Interest Tax Research Articles

Tax Policy Assessment Challenges: The Case of the Slovenian Interest Tax Shield

Globalization affects national government fiscal policy; therefore, the recent policy debates focus on international fiscal competition. The national tax policies pay special attention to multinational companies, which are highly mobile and able to avoid taxes. The trend of tax rate cutting and tax base broadening (“the race to the bottom”) means that tax completion is one of the most important topics in the professional public. There are two main instruments to avoid the multinational companies' profit shifting; decreasing the corporate tax rates or the implementation of anti-avoidance rules. While tax policy implementation affects multiple stakeholders, a thorough, empirically tested and publicly aligned impact assessment procedure should be carried out. The main idea of this article is to analyze the procedure of impact assessment for tax policy in Slovenia, focusing mainly on the example of the interest tax shield, verifying the impact of the tax policy (thin capitalization rule) implemented in 2005 and offering recommendations for future tax policy. The results revealed that the Slovenian procedure for impact assessment concerning tax policy is used to fulfill formal compliance requirements. Such a declaratory and theoretical level of usage cannot contribute to effective results for tax policy. This turned out to be proved by the data from the financial reports of foreign companies operating in Slovenia for the tax policy instrument (thin capitalization). Contrary to expectations, the amount of debt to parent companies has on average increased, causing a capital to debt (to parent company) ratio considerably lower than the tax rules have restricted. The recommendations therefore are concentrated on a thorough quantitative and qualitative analysis of specific policy challenge. The globalization trend has affected tax policies all over the world, causing tax competition among countries. Multinational companies (MNCs) are very mobile and able to avoid taxes, so the tax code is one of the important factors in investment decisions. In this manner, the national tax policy can either decrease the corporate tax rates or implement anti-avoidance rules. The main article objectives are focused on a review of the existing procedure for tax policy evaluation, including the analysis of the impact of the thin capitalization rule on MNCs operating in Slovenia. The article finally provides recommendations for the tax instrument implementation of thin capitalization in general. The research methodology in based on a systematic literature review concerning the procedure for tax policy evaluation, while the second part employs statistical analysis including the Friedman test to evaluate the effectiveness of the thin capitalization rule and its impacts on foreign direct investment (FDI) in Slovenia. The research findings reveal a rather loose procedure considering the evaluation of the future impacts of tax policies, whereas the tax policy evaluation is addressed on the regulatory and declaratory level, while in practice it is often based on inertia, intuition, and incomplete recommendations from international organizations and supranational bodies. © 2017 Wiley Periodicals, Inc.

Using multiple random walk simulation in short-term grade models

Abstract Geostatistical simulation comprises a variety of techniques which can help on the decision-making process for uncertainties. They allow the uncertainty assessment of function responses (which depend on the simulated inputs) commonly through a non-linear relationship (net present value, interest tax return, geometallurgical ore recovery...). However, one of their limitations is that running the simulation can take considerable processing time to be executed in large deposits or large grids. Herein is presented an attempt to solve this problem in short-term modeling cases, via the use of Multiple Random Walk Simulation. This algorithm combines kriging with the simulation of independent random walks in order to generate simulated scenarios much faster than via traditional simulation algorithms. A case study is presented to illustrate the application of the method in an iron mine. The Multiple Random Walk Simulation models were properly built, respecting the reproduction of both histogram and variograms. Also, the speed-up was compared with standard methods of geostatistical simulation and there was a considerable speed gain with Multiple Random Walk Simulation (3.39 to 5.65 times faster than the others).

The Mortgage Interest Tax Deduction and the Great Recession

This paper revisits the mortgage interest deduction (MID) in the U.S. and its distribution across households using ZIP-code level data from the IRS Statistics of Income. Since the Great Recession, the total and average amount of mortgage interest deducted has fallen significantly along with the number of deduction claimants as the home-ownership rate has declined dramatically since the peak of the mid-2000’s housing boom. We also use housing supply as an instrumental variable to better understand how geographic dispersion in housing prices can account for variation in ZIP-code average MID claims. While housing tax benefits are concentrated in high-income areas and regions with inelastic supply, the dollar share of the MID has fallen among the wealthy since the housing bust. We further discuss the implications for policy changes such as the prospects of capping or eliminating the MID or relaxing zoning laws.

