Interest Deduction Research Articles

How to Broke the Dependence on Debt and Strengthen Firms: the DEBRA Proposal Against the Tax-induced Debt Bias

Objective: This article assesses the impact of the debt-equity bias reduction allowance (DEBRA) proposal on the tax-induced debt bias. The tax-induced debt bias is present in most fiscal systems around the world that “subsidize” debt. Debt is more interesting than equity because its cost, the interest, is tax-deductible. As a result, firms tend to have more debt, which then generates negative externalities. To break this trend, the European Commission published a directive proposal comprising a DEBRA. Methods: The proposal includes both a notional deduction on growth in equity and an additional limitation on interest deduction for corporate income tax purposes. To evaluate the impact of the DEBRA proposal, Polish firms’ data from the BACH database over six years, from 2015 to 2020, are analyzed. Two criteria are analyzed: the impact on the ratio of total financial debt to net equity and on an Altman’s Z-score to estimate their solidity. Results: We observe that firms tend to keep a higher level of net equity and to reduce the level of debt. A stronger solidity of firms is also noted by a reduction in their likelihood of bankruptcy. Conclusion: The DEBRA should be an interesting fiscal tool in building an anti-fragility fiscal system. The proposal appears to be promising as it reinforces the stability of the firm in reducing the global level of its financial debt. Moreover, in improving the Z-score ratio, the DEBRA proposal tends to reduce the probability of firms going bankrupt.

Proposed Interest Deduction Limitations and Applying the Arm’s Length Standard to the Quantum of Intra-Group Debt

Following the work of the OECD and G20, the Australian government is seeking to realign its thin capitalization and interest deductibility rules in accordance with the recommendations arising from BEPS Action 4, including shifting the focus from assets-based testing to profits-based testing for most entities. This is likely to be supplemented with a requirement to evaluate the arm’s length nature of the quantum of an Australian taxpayer’s intra-group borrowings and a unique integrity measure which seeks to deny debt deductions associated with borrowings that are connected with certain related-party asset acquisitions and payments. These measures represent a continued tightening by countries on tax deductions associated with high levels of debt.

Interest Deduction Limitations in Sweden Post-Lexel: The Relevance of the Free Movement of Capital

In Lexel (Case C-484/19), the Swedish interest deduction limitation rules were found to be in breach of article 49 of the TFEU on the freedom of establishment, as they presumed abusive practices even in respect of arm’s length-based transactions. The present article puts the case into context and highlights follow-up issues raised before lower Swedish tax courts in the context of loan transactions involving associated companies in third countries. Indeed, recent ECJ case law indicates that transactions between associated companies in the European Union and in third countries are protected under article 63 of the TFEU on the free of movement of capital.

The macroeconomic effects of business tax cuts with debt financing and accelerated depreciation

This paper studies the macroeconomic effects of business tax cuts using a dynamic general equilibrium model that incorporates endogenous debt and equity financing, interest deductibility, and accelerated capital depreciation. A cut in the tax rate stimulates business investment and output persistently, but the size of the effects is small. On impact, a ten percentage point permanent tax cut raises investment and output by 2 percent and 0.4 percent, respectively. The cumulative tax multiplier ranges from −0.4 in the initial year to −0.6 after ten years. The model would predict more expansionary effects without debt financing and accelerated depreciation. The multiplier of investment tax credits is larger in absolute value than the tax rate multiplier. The multiplier of depreciation allowances is much smaller on impact than at long horizons.

Young Households’ Diminishing Access to Homeownership Attainment in Europe

This multi-country article focuses particularly on homeownership among the young. After all, relying on European Union Statistics on Income and Living Conditions (EU-SILC) data in twelve European countries, we can see that in contrast to the aggregate homeownership rate of ‘all’ households (i.e., no matter what age the households’ heads are) that has remained relatively stable, the aggregate homeownership rate of young households (with heads aged 0–35 years) has fallen substantially in Europe in recent decades. Multiple analyses and quantitative comparisons confirm the stylized fact that acquiring a home has indeed become a challenge for young adult households (also no matter the income quartile in which they fall); rather than that, however, their lowering homeownership rates are simply due to changing sociodemographic characteristics (such as having children later in life and staying longer in education). Moreover, it is unveiled that young tenants and lower income young households are especially disadvantaged with regard to access to the housing market. Through our actual research, we aim to answer the question: Has the government’s fiscal policy strengthened or weakened the declining trend in young people’s homeownership? After all, some evidence exists of an MID having a perverse effect, i.e., capitalizing on higher housing prices. However, multilevel mixed-effects logistic regressions reveal that the use of a mortgage interest deduction (MID) has had a significant positive effect on young adults’ homeownership probability—with the strongest effect for the highest incomes. We believe that all the above results are—in the first place—relevant for governments that are willing to stimulate homeownership. They indicate that some (additional) policy interventions are indeed needed, next to or instead of granting an MID, and that the focus of housing policy should also (and more) be on tenants and those with lower incomes.

