Interest Deduction Research Articles

Implementation Of The ATAD: ATAD Implementation in the Netherlands

In this contribution, the authors provide an overview of the implementation of the EU Anti-Tax Avoidance Directives (ATADs) 1 and 2 in the Netherlands. After providing an overview of the implementation process, the authors will analyse and comment on the several amendments made to Dutch corporate income tax law. There is specific focus on the interest deduction limitation rule, controlled foreign company (CFCs), general antiabuse rule (GAAR), and hybrid mismatches. The authors will address certain ambiguities and highlight some potential issues from an EU law perspective. The authors will also briefly discuss recent developments such as the Netherlands’ proposal to unilaterally address certain transfer pricing mismatches and the impact of the ECJ case law on abuse and tax avoidance. This contribution will not examine tax treaty implications. ATAD, ATAD2, EBITDA, earnings stripping, interest deduction limitation, CFC, hybrid mismatch, hybrid, GAAR, documentation requirements.

Notional Interest Deduction – Impact on the Cost of Equity in Investment Projects

Purpose: The Notional Interest Deduction (NID) was introduced to achieve equal treatment of debt and equity financing by granting an additional tax deduction from self-financing. Our purpose was to analyze the practical meaning of the introduced mechanism as a factor of the Weighted Average Cost of Capital (WACC) calculation and evaluation of the efficiency of development projects. In the art, the WACC is used to determine the rates of discount for the calculation of future cash flows (CF) and net present value (NPV) of investment projects. Design/Methodology/Approach: The NID mechanism is recognized as the Allowance for Economic Growth (ACE) and the countries benefiting from this relief are recognized as applying the ACE regime. The individual ACE regime is monitored and evaluated for compliance with the European Code of the Conduct Group for business taxation. The documents published by the Council of the European Union became the basis for the tax shield rate analyses and assessment of the impact of NID on WACC changes. Findings: It has been shown that the benefits of NID mechanism can correct Weighted Average Cost of Capital in minus and the differences between countries result from the ACE regime model used, the method of calculating the qualified base and the method of determining the reference rate for the calculation of the notional interest deduction. Practical Implications: The presented use of the notional interest deduction mechanism will fill the gap in the literature on the subject and indicate new opportunities to study the efficiency of the development of organizations. The results can also help practitioners to identify a mechanism whose use may be beneficial to the company due to the possibility of a more precise assessment of the efficiency of the investment project. Originality and Value: The NID mechanism is relatively new and the issues related to it have not yet received much analysis, in particular in connection with non-tax benefits. Meanwhile, taking into account the effects of ACE regime in discounting cash flows may affect the decision to implement or reject an investment project.

Computational Analysis of Heat Transfer Intensification of Fractional Viscoelastic Hybrid Nanofluids

In the current article, we have performed computational analysis on convection heat transfer of a hybrid nanofluid in occurrences where porous media and the effect of magnetic force are involved. In order to assess the time-fractional derivatives, Caputo’s notion is utilized while the Darcy–Forchheimer model is applied due to the involvement of the porous medium. Moreover, the boundary conditions are assumed to be nonuniform through the equilibrium between the surface tension and shear stress over a semi-infinite permeable flat surface. Keeping in view the complexity of the fractional derivative model and nonuniform boundary conditions, the problem in question is a complicated one. Accordingly, the coupled momentum and energy equation is linearized and the finite difference scheme is then applied and implemented in MATLAB Code R2020b. Furthermore, we have also offered a comprehensive analysis regarding error and convergence of the proposed numerical method. The newly introduced numerical technique to determine the numerical solutions and some unique and interesting deductions are established. From the computational results, one can conclude that the fluid motion in both hybrid and single nanofluids slows down due to magnetic field, porosity, and inertia coefficient as the magnetic and electric fields are synchronized due to the formation of the Lorentz force and viscous interference. We believe that our proposed numerical technique regarding employment of the fractional model for heat transfer application to the hybrid nanofluid over a semi-infinite nonuniform permeable surface along with variable heat flux is not found in the literature so far. Furthermore, the obtained results will be a valuable addition to fractional calculus from an engineering point of view.

