Chapter

IX. Direct Investment

Author(s):
International Monetary Fund
Published Date:
April 1996
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The Concept of Direct Investment

509. Direct investment is a category of international investment in which a resident entity in one economy (the direct investor) acquires a lasting interest in an enterprise resident in another economy (the direct investment enterprise). Direct investment implies a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence by the direct investor on the management of the direct investment enterprise. Direct investment comprises the initial transaction between the two entities—that is, the transaction that establishes the direct investment relationship—and all subsequent transactions between the entities and among affiliated enterprises, both incorporated and unincorporated.

510. The Organisation for Economic Cooperation and Development (OECD) presents the same concept of direct investment in the Detailed Benchmark Definition of Foreign Direct Investment (BMD). The BMD is complementary to the Balance of Payments Manual. The purpose of the BMD is to provide a detailed operational definition of direct investment to serve as a reference, or standard, against which each country can compare its statistical system by using the concept and definition of direct investment contained in the Balance of Payments Manual. The BMD supplements the information provided in the Balance of Payments Manual.

511. The concept of direct investment differs from the concept of control. To be classified as a direct investor, an investor need not have the controlling share, or even the largest share, of ownership in an enterprise.

Motivation for Direct Investment

512. Direct investors expect to derive benefits from having a voice in the management of an enterprise. Portfolio investors, who do not exercise significant influence over the enterprises in which they invest, expect to obtain different benefits. From a direct investment perspective, enterprises often represent units in a multinational operation, the overall profitability of which depends on advantages gained by deploying resources available to each unit in a way that best enhances the synergy of the group. For example, the direct investor may be able to obtain resources or access to markets that might otherwise be unavailable to the enterprise. Direct investors may also be able to increase enterprise profitability and value through management skills and other expertise. Direct investment may also allow the direct investor to diversify and manage risk more effectively.

513. Therefore, direct investors may receive benefits in addition to income that would otherwise accrue on invested capital. In contrast, portfolio investors are primarily concerned about return on investment and the likelihood of appreciation in value. Portfolio investors generally evaluate prospective investment units separately and often shift their investments according to changes in prospects.

Defining the Direct Investment Relationship

514. The direct investor may be an individual, an incorporated or unincorporated private or public enterprise, an associated group of individuals or enterprises, or a government or government agency that owns a direct investment enterprise (as described subsequently) in an economy other than that in which the direct investor resides. A direct investment enterprise is an incorporated or unincorporated enterprise in which a direct investor owns 10 percent or more of the ordinary shares or voting power (for an incorporated enterprise) or the equivalent (for an unincorporated enterprise). The direct investment relationship extends to direct investment enterprise subsidiaries, direct investment enterprise associates, and branches directly or indirectly owned by the direct investor.

515. Enterprise X is a subsidiary of enterprise N only if:

(1) enterprise N owns more than half of the shareholders’ or members’ voting power in X

or

(2) enterprise X is a subsidiary of any other enterprise that is a subsidiary of N.

Enterprise K is an associate of enterprise N only if:

(1) enterprise N and its subsidiaries own 10 percent or more of the shareholders’ voting power in enterprise K and enterprise K is not a subsidiary of N

or

(2) enterprise K is a subsidiary of any other enterprise that is an associate of N.

Therefore, an investor need not control or be the largest shareholder in an enterprise for a direct investment relationship to exist between them. The concept of direct investment is fundamentally different from the concept of foreign-controlled enterprises. While all foreign-controlled enterprises are direct investment enterprises, enterprises not considered foreign controlled may also be in direct investment relationships with nonresident direct investors.

516. The rule of 10 percent is used to ensure consistent classification of investor/investee relationships for all countries’ statistics. In many countries, regulatory and other authorities consider 10 percent ownership to constitute a relationship implying a degree of influence by the investor. Sometimes, investors who own 10 percent or more of an enterprise have little or no influence on enterprise management (e.g., pension funds not involved in the management of enterprises in which the funds have substantial investments). On the other hand, investors who own less than 10 percent may have an effective voice in enterprise management (for example, by being able to appoint managing directors). In the interest of comparability, however, use of the 10 percent rule is preferable to subjective judgment. Furthermore, as most direct investment enterprises are branches or subsidiaries that are wholly or majority owned by nonresidents, borderline cases are relatively insignificant.

