The Puzzle of Multinationals’ Profits: Why Tax Havens Yield Higher Returns

A striking pattern emerges when examining the returns that U.S. multinational companies generate on the assets they invest across different countries: Investments in tax havens consistently yield returns of 8% to 17%, while investments in other G7 economies (Canada, France, Germany, Italy, Japan and the U.K.) yield more modest returns of 4% to 9%. This remarkable difference raises a question about the nature of multinationals’ profit patterns.

Multinational Companies Generate Higher Returns in Tax Havens

To illustrate this phenomenon, the figure below plots average foreign direct investment (FDI) yields against average corporate tax rates for the period from 2007 to 2017. FDI yield measures how much profit companies generate relative to their invested capital in a country. It represents the ratio between direct investment income (including profits, dividends and reinvested earnings) and the stock of foreign direct investment at a given point in time.

Tax havens, marked by red triangles, cluster in or near the upper left quadrant, combining extraordinarily high FDI yields with low corporate tax rates. In contrast, G7 economies, shown as blue dots, occupy the lower right quadrant, with more modest FDI yields despite their sophisticated markets and infrastructure.

U.S. Multinationals’ Returns on Foreign Investment in Tax Havens vs. G7 Economies, 2007-17

SOURCES: U.S. Bureau of Economic Analysis and authors’ calculations.

NOTES: The Caribbean comprises the British Virgin Islands, Cayman Islands, Montserrat, and Turks and Caicos. The dashed line shows the linear trend.

Multinational Companies’ Tax and Profit-Shifting Strategies Help Explain Return Differentials

Does this pattern suggest that U.S. multinationals’ affiliates in tax havens are simply more productive than those in richer countries? Probably not. In competitive markets, we would expect capital to flow until returns equalize across countries. To understand what’s driving these return differentials, we need to examine both sides of the FDI yield calculation: profit (the numerator) and the investment base (the denominator).

On the denominator side, several measurement issues come into play. According to International Monetary Fund research, a significant portion of FDI in tax havens consists of what the authors term “phantom investments”—financial flows through empty corporate shells—rather than genuine productive capital.

Moreover, official statistics may understate the true investment base by not fully capturing intangible assets. Academic research has suggested that accounting for intangible assets and repatriation taxes can explain more than half the observed return differentials. Measuring FDI stock in tax havens is particularly challenging due to complex corporate structures and the prevalence of special-purpose entities.

The profit side of the equation also contributes to these FDI yield differences. Companies may legitimately locate valuable intellectual property rights in low-tax jurisdictions, generating royalty income that increases reported profits in these locations. Additionally, tax-planning strategies, such as transfer pricing optimization, can result in profits being recognized in low-tax jurisdictions even when the underlying economic activity occurs elsewhere. The structure of taxation systems worldwide may create incentives for companies to strategically time profit realization in different jurisdictions.

Rather than indicating substantially higher productive efficiency in tax havens relative to efficiency in G7 economies, the FDI yield differentials we observed on U.S. multinational companies’ investment abroad likely reflect a combination of measurement challenges in capturing the true capital base of foreign investment and corporate strategies for managing global operations and tax obligations. These results highlight the complexity of measuring and interpreting the returns that firms earn on their foreign investments.