The Option Value of Mortgage Interest Tax Deductibility

We offer a continuous-time contingent claims valuation framework to quantify the tax shield value of US mortgage interest deduction (MID) under uncertainty. We identify non-linear forms (both convex and concave regions) in the pay-off of MID, and discuss the implications for optimal mortgage purchase decisions. The model provides insights regarding the relationship between the effective MID and a set of underlying variables, including income level, house price, mortgage size, and state and local tax rates. In particular, we show how the tax shield value of a mortgage loan changes with key variables such as the life of the loan and the volatility of underlying processes. We apply the model to the case of optimal choice of adjustable versus fixed rate mortgages and prove that under a mean-preserving interest rate, an adjustable mortgage always offers a bigger tax saving. Our work demonstrates a novel aspect of dynamic analysis in the mortgage market.

Tax Policy Assessment in Slovenia – Case of Interest Tax Shield

AbstractThe tax policy assessment is an indispensable strategy within any modern country’s system of governance. There are several types of “impact assessments”, with RIA as one of the most commonly used. This tool is used to measure and analyse the benefits, costs and effects of a new or existing legal regime, which can be carried out by collecting and analysing empirical data in the context of a broader decision-making framework. The main objective of the paper is to analyse which stage the Slovenian regulatory impact assessment is in, and whether this stage is sophisticated enough to provide for the essential verification of tax policy and specific instruments, focusing mainly on the case of interest tax shield issues. Methodologically, the paper is based on a systematic literature review, a survey for public consultations and statistical tools for calculating the differences in internal indebtedness in different observed periods. The results show that the Slovenian RIA is not sophisticated enough to evaluate complex tax instruments and policy. Nevertheless, tax policy decision-makers should reconsider the implementation of a thin capitalization rule (but also future tax policy instruments) focusing also on other, non-tax revenue, factors.

From interest tax shield to dividend tax shield: A corporate financing policy for equitable and sustainable wealth creation

This study critically analyzes debt-incentivized corporate tax and financing policy and provides an Islamic perspective to this important tax deductibility debate. This study advocates that the corporate tax incentive to debt (interest tax shield) be abolished and shifted to equity (dividend tax shield). Later, we use the implications of our proposed taxation policy to reframe the firm financing model and modify M & M's firm valuation model. We use a scenario-based simulation technique and conduct various policy experiments to assess the impact of conventional and proposed tax regimes on levered and zero-levered firms and their values. We find that aligning corporate financing policy with the fundamentals of Islamic finance helps restrain corporate indebtedness and promote profit and loss sharing. According to our proposed model, firms have a reduced cost of financing, tend to be more stable, and are value oriented, especially when they avoid debt to the maximum extent. We further propose that an optimal dividend payout ratio may lead to aggregate equilibrium amongst cost of financing, firm value, and corporate tax contribution to the economy. This study provides new contributions to the discipline of Islamic corporate finance.

Low Homeownership in Germany - A Quantitative Exploration

The homeownership rate in Germany is one of the lowest among advanced economies. To better understand this fact, we analyze the role of three specific policies which discourage homeownership in Germany: an extensive social housing sector with broad eligibility criteria, high transfer taxes when buying real estate, and no tax deductions for mortgage interest payments by owner-occupiers. We build a lifecycle model with uninsurable income risk and endogenous homeownership in order to quantify the policy effects on homeownership and welfare. We find that all three policies have sizable effects on the homeownership rate. At the same time, household welfare would be reduced by moving to a policy regime with low transfer taxes and mortgage interest tax deductions, but it would improve in the absence of social housing, in particular when coupled with housing subsidies for low-income households.

The Effect of Taxation on Corporate Financing and Investment

This paper studies the impact of taxation on corporate investment, debt, equity, and dividends. There is a classical tax code in which the firm pays tax on profits and the investor pays taxes on dividends, interest, and capital gains. We find that a small increase in the dividend tax (or the capital gains tax) has no effects on consumption, production or government revenue. Instead, the firm alters the dividends and share issuance policies. A small increase in corporate profits tax (or a cut in the tax on interest) reduces consumption, increases government revenue, and for realistic tax parameters increases production. There is one approximate symmetry between the impact of corporate profits tax and interest tax, and another between dividend tax and capital gains tax.