517. Illustrated below are subsidiary and associate relationships. Enterprise N has these investments:

According to the definition of direct investment:

A is a subsidiary of N.

B is a subsidiary of A and therefore a subsidiary of N, even though only 33 percent of B is indirectly attributable to N.

C is an associate of B and therefore an associate of N through N’s subsidiary B, even though only 4 percent of C’s capital is indirectly attributable to N.

D is an associate of N.

E is a subsidiary of D and therefore an associate of N, even though only 6 percent of E is indirectly attributable to N.

F is an associate of N.

G is an associate of F but not of N as F is only an associate of N.

H is neither a subsidiary nor an associate of N.

J is a subsidiary of H but neither a subsidiary nor an associate of N.

K is a subsidiary of N.

L is a branch of K and thus a branch of N.

Therefore, enterprises A, B, C, D, E, F, K, and L are involved in a direct investment relationship with N and in direct investment relationships with each other. Transactions between company E and company K, for example, represent direct investment transactions.

518. For purposes of the balance of payments and the national accounts, enterprises that have significant long-term (that is, more than one year) operations in more than one economy are divided into separate entities in each economy. These entities are always in a direct investment relationship; the head office constitutes the direct investor and the branches constitute the direct investment enterprises. Land and structures directly owned by nonresidents (other than foreign governments) are, in the balance of payments and the national accounts, considered to be owned by notional resident units that are in direct investment relationships with the legal owners of the land. Also considered to be owned by enterprises that are resident in the host country and in direct investment relationships with the actual operators of equipment (such as ships, aircraft, gas and oil drilling rigs) is mobile equipment that operates in an economy for at least one year, is accounted for separately by the operator, and is recognized by taxation and similar authorities of the host country as part of the country’s capital stock.

Direct Investment Capital

519. Direct investment capital is (1) capital provided by the direct investor—either directly or through other enterprises related to that investor—to the direct investment enterprise or (2) capital received by the direct investor from the direct investment enterprise. Direct investment capital includes equity capital, reinvested earnings, and other capital involved in various intercompany debt transactions. Direct investment capital includes only actual amounts provided; for example, funds for which the direct investor merely makes the arrangements or guarantees repayment are not considered direct investment capital.

520. Equity capital covers equity in branches, all shares (whether voting or nonvoting) in subsidiaries and associates, and other capital contributions (for example, the provision of machinery—which constitutes part of the capital of the direct investment enterprise—by a direct investor to a direct investment enterprise). Equity capital also covers the acquisition by a direct investment enterprise of shares in its direct investor. Reinvested earnings are the direct investors’ shares (in proportion to equity held) of the undistributed earnings of the direct investment enterprise. These reinvested earnings are recorded as income with an offsetting capital transaction. The rationale for including reinvested earnings in the balance of payments is discussed in chapter 6.

521. Other capital (or intercompany debt transactions) covers the borrowing and lending of funds, including debt securities and trade credits, between direct investors and direct investment enterprises and between two direct investment enterprises that share the same direct investor. Debt claims on the direct investor by the direct investment enterprise are also recorded as direct investment capital.

522. However, in regards to investments between affiliated banks and other financial intermediaries, only those investments associated with equity and permanent debt (that is, loan capital) are considered to be direct investment. Other debt investment (such as deposits and other claims and liabilities related to normal banking activity) between affiliated banks and other financial intermediaries is considered to be portfolio investment or other investment.

523. In practice, it is sometimes difficult to distinguish between the equity capital and the other capital of direct investment enterprises. Differentiation is particularly difficult when an enterprise is 100 percent owned by a direct investor. In these situations, the classification of capital for the balance of payments could be the same as that used in the direct investor’s (or direct investment enterprise’s) accounting records. That is, when a claim of the direct investor on the direct investment enterprise is considered—in the accounting records of the direct investor or the enterprise—to be equity capital or shareholder funds, this claim is also considered equity capital in the balance of payments.