Case Law Trends: New Targeted Interest Deduction Limitation Rules Post Lexel

Case Law Trends: New Targeted Interest Deduction Limitation Rules Post Lexel

Intra-Group Funding Mechanisms at Risk: Denial of Interest Deductibility on Leveraged Share Premium Distribution by Application of the Spanish GAAR

This article analyses the binding report issued in July 2022 by the Advisory Committee to the Spanish tax authorities,Advisory Committee report on the conflict in the application of the norm. Conflict number 9, published in Sept. 2022 (Informe de la Comisión Consultiva sobre conflicto en la aplicación de la norma. Conflicto nº9 publicado en Septiembre de 2022, available at 09CONFLICTO_ PQ_HOLDING.pdf (agenciatributaria.gob.es) (accessed 9 Feb. 2023). which concluded that a series of restructuring transactions undertaken by a Spanish taxpayer were wholly artificial and, therefore, abusive. The Advisory Committee applies the Spanish General Anti-Abuse Rule to deny the deductibility of interest from an intercompany loan granted to distribute a share premium to the ultimate shareholders, claiming that such premium was artificially generated through unnecessary restructuring transactions. The author explores the different transactions undertaken by the taxpayer, the reasoning behind the alleged existence of abuse and the potential implications for multinational enterprises, providing recommendations for audit-proof structures.

Enhanced WPT structures via EC-SRR-based metasurfaces

PurposeThe purpose of this paper is to present a family of robust metasurface-oriented wireless power transfer systems with improved efficiency and size compactness. The effect of geometric and structural features on the overall efficiency and miniaturisation is elaborately studied, while the presence of substrate losses is, also, considered. Moreover, to further enhance the performance, possible means for reducing the operating frequency, without comprising the unit-cell size, are proposed.Design/methodology/approachThe key element of the design technique is the edge-coupled split-ring resonators patterned in various metasurface configurations and optimally placed to increase the total efficiency. To this goal, a rigorous three-dimensional algorithm, launching a new high-order prism macroelement, is developed in this paper for the fast evaluation of the required quantities. The featured scheme can host diverse approximation orders, while it is drastically more economical than existing methods. Hence, the demanding wireless power transfer systems are precisely modelled via reduced degrees of freedom, without the need to conduct large-scale simulations.FindingsNumerical results, compared with measured data from fabricated prototypes, validate the design methodology and prove its competence to provide enhanced metasurface wireless power transfer systems. An assortment of optimized 3 x 3 and 5 x 5 metamaterial setups is investigated, and interesting deductions, regarding the impact of the inter-element gaps, the distance between the transmitting and receiving components and the substrate losses, are derived. Also, the proposed vector macroelement technique overwhelms typical implementations in terms of computational burden, particularly when combined with the relevant commercial software packages.Originality/valueSystematic design of advanced real-world wireless power transfer structures through optimally selected metasurfaces with fully controllable electromagnetic properties is presented. The analysis is performed by means of a rapid prism macroelement methodology, which leads to very confined meshes, accurate results and significantly reduced overhead. The selected metamaterial resonators are found to be very flexible and reconfigurable, even in the case of large substrate conductivity losses, whereas their contribution to the system’s total efficiency is decisive.

Earnings Stripping Rules and Limitation of Interest Deductibility Based on the ATAD

This note comments on the recent amendment to the Slovak Income Tax Act implementing, inter alia, a new interest deductibility limitation rule in respect of corporate taxpayers. This is the final provision mandated by the EU Anti-Tax Avoidance Directive (2016/1164) to be implemented in the Slovak Republic.

