Tax holidays and profit-repatriation rates for FDI firms: the case of the Czech Republic

The study investigates how tax-holiday incentives influence the profit-repatriation behavior of foreign direct investment (FDI) firms operating in the Czech Republic. Tax holidays are widely used by host countries to attract FDI, yet evidence on how such incentives affect firms’ post-entry behavior—particularly dividend payout versus reinvestment—remains limited. The Czech Republic is a suitable context given its high repatriation rate (dividend repatriation to GDP of 5.739% in 2019, among the highest in OECD). The paper formulates two hypotheses: H1: supported firms (with tax holidays) repatriate less profit than non-supported firms; H2: among supported firms, those within the tax-holiday period repatriate less than those after the tax-holiday period. The research aims to provide empirical evidence on whether tax holidays are associated with lower repatriation and to identify determinants of repatriation rates.

The background draws on the eclectic (OLI) paradigm, emphasizing location (L) advantages—such as tax incentives—as a host-country lever to attract multinationals (Dunning, 1988). Dividend policy theories are used to frame firms’ payout versus reinvestment choices, including stable dividend, residual dividend, dividend irrelevance (Miller & Modigliani, 1961), and relevance due to market imperfections (taxes, asymmetric information, agency costs). Tax-preference theory suggests taxes can shape payout decisions; agency theory highlights managers’ incentives affecting retention versus payout. Empirically, studies document tax incentives’ role in attracting FDI (Wilson, 1999; Klemm & Parys, 2012; Sabina & Eldin, 2022; Tobing & Jayadi, 2020), and their effects on firm performance and behavior (e.g., productivity, innovation, spillovers: Harris & Li, 2019; Huang, 2015; Czarnitzki et al., 2011; Du et al., 2014; Aghion et al., 2015). Research also shows income shifting and investment timing around tax holidays (Lin, 2006; Azevedo et al., 2019; Agliardi, 2002). However, prior work largely focuses on location decisions or performance, not comparative repatriation behavior of firms with versus without tax holidays or within and after tax-holiday periods. The paper addresses this gap with hypotheses H1 and H2.

Data: Unbalanced panel of Czech FDI firms from 2008–2019 sourced from CRIBIS. Total observations: 7,669 (3,142 firm-year observations with tax incentives at entry; 4,527 without). Among supported observations, 1,555 are within the tax-incentive period and 1,587 are no longer in the period. Tax support status was compiled from the Ministry of Trade and Investment to construct Support (0/1) and Tax_period (0/1) dummies. Variables: Profit repatriation = Dividend/Net earnings (%). Determinants include Age (years since establishment), Size (log total assets), Liquidity (current assets/current liabilities), Leverage (total liabilities/total equity), Profitability (EBIT/total assets, ROA), Investment opportunities (asset growth). Stationarity was checked via Im-Pesaran-Shin panel unit root tests.

Estimation of determinants: Fixed-effects (FE) model with instrumental variables (IV) to address endogeneity of Liquidity and Leverage (instruments: their lagged values). Hausman test favored FE over RE (Chi-square = 61.41, p=0.000). Robust standard errors clustered by 24 NACE sectors. Models estimated for full sample and sub-samples: (i) with tax incentives, (ii) without tax incentives, (iii) supported and within tax period, (iv) supported and after tax period.

Hypotheses testing: Applied Kitagawa–Oaxaca–Blinder (KOB) decomposition extended to panel data (Kroger & Hartmann, 2021) to decompose differences in repatriation rates into endowment, coefficient, and interaction effects for levels (cross-sectional years) and changes (across time). Levels decomposition was examined for 2008, 2014, 2018; changes captured differences across years. Additional Oaxaca decomposition pooled across years to quantify contributions of specific endowments.

Robustness: Tested interactions with firm lifecycle stages (Dickinson, 2011; stages 1–5) via Tax_period × Stage; tested effects of the global financial crisis via a Crisis dummy and its interaction with Tax_period.