Who generated the loopholes? A case study of corporate tax advisors’ regulatory capture over anti-tax avoidance legislation in Finland

Abstract Recently welfare economists and international political economy scholars have increasingly discussed how the corporations seek profits by corroding policies that tackle tax avoidance and undermine public interest. This article contributes to these discussions on so-called regulatory captures in the global wealth chains by providing a comprehensive case study on anti-tax avoidance legislative processes in Finland. The author analyzes the statements that various stakeholders provided during several phases of enacting the interest deduction limitation rule that targets so-called thin capitalization arrangements. Because of this specific research material, the author is able to undertake a nuanced analysis in describing how and whose statements made the difference from the draft version of legislation to the final wording of the law. The evidence suggests corporate interest groups and tax advisory firms influenced the content of the rule as notable tax base eroding loopholes have been included in the Finnish anti-tax avoidance rule. The author also assesses remedies of regulatory captures.

IPOs and Corporate Taxes

How does going public affect firms’ tax obligations and tax planning? Using a panel of U.S. corporate tax return data from 1994 to 2018, we compare tax payments for firms that completed an IPO with those that filed for an IPO but later withdrew and remained private. We find that in the years immediately following IPO completion, firms have a higher probability of paying taxes and pay more U.S. tax. The effects occur regardless of tax status in the pre-IPO period and are not explained by statutory limitations imposed on the use of pre-IPO losses. Higher income reported for financial reporting purposes, as well as lower interest deductions attributable to debt repayment, contribute to the increased tax payments. These increases are partially offset by higher tax deductions for post-IPO investment and employment spending. Furthermore, the IPO is associated with increased tax planning through foreign tax haven use. The evidence adds to the nascent literature examining corporate tax implications of the IPO decision.

An Ex-Ante Assessment of the AGI: Firm-Level Evidence from Belgian Tax Return Data

Abstract Using confidential tax return data, we provide a unique research setting in which the Belgian notional interest deduction (NID) is replaced by the Allowance for Growth and Investment (AGI) as it is proposed by the European Commission. Our results show that the AGI would be a more viable option from a budgetary view. From a company view, however, introducing an AGI system would increase the probability of a higher effective tax rate (ETR). Especially large companies would be harmed as they would face a 7.6 percentage point higher probability of an ETR increase compared with SMEs. Furthermore, we find that there is a positive relationship between the equity ratio and the increased ETR, which is stronger for large firms compared to SMEs. This is in line with previous studies stating that large firms adjusted more aggressively to the NID by increasing their equity ratio more heavily than SMEs. However, large firms still face an ETR that is on average 10.4 percentage points lower compared with SMEs, indicating that the AGI is insufficient to undo the unequal level playing field between large and small companies. (JEL codes: H21, G32, H25, K34).

Commission

This overview highlights the Commission’s (i) launch of a roadmap and a public consultation to fight the use of shell entities for tax purposes (ATAD III) and a roadmap to tackle debt-equity bias in corporate taxation (DEBRA), (ii) request to Bulgaria to abolish the exemption for undertaxed subsidiaries, to Germany to communicate all measures implementing ATAD and ATAD II and to Sweden to amend its interest deductibility rules for EU/EEA States, (iii) closure of infringement procedures against some Member States, (iv) approvals of the Danish tax deferral schemes aimed at supporting enterprises and the Italian scheme to support audio-visual production companies affected by the COVID-19 pandemic.

Implications of a Mortgage Interest Credit for the United States

The US mortgage interest deduction (MID) allows homeowners to deduct the interest paid on their mortgages from their federal tax returns, provided that they itemize deductions. Since the benefit depends on a taxpayer’s marginal tax rate, which increases with income, the MID is an “upside-down subsidy” that becomes more valuable for higher-income homeowners. I analyze the implications of converting the US MID to a mortgage interest credit (MIC) and evaluate the effects on federal revenue and the distribution of income. I argue that a MIC could be better targeted at low- and middle-income taxpayers on the margin of homeownership while also being more progressive and less expensive than the current MID.