Mortgage Interest Tax Shield and Home Mortgage Refinancing Decision

Under current low interest rates, the decision whether or not to refinance a mortgage is a timely and practically useful topic. However, the home mortgage refinancing decision is also affected by other variables such as personal tax rate. In addition, financial institutions provide different types of mortgage loans in terms of maturity (loan period), interest rate, processing cost, points (bank fee), and so forth. Several websites are available which can be used to aid making the refinancing decision. However, these websites programs are not explicitly geared towards selecting a low cost mortgage loan. Furthermore, these websites are limited in their usefulness due to inadequate assumptions or the difficulty of acquiring information required for the program. For example, a certain website requires information such as the expected future interest rate, the expected inflation rate, the standard deviation of mortgage interest rates, and so forth. To be practically useful, the assumptions should be simple and reasonably realistic. The objective of this paper is to prepare, under realistically reasonable assumptions, an Excel program which can select a low cost mortgage loan after consideration of the tax deductibility of mortgage interest rate. This paper can be used as a case problem for both undergraduate and MBA students. From the case, students learn how Excel (or any spread sheet program) can be programed and used to analyze finance problems.

THE RELATIONSHIP BETWEEN CAPITAL STRUCTURE AND CORPORATE TAXES FOR COMPANIES LISTED IN THE NAIROBI SECURITIES EXCHANGE

Purpose: The purpose of this study was to analyze the relationship between capital structure and corporate taxes for companies listed in the Nairobi securities exchangeMethodology: The study used descriptive survey research design. This study used Secondary data sourced from annual audited financial statement of the firms listed on Nairobi Securities Exchange. The population of the study consisted of companies listed on the NSE. Purposive sampling was used to select respondents from the sampling frame. A sample size of 46 listed companies for the year 2001 to 2011 were selected through random sampling. Data was analyzed using Statistical Packages for Social Sciences (SPSS) to derive descriptive results.Results: Finding indicated that the relationship between debt equity ratio and taxes profit ratio was negative and significant and that debtequityratio has a significant effect on taxesprofitratio.The findings pointed out that the existence of tax shield in a perfect capital market conditions cannot be reached, in an imperfect financial market, the capital structure changes will affect the company's value. The findings also pointed that firm which follows the trade-off theory sets a target debt to value ratio and then gradually moves towards the target. Accordingly, the findings agreed pointed that the value of the firm will increase or the cost of capital will decrease with the use of debt due to tax deductibility of interest charges. Findings also pointed that a firm facing a low enough tax rates would also use equity, because investors pay more taxes on debt interest than on equity income. In conclusion, the findings pointed that the more profitable the firm the lower is the debt ratio.Unique contribution to theory, practice and policy: The study is recommended for commercial banks to issue corporate bonds as this would form a cheap source of finance and also the use of corporate bonds entails the enjoyment of the interest tax shield and consequently improving the shareholder’s wealth. The study also recommended that commercial banks should engage strategic investors. Further to that, the study recommended that the equity share holder should be substituted for debt shareholding in future, this is because an increase in debt shareholding arising out of substitution would be beneficial to the commercial bank because it will result into interest tax saving.

Report on the 2016 Conference Tax Treaty Case Law Around the Globe

Each year the international conference Tax Treaty Case Law Around the Globe provides a forum to discuss with outstanding experts of the relevant jurisdictions the most important and interesting tax treaty cases which recently have been decided all over the world. This article provides a report on the 2016 Tax Treaty Case Law Around the Globe conference held in the Netherlands at Tilburg University on 19–21 May 2016 and which covered seven main topic clusters: (1) Scope, tax treaty interpretation and residence; (2) Permanent establishment (PE); (3) Business profits and transfer pricing; (4) Labour income; (5) Beneficial ownership, royalties and capital gains; (6) Relief for double taxation and limitation on benefits (LOB); and (7) Non-discrimination, exchange of information and recovery.

The scope and levying of interest subject to the withholding tax in terms of sections 50A–50H of the Income Tax Act No. 58 of 1962

A withholding tax on interest is levied in terms of sections 50A to 50H of the Income Tax Act No. 58 of 1962 (as amended) and has been effective since 1 March 2015. In this study, certain areas of concern were identified regarding the scope of interest subject to withholding tax and the timing of the levying of the withholding tax. A secondary concern involved the application of section 23M of the Act. A literature review of the theoretical basis for the taxation of interest was undertaken. Relevant terms and phrases; other sections of the Act which might affect, or be affected by the application of the withholding tax on interest provisions; South African case law; international case law and the Model Tax Convention of the Organisation of Economic Cooperation and Development were analysed. Based on the findings, it is recommended that the provisions of section 50A to 50H of the Act be amended or extended to include a definition of interest subject to withholding tax and that section 50D(3) of the Act be amended to allow for interest paid in the form of an annuity to be exempt from withholding tax or for interest subject to withholding tax to be exempt from normal tax. Finally, the alignment of the wording of section 50D(3)(a) and section 10(1)(h)(i) of the Act is also recommended in order to remove contradictions in the accrual and payment of interest and to prevent the potential non-taxation of interest income.

