incentives. Countries should focus on improving other sustainable factors, instead of attracting FDI capital with tax incentives.

However, in practice, developing countries tend to use tax incentives as a tool to compete in attracting capital flows. There are being many conflicting opinions on the impact of tax competition. Tax competition can have positive effects like facilitating business environment and attracting foreign investment. Because of tax competition pressure, each country must reform its tax system to be more effective as well as rationalize government spending. This competitive pressure not only stimulates efficient resource allocation but also enhances economic development. Market-based tax reforms help the economy grow faster and improve people’s living standards. Therefore, countries will create more jobs and attract more domestic and foreign investment. On the contrary, tax competition also causes potential problems. Tax competition countries can cause tax imbalances, resulting in a shortage of revenue for national projects. The trend of tax competition makes countries compete more, forcing them to trigger a “race to the bottom”, weakening the government’s ability to provide social protection. In addition, the race to reduce taxes among countries can lead to global tax losses and unfairness in the distribution of resources. Accordingly, in terms of policy, many countries believe that unfair tax competition is harmful and tax harmonization must be established (Avi-Yonah, 2008). Another effort to harmonize taxes on a global scale is the Global Minimum Tax (GMT). The main content of the global minimum tax rule includes two main pillars or “Two-Pillar Solution”. According to the OECD’s “Two-Pillar Solution”, the first pillar will determine the rules for sharing tax rights among countries based on revenue and profit levels. The second pillar will create a global minimum tax to ensure that companies do not avoid taxes by shifting profits to low-tax countries. Accordingly, the global minimum tax rate that FDI enterprises must pay is equal to 15%. If the host country does not collect enough tax, the investing country has the right to collect additional tax to ensure that the global income of the FDI enterprise is subject to this minimum tax.

It is worth noting that this 15% minimum tax rate is effective. In fact, although most of the statutory tax rates of Southeast Asian countries are higher than the 15% level under the global minimum tax regulations, because of tax incentives, the effective tax rates in many countries are significantly lower than this level. This article analyzes the impact of tax incentives on FDI in Southeast Asian countries through the Effective Tax Rate (ETR), providing insights into how tax incentives are used to attract FDI.

Adjusting tax policies in the context of applying global minimum tax

This study is very meaningful in the context of applying the global minimum tax rule GMT. In fact, although most of the statutory tax rates of Southeast Asian countries are higher than the 15% level according to the global minimum tax rule, because of tax incentives, the actual tax rates in many countries are significantly lower than this level. The research results confirm the important role of tax incentives in attracting FDI when lower effective tax rates help increase the attractiveness to foreign investors.

However, from the opposite perspective, the effectiveness of tax incentives is expected to decrease significantly under the impact of the global minimum tax rule. This poses a challenge for Southeast Asian countries in general and Vietnam in particular in maintaining competitiveness without relying entirely on tax incentives. The analysis of the current situation in Vietnam indicates that the GMT rule brings both opportunities and challenges. Therefore, the government needs to change their tax incentive policies appropriately and promptly, as well as focusing more on sustainable factors like economic growth, population size and quality, and political stability.

Policy implications for Vietnam

It can be stated that the global minimum tax rule brings both opportunities and challenges to Vietnam. From the above research results, the UEH research team proposes some policy implications for Vietnam in the context of applying the current global minimum tax (GMT) rule.

In the short term, the government needs to innovate their tax policies to adapt to this tax rule. The government needs to build an effective supplementary tax adjustment mechanism to ensure that Vietnam collects the rightful tax portion while ensuring transparency and fairness in determining tax rights. In addition, the government needs to strengthen international cooperation to share experiences and to build harmonious policies with partners in the Southeast Asian region.

In the long term, as the impact of current tax incentives gradually decreases, Vietnam needs to make policy adjustments to maintain our competitiveness in attracting FDI. Accordingly, the government needs to replace current broad tax incentives with targeted incentives like supporting strategic industries or investment projects with technology transfer commitments. In addition, Vietnam also needs to focus on non-tax factors that affect FDI attraction capacity such as improving infrastructure, reforming administrative procedures, and enhancing transparency in management to create a more favorable environment for investors. In addition, the government needs to promote policies to develop high-quality human resources to meet the needs of high-tech and high value-added industries.

The full-text research article on Tax incentives and FDI attraction: Recommendations for the application of global minimum tax can be accessed HERE.

Authors: Assoc.Prof. Diep Gia Luat, Dr. Tran Trung Kien, Dr. Tran Ngoc Linh, Pham Thi Ngoc Dung – University of Economics Ho Chi Minh City.