524. Capital provided to a direct investment enterprise by economic units other than the direct investor and enterprises related to the direct investor is not direct investment capital. For example, if a direct investment enterprise borrows money from an enterprise that is not affiliated with the direct investor, this borrowing is classified in the balance of payments as other investment.

525. The following example illustrates the concept of direct investment capital. Enterprise X in Namdarb is 50 percent owned by enterprise Z in Coonawarra. Forty-five percent of enterprise X’s shares are owned by residents of Namdarb, and 5 percent are owned by a resident in Cromania. In a particular year, enterprise X undertakes the following transactions:

(1) One hundred shares of new equity are issued, and these are purchased by shareholders of enterprise X in proportions equal to their existing shareholdings.

(2) Enterprise Z provides enterprise X with 20 units’ worth of machinery, which is entered in the accounting records of enterprise X as non-voting equity.

(3) Enterprise Z sells goods worth 40 units to enterprise X. Enterprise X pays 20 units, and the remaining 20 units are entered, in the accounting records of enterprise X, as a trade credit payable.

(4) Acting as a guarantor for the loan, enterprise Z arranges for an unrelated bank in Dromesia to lend enterprise X 75 units.

(5) Enterprise X’s operating profit, after tax and interest expenses, for the year is 10 units. Enterprise X does not pay any dividends during the year.

526. These entries would be made in Namdarb’s balance of payments:

CreditDebit
Goods20 (2)
40 (3)
Income-investment income-direct
investment-earnings on equity-reinvested earnings5 (5)
Direct investment in Namdarb
Equity capital50 (1)
20 (2)
Reinvested earnings5 (5)
Other capital20 (3)
Portfolio investment-liabilities-equity5 (1)
Other investment-liabilities-
loans-other sectors75 (4)
Reserve assets (or other appropriate
financial account item)20 (3)55 (1)
75 (4)

A direct investment relationship is created when an investor (or group of related investors) obtains 10 percent or more of the shares in an enterprise. If an investor does not own any shares in an enterprise prior to becoming a direct investor, the entire acquisition of shares is recorded as a direct investment transaction. Conversely, if an investor has enterprise shareholdings of less than 10 percent prior to becoming the direct investor, only the shares acquired in the transaction that makes the investor a direct investor are classified as a direct investment transaction. In other words, the reclassification of shares previously classified as portfolio investment to direct investment is not recorded in the balance of payments but is reflected instead in the international investment position.

527. For example, enterprise P in Pokolbin purchases, for 8,000 units, 8 percent of the shares in enterprise M in Madornia. One month later, enterprise P acquires, for 6,000 units, another 5 percent of the shares of enterprise M. The following transactions would be shown in Madornia’s balance of payments:

CreditDebit
Portfolio investment-liabilities-equity8,000
Reserve assets (or other appropriate financial account item)8,000
Direct investment in Madornia Equity capital6,000
Reserve assets (or other appropriate financial account item)6,000

528. If enterprise P’s investment in Madornia is valued at 15,000 units at the end of the period, the following entries would be shown in Madornia’s IIP statement:

Level

at Start

of Period
Trans

actions
Other

Changes
Level

at End

of Period
Liabilities
Direct Investment
Equity06,0009,00015,000
Portfolio Investment
Equity08,000–8,0000
Total014,0001,00015,000

Direction of Investment

529. Unlike other financial investments, direct investment is not recorded in the balance of payments on a strict asset/liability basis. Instead, direct investment is recorded on a directional basis—resident direct investment abroad and nonresident direct investment in the reporting economy. Capital invested by the direct investment enterprise in its direct investor (reverse investment) is regarded as an offset to capital invested in the direct investment enterprises by a direct investor and its related enterprises. That is, such capital is regarded as disinvestment by the direct investor rather than as an asset of the direct investment enterprise. For purposes of analysis, these investments are recorded separately in the BOP standard components. When a direct investment enterprise invests in an enterprise related to its direct investor, this investment is recorded, by the economy providing the investment, as resident direct investment-abroad and, by the economy of the enterprise receiving the investment, as direct investment-reporting economy.

