Spooky Stuff—What is a Phantom Investment?

A report from the International Monetary Fund (IMF) suggests 40 percent of foreign direct investments are actually phantom.  Scary news for sure.

Foreign direct investments (FDI) are direct investments made by one company into a company located in a different country—hence “foreign” direct investment.  The investment may be through capital, management, or technology and gives the investing company a stake in operation and direction of the company.  FDIs can fuel company and regional economic growth.  That doesn’t sound too ghostlike, does it?

An FDI goes phantom when the investment being exchanged through multinational companies is essentially empty.  Rather than processes, capital, and innovative technology being transferred from one company into another, money passes through empty corporate shells, called “special purpose entities.”

The September 2019 report from the IMF describes a global picture where almost half the capital flowing around the world is phantom, being used to wash money into offshore tax jurisdictions or to avoid taxes altogether.  Some of the findings of the study include:

• Phantom investments in corporate shells carry no real business purpose and are often used to lower the tax bill of a company.
• Luxembourg (which we have discussed a number of times), with a population of 600,000 carries as much FDI as the US—and lots more than China.  The Netherlands and Luxembourg hold nearly half of the phantom FDI in the marketplace.
• Even though phantom investments do not drive industrial growth in a tax haven like Luxembourg, they still put money into the local economy through financial and other needed accounting or tax services.
• Ireland is another destination for phantom investment, with an attractive corporate tax rate of 12.5 percent.
• The IMF notes the phantom investments total approximately $15 trillion—which equals the combined gross domestic product of China and Germany.
• Phantom investments continue to grow, exceeding the growth rate of actual FDIs.  In the past ten years, phantom investments have grown from 30 percent of FDI to 40 percent.

Like ghouls, phantom investments move quietly through holding shells on their way to a preferential tax jurisdiction.  This draining of economic vitality from the original tax base inhibits actual economic growth.

The report notes, “Globalization creates new challenges for macroeconomic statistics.  Today, a multinational company can use financial engineering to shift large sums of money across the globe, easily relocate highly profitable intangible assets, or sell digital services from tax havens without having a physical presence.”

Calling for better data, the IMF study suggests that international cooperation is key to putting the bogie of the phantom investment to rest.

Knowledgeable tax attorneys help you with matters involving foreign bank accounts

With offices in Chicago and Cleveland, the law firm of Robert J. Fedor Esq., LLC provides strategic local and international tax defense for individuals and entities facing an IRS criminal tax investigation, civil tax audit, or other tax controversy.  Contact our law firm today.