The influence of a mortgage interest deduction on house prices: evidence across tax systems in Europe

In a large majority of European countries, a tax relief on mortgage interest payments is granted in order to enhance homeownership. Although there is a common belief stating that a mortgage interest deduction (MID) is capitalized into house prices, empirical evidence remains scarce. Therefore, our paper is about the influence of this fiscal relief on house prices. The scope of our analysis includes fourteen European countries, for which an unbalanced panel dataset over the period 1990–2015 is constructed. All our regression results support the hypothesis that a MID has had a significant price-increasing effect in the selected countries over the observed period. However, this result does not hold for a MID in the countries where a dual income tax (DIT) is applied, suggesting a significant difference between tax systems. These results are relevant for governments because there has been much debate about whether and to what extent countries should limit its MID over the last decades.

Opinion Statement ECJ-TF 1/2021 on the ECJ Decision of 20 January 2021 in Lexel AB (Case C-484/19) Concerning the Application of the Swedish Interest Deductibility Rules

This CFE Opinion Statement, submitted to the EU Institutions on 9 April 2021, addresses the decision of the Court of Justice of the European Union (First Chamber) (ECJ) of 20 January 2021 in Lexel AB (Case C-484/19). SE: ECJ, 20 Jan. 2021, Case C-484/19, Lexel AB v. Skatteverket, Case Law IBFD. The ECJ gave its decision without an Opinion of an Advocate General. The case concerned the application of the Swedish interest deductibility rules.

Tax benefit and bankruptcy cost of debt

Different theories seek to substantiate the main determinants of companies’ capital structure. For the trade-off theory, there may be an optimal capital structure in which companies seek a balance between bankruptcy risk and tax benefits generated by the deduction of debt interest. Despite the relevance of both aspects, their joint analysis is not sufficiently studied. Thus, this study seeks to understand whether companies show conservative behavior in relation to their low leverage level. In addition, whether a possible non-optimizing of tax benefits, arising from indebtedness, is due to a higher ex-ante bankruptcy cost for the company or due to the existence of other non-debt tax benefits is intended to verify. For this purpose, tests are performed with simultaneous equations - generalized method of moments and ordered probit - and Tobit regression. The sample comprises non-financial publicly held Brazilian companies. Data are analyzed during the period from 2009 to 2018. As a result, both hypotheses are confirmed - H1 - Increased leverage results from higher debt tax benefits than ex-ante bankruptcy costs and H2 - Companies do not optimize debt tax benefits due to factors other than debt.

Do People Respond to the Mortgage Interest Deduction? Quasi-Experimental Evidence from Denmark

Using a major reform that scaled back the mortgage interest deduction for middle- and high-income households in Denmark, we study how tax subsidies affect housing decisions. We present four main findings. First, the mortgage deduction has a precisely estimated zero effect on homeownership for high- and middle-income households. Second, the mortgage deduction has a clear effect on housing demand at the intensive margin, inducing homeowners to buy larger and more expensive houses. Third, the deduction has sizeable effects on household financial decisions, inducing them to increase indebtedness. Finally, the reduction of the tax subsidy lowered equilibrium house prices. (JEL G21, G51, H24, K34, R21, R31)

Evolution in the Tax Code: (Almost) the End of Homeowner Tax Savings?

The federal government has long promoted homeownership through various provisions in the U.S. income tax code. The Tax Cuts and Jobs Act of 2017 (TCJA) renewed interest and debate about the treatment of housing via the tax code, particularly with respect to the mortgage interest deduction and the limitation on deductions for state and local taxes. We document the extent that the TCJA magnifies the long-standing anti-mortgage debt bias in the tax code. Our analysis reveals that ongoing discussions about the effects of eliminating the mortgage interest deduction are largely irrelevant because most households no longer benefit from this deduction. We also demonstrate how the limitations on the deduction of state and local taxes alters the costs associated with homeownership across geographic areas, and we provide detailed calculations of the average and marginal tax rates at which housing related expenses are deducted. Finally, we calculate how the major tax benefit of owner-occupied housing — the nontaxation of net implicit rental income varies across income groups and locations.

The Mortgage Interest Deduction: Revenue and Distributional Effects

Conventional estimates of the size and distribution of the mortgage interest deduction (MID) in the personal income tax fail to account for potentially important responses in household behavior, and thus overstate the increase in revenues and the progressivity associated with eliminating the MID. Were the MID to be eliminated, households would sell financial assets to pay down their mortgage debt, and the smaller holdings of these taxable assets would offset some of the revenue gains from taxing mortgage interest. We build on previous work that estimates the consequences of removing the MID using a framework that allows for portfolio rebalancing. Our estimates of the revenue loss of the MID are robust to various assumptions about household rebalancing behavior and the ratio of the conventional estimate to the rebalancing estimate is relatively stable over time. Based on these findings, we provide a rule of thumb for policymakers for estimating behavioral responses to changes in the MID.