530. In some instances, two enterprises or groups of related enterprises hold 10 percent or more of each other’s voting shares. Thus, two direct investment relationships are established, and investments between the two enterprises or groups of enterprises are recorded on a full asset and liability basis—that is, as direct investment- reporting economy and as direct investment- abroad.

531. The following two examples illustrate the directional basis for recording direct investment transactions. In the first example, enterprise A in Algornia is 100 percent owned by enterprise N in Nostaw. Enterprise N owns 100 percent of enterprise E in Essendonia. In a particular period, enterprise A is involved in the following transactions:

Enterprise N provides machinery worth 50 units to enterprise A. The machinery is recorded as an equity investment in the accounting records of enterprise A.

Enterprise A lends enterprise E 100 units. The loan is repayable in five years. Enterprise E pays interest of 5 units on the loan during the year.

Enterprise E sells to enterprise A goods worth 50 units. Enterprise A provides payment in the form of trade credit, which remains outstanding at the end of the year. Enterprise A pays interest of 4 units on the trade credit.

Enterprise A purchases 80 units of bonds issued by enterprise N and receives 8 units in interest income.

Enterprise A’s operating profit, after taxes and interest, is 25 units; dividends equal to this amount are paid.

The following entries would be recorded in Algornia’s balance of payments:

CreditDebit
Goods100
Income
Direct investment
Income on equity-dividends25
Income on debt15–4
Direct investment in Algornia
Equity capital
Liabilities to direct investor50
Other capital
Liabilities to direct investor50
Claims on direct investor80
Direct investment abroad
Other capital100
Reserve assets (or other appropriate
financial account item)196

532. In the second example, enterprise H operating in Hughesavia is 50 percent owned by enterprise L in Longa. In a particular year, these transactions occur in the order of presentation:

Enterprise H lends enterprise L 45 units.

Enterprise H purchases 20 percent of the shares of enterprise L for 1,200 units.

Enterprise H lends another 15 units to enterprise L.

Enterprise H receives interest of 6 units on funds lent to enterprise L.

Enterprise H’s operating profit, after taxes and interest, is 50 units. No dividends are paid.

Enterprise L’s operating profit, after taxes and interest, is 80 units. Dividends of 40 units are paid to shareholders.

533. The following entries would be made in Hughesavia’s balance of payments:

CreditDebit
Investment income
Direct investment
Income on equity
Dividends8
Reinvested earnings825
Income on debt6
Direct investment in Hughesavia
Reinvested earnings
Liabilities to direct investor25
Other capital
Claims on direct investor45
Direct investment abroad
Equity capital1,200
Reinvested earnings8
Other capital15
Reserve assets (or other appropriate
financial account item)1,246

Enterprise H’s first loan to enterprise L is shown as reverse investment because, at the time the loan is made, enterprise H does not have a direct investment interest in enterprise L. The second loan, which is made after enterprise H becomes a direct investor in enterprise L, is treated as direct investment-abroad. As all of the interest is paid after enterprise H becomes a direct investor in enterprise L, this amount is shown as a direct investment credit rather than as a negative direct investment income debit. The value of enterprise H’s stock of direct investment abroad would be shown in Hughesavia’s statement of international investment position at the end of the period as the entire amount that enterprise H has lent to enterprise L. The reclassification of the first loan would be shown as a non-transaction change in levels.

Valuation

534. The recommendation of the BPM is that market values be used to value direct investment financial flows, income transactions, and stock positions. Use of market values is consistent with valuation principles recommended for recording other entries in the balance of payments and the international investment position. The recommendation to use market values for the valuation of direct investment is made for two primary reasons. First, comparisons of direct investment and other financial investment recorded in the balance of payments and international investment position would be invalid if inconsistent valuation bases were used. Second, market valuation provides the most meaningful measure of the economic value of resources available to, or transferred between, economies.

535. Unfortunately, because of the nature of the direct investment relationship, the criterion used for establishing market values is generally not satisfied as a key aspect of this criterion is that the parties to transactions must be independent. With regard to transactions, values shown in the accounting records of the direct investor and direct investment enterprise often serve as acceptable proxies for market valuations. However, in some instances, transactions occur between enterprises in a direct investment relationship, and the values shown in the accounting records of the transactors are significantly distorted from market values. For example, an enterprise may use prices that are unrelated to costs of production or acquisition in selling goods to a related enterprise. Such pricing might be employed as a means of transferring profits from one country to another for tax reasons or because the country of the direct investment enterprise imposes restrictions on repatriation of income by more straightforward means. In other instances, transfer prices may be used as a means by which a direct investor makes a capital investment in a direct investment enterprise.

