Global services trade is expanding rapidly, but its intangible nature makes it a prime channel for profit shifting, prompting many countries to apply withholding taxes. This column shows that such taxes dampen bilateral service imports – especially royalties, where the response is four times larger – with no evidence of an effect on categories unlikely to be used for tax planning. Yet total service imports do not fall; firms simply reroute payments through partners offering lower treaty rates. The results suggest that, at prevailing levels, withholding taxes curb profit-shifting channels without hampering countries’ ability to import growth-enhancing services.

Global services trade – as the future of global trade – is expanding rapidly (Baldwin et al. 2024, Cernat 2024, Francois and Hoekman 2010). Many countries use withholding tax (WHT) rates on payments on many of such services. Why do they do that and what are the implications?

The key motivation to use WHTs is to reduce the risk of revenue losses. If an intermediate service is purchased, profits move from the importing to the exporting country as payments for the service. While that is, of course, also the case for intermediate goods, the nature of services makes them more prone to abuse. An intangible input, such as a patent, is more easily relocated to a low-tax jurisdiction. And in the case of a related-party transaction, the price paid for the right to use such an input is more likely to be subjective and it will be harder to find arm’s length comparables than for goods. There is ample empirical evidence that profit shifting through services does indeed occur (Accoto et al. 2024, Delis et al. 2021, Hebous and Johannesen 2021). A withholding tax can potentially protect revenues, both directly by collecting revenue and indirectly by discouraging exaggerated service imports.

At the same time, the use of WHTs is not without risks. Importing intangible inputs such as intellectual property, consulting, design, and other knowledge-intensive services is crucial to support productivity and technology diffusion, especially in emerging and developing economies (IMF 2024).

In deciding on the tax treatment of service imports, policymakers thus need to find a balance between preventing tax-reducing strategies and avoiding dampening growth-relevant imports. This is a complex task, but surprisingly, even the more basic question about how WHTs affect trade flows has not yet been studied empirically. This gap in literature covering the policy-relevant issue of service imports motivated us to prepare a first empirical assessment (Liu et al. 2025).

Assembling data for an analysis of WHTs

WHT can cover various services. Of greatest interest to us are ‘modern services’, which we define as telecommunications, computer and information services, other business services, financial services, and royalties for IP. Services such as tourism, which are of less relevance for profit shifting, can serve as a useful benchmark.

Before analysing WHTs, it is necessary to understand the basics of how they work. When a WHT is in place, anyone paying for a covered service will need to withhold the tax and remit it to the tax authority – it is thus collected from the tax inclusive import cost. This distinguishes it from a tariff on a good, which is added to the tax-exclusive cost. Another difference is that the WHT is usually creditable against corporate income tax in the exporting country. For the firm, the WHT thus represents a true cost only if it exceeds the tax rate in the country from which the import stems. Another important aspect of WHTs is that they are often reduced through double-taxation treaties. As a result, every bilateral flow requires checking not only the statutory WHT rate in the law, but also whether it is reduced by treaty (if the treaty specifies a higher rate, it is not binding, just as happens when countries charge a lower tariff than what is allowed under a trade treaty).

We thus need a dataset with granular information on service imports by type of service and with bilateral WHTs taking double taxation treaties into account. As no ready-made data set exists, we combined standard macroeconomic data – the IMF World Revenue Longitudinal Database (WoRLD) and World Economic Outlook (WEO), tax rates – with the following:

• Bilateral service import data from the OECD-WTO Balanced Trade in Services database (BaTIS; OECD 2025), tracking bilateral services flows for 202 economies and their partners across 12 major categories from 2005-2021.
• Statutory and treaty-reduced WHT rates sourced from domestic laws and more than 3,000 bilateral and multilateral tax treaties. The starting point is the Tax Treaties Explorer dataset compiled by the International Centre for Tax and Development (ICTD), which we expand and, importantly, complement by adding the non-treaty statutory rates.

The rise in service trade

Before tackling more complex questions, documenting the development of modern service imports confirms their great increase over recent years (Figure 1). While the absolute increase was highest in emerging and developing economies, the share of such imports grew most in advanced economies. But clearly all will have to consider the consequences of this increase.

Figure 1 Growing modern services trade, 2005-2021

a) Imports of modern services

b) Modern services as a share of services imports

Note: This figure shows the absolute (top panel) and relative (bottom panel) growth in imports of modern services across source country income groupings. Modern services include telecommunications, computer and information services, other business services, financial services, and royalties for IP.

Bilateral service imports are affected by WHTs…

Our central finding is that withholding taxes play a powerful role in shaping global trade in services.

• Withholding taxes significantly reduce bilateral service imports. Bilateral imports decline by around 1% for each percentage point increase in WHT, suggesting that WHTs are an important factor in shaping where firms choose to source cross-border services.
• Royalty payments are four times more responsive. The strongest responses occur for royalties, with a semi-elasticity of about 4. This aligns with long-standing evidence that intellectual property payments are a common channel for profit shifting. Technical services – such as managerial and consultancy fees – respond with a semi-elasticity of approximately 1, similar to overall services.
• Categories unlikely to be used for tax planning show no response. Government services and travel payments do not react to changes in WHTs, providing a useful placebo check.

Figure 2 Sensitivity of service trade to WHTs

Notes: This figure shows the semi-elasticity of service imports with respect to the associated WHT, from the Poisson pseudo-maximum likelihood (PPML) estimation of augmented gravity model. Importer fixed effects, exporter fixed effects, and year fixed effects are included, as well as gravity variables including physical distance and indicators for contiguity, common official language, and common colonizer for each importer-exporter pair. Macroeconomic controls include source country nominal GDP, trade openness, capital account openness, exchange rate for national currency to USD, and consumer price index. Standard errors clustered at the importer-exporter pair level.

Moreover, the effect of WHTs varies across types of economies. Emerging and developing economies exhibit particularly strong responses for royalty and technical-service payments to investment hubs, consistent with their greater vulnerability to profit shifting. Advanced economies show stronger interactions between WHT effects and domestic corporate income tax rates. These differences underscore the importance of considering treaty networks and domestic tax systems jointly.

…but total service imports do not decline

Despite the measurable effect on bilateral flows, we find no significant impact on total service imports. This means that firms tend to reroute payments when faced with higher WHTs, rather than reducing their overall importation of foreign services.

Several patterns are consistent with this rerouting:

• When a partner’s WHT increases, imports shift toward countries with lower treaty rates or investment hubs.
• The response is strongest at the lowest available WHT rate, suggesting that firms organise payment structures to access the most favourable treaty provisions.
• These patterns are consistent with treaty shopping, where firms route transactions through intermediaries to benefit from lower rates.

Concluding remarks

The rising global trade in services is important for economic development and knowledge diffusion but creates risks of profit shifting. Our findings of strong bilateral effects in combination with little impact on aggregate service imports can be interpreted as suggesting that withholding taxes – at least at the average levels used so far – appear to have mostly reduced profit shifting.

Source : VOXeu