• Descriptive and mean-difference tests:
  • No significant mean difference in repatriation between supported and non-supported firms (Model 1: Support coefficient −1.5305, n.s.).
  • Among supported firms, those within the tax period repatriate significantly less than those after the period (Model 2: Tax_period coefficient −10.0707, significant at 5%).
• Determinants of repatriation (Fixed-effects IV, full sample, Model 3):
  • Liquidity: positive and significant; 1% increase in Liquidity → +0.1803% in repatriation rate (SE 0.0333, p<0.001).
  • Size: positive; coefficient 3.2615 (SE 1.5551, p<0.05).
  • Leverage: negative; 1% increase → −0.1135% (SE 0.0285, p<0.001).
  • Investment opportunities: negative; −0.3611 (SE 0.0671, p<0.001).
  • Age and ROA not significant.
  • Sub-samples:
    • With tax incentives (Model 4): Leverage (−0.1364**), Liquidity (+0.1570**), Investment opportunities (−0.6980***), Size (+4.4393*).
    • Without tax incentives (Model 5): Age (+1.3371+), Leverage (−0.1038**), Liquidity (+0.2004***), Investment opportunities (−0.1974*).
    • Supported and within tax period (Model 6): Leverage (−0.220***), Liquidity (+0.2340**), Investment opportunities (−0.4381**), Size (+7.3292+).
    • Supported and after tax period (Model 7): Liquidity (+0.2376*), Investment opportunities (−0.889***), Size (+7.5921*).
• Oaxaca–Blinder decompositions:
  • Supported vs non-supported: No significant level or change differences (Table 4).
  • Within supported: Tax_period vs Non-tax_period shows significant level differences in multiple years (e.g., 2014 coefficient 34.734*, Table 4), indicating lower repatriation within the tax period.
  • Pooled levels decomposition (Table 5): Firms in tax period repatriate 54.7418% vs 64.6347% after period; difference = 9.8929% (SE 3.9099, p<0.05). Endowments explain 5.1754 (≈52.3%) of the gap (p<0.001); coefficients and interaction not significant.
    • Endowment contributions (significant): Age +2.3434***, Investment opportunities +2.5279***, Leverage +1.4447**, Size −2.1191*; Liquidity and ROA not significant. Positive signs indicate reducing those gaps would shrink the repatriation gap; negative sign for Size implies equalizing sizes would increase the gap.
• Hypotheses:
  • H1 rejected: supported vs non-supported firms do not differ in repatriation behavior.
  • H2 supported: supported firms repatriate less during the tax-holiday period than after.
• Robustness:
  • Lifecycle (Tax_period × Stage) interactions not significant (Model 8); Stage dummies not significant (Model 9).
  • Crisis and Tax_period × Crisis not significant (Models 10–11).
• Sample sizes and composition:
  • Total observations: 7,669; supported: 3,142; non-supported: 4,527; within supported: tax period 1,555; after period 1,587.

Findings indicate that tax-holiday status per se does not differentiate repatriation behavior between supported and non-supported FDI firms, suggesting that tax incentives may not be an effective lever to induce lower repatriation relative to firms without such incentives—possibly because other support (e.g., EU programs) offsets differences. However, timing matters: during the tax-holiday period, supported firms repatriate less, consistent with theories that firms exploit favorable tax conditions to reinvest and shift income into low-tax windows. Oaxaca decompositions attribute roughly half of the within-supported group gap to endowment differences—primarily investment opportunities, firm age, leverage, and size—rather than differences in returns to these characteristics. Policy-wise, to curb post-holiday repatriation, host-country measures that raise investment opportunities (e.g., project pipelines, innovation support) and facilitate prudent leverage (via developed financial markets) could be effective; support for SMEs may also help, as larger firms tend to repatriate more. The lack of lifecycle or crisis effects suggests the observed patterns are robust to firm maturation stages and macro shocks during 2008–2019.

The study analyzes Czech FDI firms (2008–2019) to identify determinants of profit repatriation and to test whether tax holidays relate to repatriation behavior. Liquidity and firm size raise repatriation, whereas investment opportunities and leverage reduce it. There is no difference in repatriation between supported and non-supported firms, but within supported firms, those in the tax-holiday period repatriate less than those after the period. Decomposition shows endowments—especially investment opportunities, leverage, age, and size—explain most of this gap. Policy implications: tax holidays alone do not secure reinvestment; complementary policies that expand investment opportunities, strengthen financial markets, and support smaller firms could reduce repatriation after tax holidays end. Future research should examine behavior across finer-grained stages within tax-holiday periods (e.g., first 2 or 5 years) to uncover dynamic effects.

The study could not analyze differences in repatriation across finer stages within the tax-holiday period; future work should split the tax period into smaller stages (e.g., first 2 or 5 years) to capture dynamic behavior. Data are limited to Czech FDI firms using proprietary CRIBIS records over 2008–2019, which may constrain broader generalization.