536. The recommendation of the BPM is that, when the actual transaction price of a transfer of real resources between enterprises in a direct investment relationship differs from the value that could have been expected if the enterprises had been independent, the BOP compiler should make an adjustment to these values as shown in the balance of payments. The BPM also contains the caution that such adjustments should be made only when significant distortions are encountered.

537. When adjustments are made to one side of a BOP transaction, similar adjustments must be made to the other side of the exchange to preserve equality between credit and debit entries. Offsetting adjustments are always made to investment income or to direct investment financial transactions.

538. The following two examples illustrate the adjustment process. In the first example, direct investment enterprise U in Urangastan produces copper. Were this copper sold to an unrelated enterprise, direct investment enterprise U could expect, on the basis of the production cost of the copper, to earn 50 units per ton. However, the government of Urangastan has imposed restrictions on the repatriation of income to nonresidents. Therefore, enterprise U sells—to direct investor C in Clintonstan—1,000 tons of copper at only 10 units per ton. In this case, direct investment enterprise U and direct investor C are using transfer pricing to achieve a repatriation, which would otherwise not be permitted, of income to Clintonstan. These entries would be made:

Balance of Payments of Urangastan
CreditDebit
Goods
As shown in transactors’
accounting records10,000
Adjustment to market valuation40,000
Direct investment income
Income on equity40,000
Reserve assets (or other appropriate financial account item)10,000

539. In the second example, direct investor D in Daniherland wishes to increase his investment in wholly owned subsidiary B in Bushland. However, Bushland’s foreign investment policy restricts further explicit financial investment. To circumvent this policy, direct investor D sells machinery to subsidiary B for 2,000 units. Direct investor D could have sold this machinery to an unrelated enterprise for 5,000 units. The following entries would be shown in Daniherland’s balance of payments:

CreditDebit
Goods
As shown in transactors’ books2,000
Adjustment to market valuation3,000
CreditDebit
Direct investment abroad
Equity capital3,000
Reserve assets (or other appropriate financial account item)2,000

540. The concept of market valuation can also be difficult to apply to direct investment relationships for valuations of equity positions in the IIP statement. Stock positions for equities and other securities are generally valued by using prices prevailing in an independent market on the date for which the IIP statement is prepared. As an independent market often does not exist for equity investment in direct investment enterprises, the BPM recommendation is that market value proxies be used. In the absence of regular market trading, the value of equity investment could be calculated as the net worth of an enterprise; one would apply current market values to the assets (including intangibles) and liabilities of the enterprise and determine the difference. See chapter 13 for valuation of direct investment equity stocks.

Special Cases

541. Four types of direct investment require elaboration: (1) special purpose entities, (2) construction enterprises, (3) investment in land, and (4) mobile equipment stationed in an economy for more than one year.

Special Purpose Entities (SPEs)

542. Special purpose entities (SPEs) are (1) generally organized or established in economies other than those in which the parent companies are resident and (2) engage primarily in international transactions but in few or no local operations. SPEs meeting the criteria presented in paragraphs 514–518 are included, with one exception, as direct investment enterprises. Excepted are SPEs with the sole purpose of serving as financial intermediaries; for these, investments recorded under direct investment are limited to equity capital and permanent debt.

543. Two examples illustrate the BOP treatment of SPEs. An Australian enterprise sets up an enterprise in Bermuda with share capital of $2. The enterprise is (1) to purchase and hold $2 million of portfolio equity investment in the United States; (2) to purchase and hold $1 million of bonds issued by a German company; and (3) to purchase, for $5 million, and hold a 50 percent interest in a United Kingdom company. Half of the $8 million required for the investments is provided by the Australian direct investor and half is provided by a bank in the Netherlands Antilles. Bermuda’s balance of payments would show the following transactions:

CreditDebit
Direct investment in Bermuda
Equity capital2
Other capital4,000,000
Direct investment abroad
Equity capital5,000,000
Portfolio investment-assets
Equities2,000,000
Bonds1,000,000
Other investment-liabilities
Loans-other sectors4,000,000
Reserve assets (or other

appropriate financial

account item)
2

As the enterprise in Bermuda is not purely a financial intermediary, BOP transactions with related enterprises are recorded on the same basis as other direct investment transactions are—although the enterprise has no operations in Bermuda.