Editorial: Taxing Interest in the Debtor State as an Alternative to DEBRA

Basically, a company can be financed by debt or equity. The general national tax systems are that interest, the compensation paid for funds put at disposal by means of a loan, are deductible and that the compensation for funds put at disposal by means of equity is not. In this context, the question often arises of whether this different treatment is justified. Or should they be treated (more) the same? The European Commission has proposed a directive to tackle to debt-equity bias by introducing a notional allowance on equity, on the one hand, and a new limitation on interest deduction, on the other hand (DEBRA). This editorial raises the questions of whether the tax treatment of the remuneration paid on loans (interest) by companies and the remuneration on their equity (profits) as proposed in DEBRA is sufficiently based on principles to contribute to a sustainable tax system with regard to company financing, and if not, what an alternative would be that better complies with those principles. The author concludes that DEBRA is another stopgap for flaws in the current tax systems, which has the potential to further distort the capital markets. He suggests an alternative system based on the principle of origin to remove the debt-equity bias. debt-equity bias, capital markets, tax neutrality, ability-to-pay, direct benefit principle, principle of origin, territorial principle, territoriality principle, taxation of interest, distortion of competition, sustainability

English

The Tax Cuts and Jobs Act (TCJA), effective on December 22, 2017, is the most comprehensive overhaul of the U.S. tax code in the last 30 years. Historically, when corporate tax rates are high, the interest deduction on debt is greater, thereby reducing firms’ taxable income. However, with the new reforms significantly reducing corporate tax rates, the deductibility of the interest is no longer as favorable. In this paper, the effect of the TCJA on corporate debt ratios is analyzed. The authors hypothesize that corporate debt ratios have decreased since the passage of the TCJA.  The results of the paper support our hypothesis that the long-term debt ratio is significantly negatively related to the implementation of the TCJA.   Key words: Tax cuts and jobs act; corporate tax; debt ratio; short-term debt; long-term debt.

Who Benefits From Homeowner Tax Preferences?

This paper relies on estimates from a microsimulation model to analyze the distributional impacts of the preferential tax treatment of owner-occupied housing by race and income. Compared to other homeowner tax advantages, which are more equally distributed than tax burdens, the mortgage interest deduction is more unequally distributed than tax burdens. Although current tax policy is more progressive than a tenure-neutral tax policy that treats homeowners and renters the same, a tenure-neutral tax policy yields larger reductions in after-tax income inequality. Among median-income households, white households receive a larger share of homeownership tax benefits than Black households, relative to each racial group’s share of the overall tax burden. Residential location explains the largest portion of the racial gap in the imputed rent exclusion, while household income explains the largest portion of the racial gap in the mortgage interest deduction and capital gains tax exclusion.

The income bond puzzle

The income bond puzzle

Incentive Strategy for Energy Efficiency Programs in Industries Consuming 6 000 TOE/year with Sustainable Energy Performance

This study aims to obtain the incentives strategy that can increase the participation of energy users greater than or equal to 6000-TOE in fulfilling their obligations on energy conservation through energy management with Sustainable Energy Performance (SEP). Several steps need to be carried out. First, data collection on industries that must carry out energy management, and will be analyzed to determine the level of compliance of energy users. Second, ensure that already have carried out an energy-saving program with the SEP. Third, formulating incentive schemes for energy users. Fourth, the interest deduction for the company when they implement the SEP. The results show that only 10.25 % fully comply with the regulation, 36.89 % are partially compliant and 52.87 % are not compliant with energy management activities at all. For industries that have implemented energy conservation and SEP, several benefits are obtained, including capital expenditure (capex) savings when purchasing new imported equipment for creating another energy efficiency, by up to 30 % and incentives in the form of lowering interest rates by up to 4 %.

Tax Incentivisation of Debt Financing vs. Equity Financing: Present Status and Approaches to Solve the Tax Asymmetry

Historically, the cost of financing business through debt has reduced income tax paid. Financing via new equity has not. This asymmetry has not been without consequences. The high indebtedness and relative undercapitalisation of corporates creates a risk of reduced resilience to economic shocks. Some countries have introduced tax incentivisation of equity, reduced tax incentivisation of debt, or both. In June 2022, the European Commission proposed a harmonised solution: Debt Equity Bias Reduction Allowance (DEBRA). All EU Member States, including the Czech Republic, should provide corporate income tax deduction for equity, whilst further limiting interest deduction, starting 2024.

