Debt bias in corporate taxation: possible consequences and solutions | 2016

Author(s) Ana Cristina Ferreira Oliveira
Advisor(s) João Sérgio Ribeiro
Year 2016

Synopsis This research first addresses the different tax treatment that is given to debt and equity financing, showing that the benefits associated with debt make this source of financing more attractive. The different treatment of these two forms of finance incentivizes debt exploitation, by which deductibility of interest payments decreases the tax base in a high-tax jurisdiction, preferably ending up in a low-tax jurisdiction’s tax base. This project shows that the deductibility of interest for tax purposes combined with the existence of a myriad of different tax systems leads to a number of possibilities for tax arbitrage, especially through international debt-shifting and hybrid financial instruments. It then demonstrates that the most popular response given by countries to mitigate this debt bias problem has been the adoption of thin capitalization rules which are aimed at limiting the deduction of interest that is deemed excessive. This research intends to look at these rules in the context of the OECD, tax treaties and EU law. The work presented concludes by providing two alternatives (the ACE and the CBIT systems) in order to achieve more neutrality between debt and equity.

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