544. A New Zealand company wishes to borrow funds on the U.S. capital market by issuing bonds valued at $3 million. Under U.S. regulations, only resident companies are allowed to issue such securities on the U.S. market. So the New Zealand company establishes “a $2 subsidiary” in Delaware (a U.S. state) and the subsidiary issues the bonds and lends the proceeds to its parent. As this SPE acts purely as a financial intermediary, only equity capital and any permanent debt provided by the direct investor are classified as direct investment. The following transactions would be recorded in New Zealand’s balance of payments:

CreditDebit
Direct investment abroad
Equity capital2
Portfolio investment-liabilities
Bonds3,000,000
Reserve assets (or other appro priate financial account item)2,999,998

Construction Enterprises

545. The treatment of international construction activity has been described in chapters 2 and 5. However, some reiteration is justified because of the relative complexity, from a BOP perspective, of this activity and its impact on direct investment statistics for some countries.

546. Work undertaken in one economy by a construction enterprise resident in another economy can be treated (1) as work performed by a notional enterprise that is resident in the host economy and engaged in a direct investment relationship with the parent enterprise or (2) as a service imported by the host economy. The important issue is determination of the economy to which production is attributed. If an enterprise maintains, or expects to maintain, a presence in the host economy for more than a year, and if separate and appropriate records are kept in respect of the enterprise’s work in the host economy, production should be attributed to the host economy. In such a case, a direct investment enterprise is created in the economy. Otherwise, no direct investment relationship is established and an import, by the host economy, would be shown in the balance of payments.

547. An example illustrates the recording of construction activity in the balance of payments if the creation of a direct investment enterprise is necessary. Enterprise J in Jaymaranda wins a construction contract that is valued at 100,000 units and is to be fulfilled in Central Paradiso. The project takes two years to complete. At commencement, enterprise J deposits 60,000 units in local currency with banks in Central Paradiso. Enterprise J also sends a machine worth 8,000 units to Central Paradiso. A payment of 40,000 units is received at the end of the first year and one of 60,000 units at the end of the second year. These payments are immediately repatriated to Jaymaranda. These costs are incurred in association with the project:

Year 1Year 2
Material purchased in
Central Paradiso20,00015,000
Salaries paid to residents of
Central Paradiso10,00015,000
Depreciation on machinery1,0001,000
Total costs31,00031,000

548. The first item to be calculated is the year-by-year profit on the project. If a constant ratio of cost to profit is assumed, the profit for each of year 1 and year 2 is half of the total profit on the project because half the total cost of the project is incurred in each year.18 As project remittances are greater than profits in both years, a portion of the total remittance is considered a remittance of profit and the remainder is considered a withdrawal of direct investment capital.19

549. As the project is a long-term one and separate project records are kept, a notional direct investment enterprise that is resident in Central Paradiso is created to account for the construction activity. The following BOP entries would therefore be recorded for Jaymaranda:

Year 1CreditDebit
(1)Goods8,000
Direct investment abroad
Equity capital68,000
Reserve assets (or other appropriate financial account item)60,000
(2)Investment income Direct investment Income on equity-remitted profits19,000
Direct investment abroad
Equity capital21,000
Reserve assets (or other appropriate financial account item)40,000

Transaction (1) reflects the initial capital provided to the direct investment enterprise in the form of machinery and working capital. Transaction (2) shows repatriation of the first year’s progress payment, a portion of which is allocated to investment income and the remainder of which is considered a withdrawal of direct investment capital.

Year 2CreditDebit
Goods6,000
Investment income
Direct investment
Income on equity-remitted profits19,000
Direct investment abroad47,000
Reserve assets (or other appropriate financial account item)60,000

In entries for year 2, return of the machinery (recorded at written-down value) and repatriation of the progress payment beyond the amount covering second-year profits are both shown as withdrawals of direct investment- abroad.