The geography of US homeownership tax expenditures

US homeowners receive income tax deductions for mortgage interest payments and state and local property taxes, pay no income tax on their home's imputed rental income, and may exclude most of the capital gains earned from a home sale. This paper characterizes the geographic distribution of the tax expenditures from these tax preferences using a new method that exploits household-level microdata from the 2019 Census Public Use Microdata Sample to simulate homeownership tax expenditures at the Public Use Microdata Area level. I estimate that in the 2018 tax year, $226.05 billion in taxable revenue was lost to the mortgage interest deduction ($28.20 billion), the property tax deduction ($9.51 billion), the exclusion of net imputed rental income ($134.82 billion), and the partial exclusion of housing-related capital gains ($53.52 billion). Large metropolitan areas and neighborhoods with high housing prices receive subsidies in excess of the cost of funding homeowner tax preferences, while the burden of homeowner tax preferences falls heavily on rural areas. If federal income tax law reverted to what existed just prior to the 2017 Tax Cuts and Jobs Act, these geographic disparities would be exacerbated.

Does a tax deduction scheme matter for jobs and investment by multinational and domestic enterprises?

AbstractMany countries have reduced corporate income tax rates or introduced tax deductions, exclusions and credits to attract foreign direct investment. This paper analyzes the introduction of the notional interest deduction (NID) in Belgium, which allows companies to deduct from their taxable income an interest that is calculated based on the company's equity. We use an event type study approach to analyze the evolution of employment and investment of foreign affiliates in Belgium. We find that the tax deduction has increased employment and investment in the Belgian affiliates on average by 7.4 and 6.1%, respectively, in the period after the introduction of the NID. The NID, however, also provides a higher after‐tax return on investment to domestic Belgian firms. Using a matching analysis, we find that domestic Belgian firms with low external financial dependence also respond to the NID but somewhat less strongly, domestic firms with high external financial dependence do not show NID‐driven investment nor employment creation.

Tax Planning Using Interest – An Organised Chaos for Those Interested

Taxation of interest is one of the most complex areas of tax in South Africa. Various provisions apply to interest, with some regulating the inclusion of interest in gross income, others allowing for the deductibility of interest incurred, others limiting the amount of interest that is deductible and yet others providing for anti-avoidance tax measures using interest. This makes tax planning using interest to be a technically intense exercise, time consuming and often costly. This article critically analyses the provisions applicable to interest and highlights the circumstances in which they apply as well as the results of their application. It also illustrates instances of the overlaps in the application of these provisions.

Article: The DEBRA Directive and Its Interplay With Pillar 2

The Debt-Equity Bias Reduction Allowance (DEBRA) directive seeks to reduce the distortionary bias towards debt on the part of companies seeking investment. Two measures are introduced to achieve this, i.e., the deduction of a deemed interest expense on capital (DEBRA) and the further restriction of the deductibility of actual interest expense. The former seeks to promote the attractiveness of equity investments while the latter endeavours to reduce the attractiveness of debt investments. While these measures initially appear to be appropriate, another legislative initiative known as the Pillar 2 directive might undermine its effectiveness. Indeed, this directive attempts to impose a minimum tax rate of 15% on large entities’ profits wherever they operate. While uncommon, the DEBRA might reduce the effective tax rate (ETR) below 15% thereby effectuating the minimum tax. The limited deductibility of interest expense might do the opposite and increase the ETR above 15% thereby preventing such minimum tax. Thus, where the DEBRA directive provides a benefit, the Pillar 2 directive might eliminate it and, where the DEBRA directive introduces a disadvantage, the Pillar 2 directive may neutralize it. DEBRA, Pillar 2, minimum taxation, debt-equity bias, EU, debt-equity bias reduction allowance, tax incentives, Capital Markets Union, limitation on interest deductibility, ATAD.

Housing Taxation and Economic Growth: Analysis of a Balanced-Growth Model with Residential Capital

Abstract Using a neoclassical model with endogenous growth, this study examines the effects of increasing housing taxation and eliminating the mortgage interest tax deduction on economic growth and household welfare in the United States. The optimal tax policy reduces taxation of income in favor of increased taxation of housing and consumption. This policy increases the growth rate by 0.49 percentage points. In addition, simply shifting the tax burden by reducing the tax rates on productive forms of capital toward housing can increase the growth rate up to 0.18 percentage points. This study also find that eliminating the income tax deduction on mortgage interest and lowering income taxes would increase growth by about 0.016 percentage points. Each of these proposed policies improves household welfare.