Tax Avoidance in Development Finance: The Case of a Finnfund Investment

Development finance institutions (DFIs) are publicly owned vehicles meant to support private sector development in developing countries. The goal of a DFI is to enhance the development impact related to projects it invests in by bringing in know-how related to the development aspects of business and by complementing and attracting private funding. The development impact of DFIs is often measured in terms of numeric financial indicators such as the amount of tax income generated in the developing countries. In this chapter, a tax avoidance case study shows howthe development impact of a DFI can turn negative if its tax policy is not in line with its development goals. The case study involves Finnish DFI Finnfund’s investment in a Malaysian timber plantation. Analysis of the case study shows that Finnfund’s tax policy was vague and its own tax reporting did not include assessment of tax avoidance. It also shows that the anti-tax avoidance legislation in Malaysia was inadequate to protect its tax base. Based on the analysis, the chapter presents a list of policy actions that
would improve the fiscal behavior of DFIs and eventually benefit the developing countries in which they invest. The list includes actions involving increased transparency, better-formulated policy goals, and more robust DFI corporate governance by the governments that own them. Also presented is a list of actions that would allow developing countries to independently tackle the tax avoidance presented in the underlying case study.