An organisation contemplating making a foreign investment must consider a number of preliminary issues.

  • Will the law of the host state allow it to make the investment at all, or only subject to some level of restriction?
  • Will the investment be subject to restrictions after it has been made?
  • Are investment incentives available?
  • Will the investment be prohibited or restricted by the laws of the investor’s own state, in particular laws imposing economic sanctions?
  • What must the investor do to ensure compliance with its own state’s anticorruption laws?
  • Will the investment be protected against double taxation, by both the home state and the host state?
  • What steps must the investor take to comply with rules governing transfer pricing between related entities?
  • Should the investor insure itself against loss resulting from political risk?

These issues are discussed in Chapters 2 through 5 and summarised here.

Chapter 2: National Regulation of Foreign Investment

Chapter 2 provides a checklist of host country regulations to be investigated when planning investments in a foreign country. The first step of course is to ascertain the host state laws and regulations governing foreign direct investment (FDI). FDI may well be regulated by one specific law, and overseen by a central government agency. However, FDI in particular industries may be subject to specific laws applicable to those industries alone. Once the laws and regulations have been ascertained, the potential investor should ask the following questions:

  • Will the investment be permitted at all? Certain strategic sectors, such as infrastructure, energy, and telecommunications, may be operated exclusively by the state, or restricted to domestic investors under a negative list.
  • Are there licensing or registration requirements? Registration and approval of FDI can be quite elaborate. Some governments impose minimum investment thresholds, and there may be reporting requirements.
  • What restrictions are imposed on FDI? In some countries FDI in particular sectors is subject to restrictions on share ownership or management structures. Sometimes specific corporate structures are required. And there may be requirements for local employment, use of local inputs, and the like (performance requirements).
  • Are investment incentives, such as subsidies or special tax treatment, available? Should the investment be made in a special economic zone, offering various advantages such as relaxed tax and tariff requirements?
  • Will the state enter into a stabilisation agreement, guaranteeing that the investor will be protected against changes in the law for a specified period of time?
  • Will there be continued obligations after the investment has been made? There may be restrictions on repatriation of capital or profits, perhaps for a minimum period of time. Are there guarantees against the sudden imposition of currency controls?

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  • Are there restrictions on the ownership of real estate? In some countries foreigners can only rent land, not own it outright, or may only own land with a local partner.
  • What are the legal protections and dispute resolution options open to the foreign investor? Many states are party to investment protection treaties, or provide special guarantees to foreign investors in domestic legislation.

Chapter 3: Extraterritorial Application of Home State Laws

Chapter 3 explains how the investor’s home state regulations governing economic sanctions must be taken into account by all investors contemplating foreign investment. Many states, particularly the United States (which has more than 35 sanctions programmes in place), and the European Union, operate sanctions programmes as foreign policy tools. Some of these apply broadly to prohibit transactions with particular countries; others apply to specific individuals or entities. Further, many countries also have strong anti-corruption laws, criminalising corrupt payments to foreign government officials. The foreign investor must maintain effective oversight over its own employees and its agents to ensure compliance with these laws.

Chapter 4: Taxation

Chapter 4 focuses on addressing two concerns that frequently arise when businesses and investors derive income from a foreign country: (i) the potential for double taxation, and (ii) the impact of transfer pricing rules.

Double taxation occurs when a business or investor is taxed in both its country of residence and the country in which it invests or operates. To minimise the impact of double taxation, states enter into bilateral tax treaties that sort out whether the host state, the home state, or both, will be entitled to tax income that a non-resident derives from the host state. Among other issues, double taxation treaties generally resolve which state may tax: (i) business operations in the host state; (ii) capital gains from the sale of host state assets; and (iii) dividends derived from host state companies.

Many states impose transfer pricing rules that apply to commonly-controlled business entities (such as a parent company and its subsidiaries) that are part of a multinational group. Transfer pricing rules seek to prevent the arbitrary shifting of profits from one group member to another to reduce the group’s overall international tax burden by comparing intra-group prices to the “arm’s length” prices that would be charged if unrelated parties were engaged in the same transaction.

Chapter 5: Political Risk Insurance

Chapter 5 examines political risk insurance, an important tool for protecting investments abroad. Political risks include expropriation, nationalisation, discriminatory regulation, and currency inconvertibility, or other events, such as war, civil disturbance or terrorism. These events are a fact of life for international business and often cannot be avoided. But the risks may be managed in a number of ways through political risk insurance, which is offered by around ninety public and private institutions. Export credit agencies such as the US Overseas Private Investment Corporation, and multilateral development banks, such as the Multilateral Investment Guarantee Agency of the World Bank (MIGA), provide political risk guarantees, as do a number of private insurers. Typically, political risk insurance covers three types of loss: currency inconvertibility, expropriation and political violence. More recently, insurers have offered coverage of losses resulting from a government’s failure to participate in an arbitration or pay an arbitral award, as well as insurance products to address financial crises, terrorism and climate change.

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