I received a media inquiry today about US investment abroad.  One of the questions was why does the Netherlands receive so much US foreign direct investment (FDI)?  Even more surprising might be the top five countries (in 2011) were: the Netherlands, UK, Luxembourg, Bermuda, and Canada.

The answer to the original question is the Dutch Sandwich.  Or if you want to get more complicated, a Double Irish with a Dutch Sandwich.

What?

The Dutch Sandwich is basically a way for firms to establish a Dutch holding company, route their foreign income through the holding company, and then send the money to a tax haven.  The outcome of this is that companies can, legally, move foreign profits from countries with high (or non-zero) tax rates to tax havens with zero tax rates.  You can get more complicated and move money from Ireland to the Netherlands and then to a tax haven.

Here is a story on how Google uses this strategy to minimize their tax burden.

There are clearly examples of firms doing this, but how much do these practices affect global FDI patterns?  Attached is the 2011 US Bureau of Economics Analysis Report on US outward and inward FDI. See my highlights on page 32.

Here is the key quote from the report:

For the third consecutive year, the position in the Netherlands was the largest—at $595.1 billion, or 14 percent of the total. Most of the position increase and 77 percent of the position in the Netherlands was accounted for by holding companies, which likely invested the funds in other countries; see the box “Indirect Ownership in the Statistics on U.S. Direct Investment Abroad.”

The biggest FDI recipient largely attracts foreign investment to avoid taxes.  Bermuda and Luxembourg aren’t attracting manufacturing investments.  These are mostly holding companies as well.

One final note.  The establishment of Dutch subsidiaries isn’t only for tax purposes.  The Dutch have an extensive network of investment treaties around the world.  Establishing an operation in the Netherlands can also give you access to use these treaties and “forum shop” different legal venues if you have an investment dispute.

UPDATE:  I had a tax lawyer friend who had a couple of comments on my blog post.  The original version of this post used the terms “evade” rather than “avoid” taxes.  This is importance since the firms are engaging in legal means of reducing their tax burden.  I also changed the language that firms are reducing their “foreign income” subject to taxation, not necessarily their US income.  I’m not 100% if firms are using these strategies to also reduce their US income, or if they are just reducing their foreign income tax burden.  This is above my pay grade/my time commitment to blogging.