Foreign Ownership of Land

550. According to conventions presented in the BPM and the SNA, land, structures and other immovable objects can only be owned by resident entities.20 When a nonresident acquires legal ownership of land, a notional resident entity owned by the nonresident is, for BOP purposes, created to own the land. The relationship between the nonresident legal owner of the land and the notional entity is a direct investment relationship. The initial investment by the direct investor is equal to the purchase price of the land. The net rent from the land—that is, gross rent minus expenses incurred in the host country—is considered income earned by the direct investor from the direct investment enterprise. If the land is subsequently sold, the sale is considered a withdrawal of direct investment, which is recorded on the basis of the sale price. This treatment applies to all types of immovable assets, whether or not the assets are used for productive purposes. For example, a household’s ownership of a holiday house in a foreign country is treated in this manner.

551. An example illustrates the treatment of nonresident ownership of land. A resident of Japan purchases land and buildings located in Hawaii and valued at US$ 250 million. In the first year, gross rent receivable is $20 million, and property taxes and other costs incurred in the United States are $5 million. The net rent, $15 million, is repatriated to Japan. In the second year, the same amount of net rent is received. At the end of the second year, the Japanese resident sells the land and buildings to a U.S. investor for $280 million. The following entries would be recorded (in millions of US$) in Japan’s balance of payments:

Year 1CreditDebit
Direct investment income
Income on equity-remitted profits15
Direct investment in the United States
Equity capital250
Reserve assets (or other appropriate financial account item)235
Year 2CreditDebit
Direct investment income
Income on equity-remitted profits15
Direct investment in the United States
Equity capital280
Reserve assets (or other appropriate financial account item)295

Mobile Equipment

552. As noted in chapter 2, mobile equipment that operates in an economy for more than one year, is accounted for separately, and is recognized by taxation and other authorities as part of the capital stock of the host economy is regarded as being operated by a resident enterprise. If such an enterprise does not actually exist, the BOP compiler should create a notional enterprise. This notional enterprise is a direct investment enterprise and the direct investor is the actual operator of the equipment.

553. In these cases, the initial investment in the notional enterprise is equal to the value of the mobile equipment at the time the equipment enters the host economy. Net profits from mobile equipment operations in the host economy are considered direct investment income. In calculating net profit, it is important to include, as a cost, depreciation on the equipment. However, as depreciation typically involves no actual payment of money, the money received by the direct investor will generally exceed the net operating profit after allowance for depreciation. Receipts in excess of direct investment income represent a withdrawal of capital by the direct investor. If the mobile equipment eventually leaves the host economy, then its departure also represents a withdrawal of investment, which is recorded as an amount equal to the value of the equipment at that time. Because of depreciation, the value of repatriated equipment will generally be less than the value of that equipment when it entered the host economy.

554. An example illustrates previous points. An oil rig operated by a Pokolbin resident is chartered by a Namdarb oil company to drill for oil in waters just off the Namdarb coast. The oil rig is valued at 500 units when it enters Namdarb’s territorial waters. In the first year, net operating profit (before depreciation) from the oil rig is 55 units and depreciation is recorded as 10 units; the amounts of net operating profit before depreciation and depreciation for the second year are the same as those for the first year. At the end of the second year, the oil rig leaves Namdarb’s waters and returns to Pokolbin. The following entries would be made in Pokolbin’s balance of payments:

Year 1CreditDebit
Goods500
Direct investment income
Income on equity-remitted profits45
Direct investment in Namdarb
Equity capital*10500
Reserve assets (or other appropriate financial account item)55
Year 2CreditDebit
Goods480
Direct investment income
Income on equity-remitted profits45
Direct investment in Namdarb
Equity capital490
Reserve assets (or other appropriate financial account item)55

In the foregoing example, income on equity is shown net of depreciation, which is shown as a withdrawal of capital. Furthermore, the value of the oil rig when returned to Pokolbin is recorded at the written-down value of 480 units—that is, 500 units minus two years of depreciation at 10 units per year.

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