Real Responses to Anti-tax Avoidance: Evidence from the UK Worldwide Debt Cap

We analyze how multinational firms reallocate real operations and debt across their affiliates in response to anti-tax avoidance policies. The UK introduced a worldwide debt cap in 2010, generating a quasi-natural experiment that limited interest deductibility for a group of multinational firms. We find that multinationals affected by the reform reduced the amount of debt held in the UK and increased debt held abroad. Affected multinationals reallocated a share of their real operations away from the UK. Our findings provide causal evidence for tax-motivated debt and real activity reallocation within multinationals and show how multinationals can circumvent tax avoidance regulations.

Corporate Tax Planning: Strategies for Troubled Times, Again

This article addresses income tax issues associated with the various strategies that corporations can employ in response to economic difficulties, focusing on debt-restructuring techniques and tax consequences for debtors. First, the article discusses the tax effects of the most fundamental debt-restructuring issues—interest deductibility and the deductibility of planning costs. Second, considering the out-of-court approaches to debt restructuring, the article examines the tax consequences that may arise where a debtor company and its creditors are able to agree on accommodations that will provide some financial relief for the debtor. Third, the article comments on the potential for the debt-parking rules to apply in the context of the assignment of debt by a creditor. Fourth, the article examines the tax implications of a debt-for-equity exchange, pursuant to which an outstanding debt is exchanged for shares in the debtor corporation. Fifth, the article presents the key tax issues that emerge where a debtor corporation sells assets as a way to mitigate debt pressure. Finally, the article considers tax questions relevant to the statutory (in-court) debt-restructuring options offered by corporate-law statutes, such as the Canada Business Corporations Act, and insolvency statutes, such as the Companies' Creditors Arrangement Act.

The Effect of Taxation on Corporate Financing and Investment

Abstract Extensive empirical research concerning the impact of taxes on corporate decisions has had trouble identifying seemingly obvious effects. Perhaps the problem is that the seemingly obvious tax predictions are not quite right. We provide an equilibrium model with both corporate and personal taxes. In the steady-state equilibrium, the corporate tax rate affects the level of production despite interest deductibility at the firm level, but not household-level taxes on interest earnings or dividends. We prove several other tax irrelevance results and document a Laffer curve in the corporate tax rate. (JEL G31, G32, G35)

Distributional effects of nonresident investors on the housing market and welfare

AbstractThis paper studies the distributional effects of nonresident housing investment on residents' consumption and welfare in a dynamic stochastic general equilibrium model with two types of agents: savers and borrowers. The model is estimated with Bayesian methods applied to Taiwan. Three main results emerge. First, nonresident housing investment raises house prices and rent, validating policymakers' concerns about housing affordability. Second, higher house prices boost homeowners' property values, which strongly promotes consumption. Third, higher investment by nonresidents increases government tax revenues, the allocation of which has important welfare consequences across agents. Using tax revenues to subsidize residents through income tax reduction produces the largest welfare improvement, followed by a provision of public goods. Increasing the tax deductibility of mortgage interest is beneficial to borrowers, while allotting tax revenues to supply public capital results in the greatest welfare losses to savers.

There and Back Again: A Commentary on Social Welfare Policy in the Wake of 2020

There and Back Again: A Commentary on Social Welfare Policy in the Wake of 2020

Tax Deductibility, Market Frictions, and Price Discrimination: Evidence from the Mortgage Market.

This study shows that borrowers who benefit from the mortgage interest deduction pay an interest rate that is on average 11.6 basis points higher than that of otherwise similar borrowers. This result implies that mortgage originators capture between 7 to 15 percent of this government subsidy. Consistent with a model of first-degree price discrimination, this additional markup increases with borrowers’ marginal tax rate and with market frictions such as concentration, search cost, and leverage in bargaining. Thus, the study suggests that interest deductibility functions as price support in credit markets characterized by high market frictions.