The differences between foreign direct investment (FDI) and portfolio buying are many. In fact, the two have little in common except they take place across national borders. In both cases, money is flowing overseas to take advantage of a certain goods, such as labor, markets or access to raw materials. It may either be direct, as in FDI, or indirect, as in portfolio investment.
FDI is the creation of business across national boundaries. Portfolio investment is buying securities of any kind from either a foreign government or already existing global firms. Portfolio investment occurs whether American money buys shares in foreign firms or shares in domestic firms that have branches abroad. Either way, portfolio investing is overseas buying of already existing securities.
Portfolio investing is never creative. It takes advantage of what is already established. It is a change of ownership only. This sort of investment can be accomplished by anyone, from firms to universities to foundations or individuals. For FDI, only established firms have the resources to create foreign subsidiaries or license agreements.
FDI is always creative. If an American firm sees a demand in a foreign country that is not being filled by domestic suppliers, then FDI will normally take place in one way or another. A portfolio investor, seeing this successful company several years later, might buy shares in it. This is the most important and fundamental difference between the two kinds of investment. International law normally considers portfolio investment as domestic speculation, since it does not create anything within foreign borders and does not come into any contact or relation with a foreign state. Hence, FDI is the main concern of international law, especially in terms of taxation.
Another major distinction between the two forms of investment is in taxing them. Taxing returns from portfolio purchases is easy. It is income, and taxed as such. FDI is more difficult. In general, U.S. tax law states that if overseas profits are invested locally, then they do not pay U.S. tax, even if 100 percent of the owners are American citizens. Tax law governing mixed ownership FDI is complex, and has led to loopholes like the existence of island tax havens and other places where accounts can be channeled to avoid taxes, which is of questionable legality. As of the time of publication, many of these tax loopholes remain in place.