On the value and determinants of the interest tax shields

We use a dynamic model of the firm to ascertain both the value and the determinants of the debt tax shields. For a representative U.S. firm, we find that the value of the interest tax shields represents less than 5 % of firm value, and it varies considerably across U.S. industries. Our results also show that this component of firm value behaves counter-cyclically over the business cycle. Finally, besides the interest rate on debt and the corporate income tax rate, we find that the curvature of the production function is one of the main determinants of the tax advantage of debt.

Can the CCCTB alleviate tax discrimination against loss-making European multinational groups?

In March 2011, the European Commission submitted a proposal for a Council Directive on an optional common consolidated corporate tax base (CCCTB). If this proposed CCCTB system comes into force, taxes calculated under the currently existing system of separate accounting might be replaced by a system of group consolidation and formulary apportionment. Then, multinational groups (MNGs) would face the decision as to whether to opt for the CCCTB system. Prior research focuses mainly on the differences in economic behaviour under both systems in general. By contrast, we study the conditions under which one or the other tax system is preferable from the perspective of an MNG, with a particular focus on loss-offsets. We identify four effects that determine the decision of an MNG: the tax-utilization of losses, the allocation of the tax base, the dividend and intragroup interest taxation. We find mixed results, e.g., that the CCCTB system proves advantageous for increasing loss/profit streams (e.g. from start-ups or R&D projects) of the individual group entities, whereas the system of separate accounting is beneficial for decreasing profit/loss streams (e.g. caused by a decrease in return from a mature product). The results of our analysis are helpful for MNGs facing the decision as to whether to opt for the CCCTB system and can also support legislators and politicians in the EU but also in other regions in their tax reform discussions.

The Choice of Valuation Techniques in Practice: Education versus Profession

We use a survey approach to learn about valuation professionals’ choices and implementations of valuation techniques in practice. The survey design allows us to control for a respondent’s professional subgroup (e.g., consulting), education, experience, and valuation purpose characteristics. We find support for the “sociological hypothesis” that profession matters more than education; different professions have different valuation cultures. Other factors are less important. There are also many commonalities across respondents. Most use both multiples and DCF, but implement DCF in a way that almost turns it into a multiples exercise. Confusion reigns with respect to interest tax shields and the WACC. Higher educational levels do not reduce the confusion. Our overall findings matter because valuation professionals function as intermediaries in the capital allocation process. The relative unimportance of education raises questions about the role and benefit of higher level finance education.

Is Dodd Frank Orderly Liquidation Authority Necessary to Fix Too-Big-to-Fail?

The Dodd-Frank Act (DFA) Orderly Liquidation Authority (OLA) has many legal issues that could prevent its use. Should there be a next financial crisis, regulators may again be forced to sell a large failing bank to a larger banking institution, creating yet another too-big-to-fail (TBTF) institution.Regulatory plans for using OLA focus on injecting parent holding company capital into the critical operating subsidiaries of systemically important financial institutions (SIFIs) to keep these subsidiaries open and operating. This goal can be achieved without OLA by imposing substantially higher minimum capital requirements on critical operating subsidiaries instead of imposing them on parent SIFIs. But, replacing OLA with this simple alternative, alone, will not solve the TBTF problem. Investor perceptions of TBTF arise naturally given flaws in the existing deposit insurance bank resolution process, and the predilection for regulatory forbearance created by conflicting responsibilities assigned to the Federal Reserve Board (FRB). The FRB duty to be the consolidated supervisor of largest BHCs and other designated SIFIs, the guardian of financial stability, and the lender of last resort make it rational for investors to expect large financial institution to receive special assistance to forestall their failure or protect their creditors from loss. In contrast, other institutions that offer similar financial services will be allowed to fail and impose losses on similarly situated creditors. To end TBTF, financial regulation must be refocused on: (i) ensuring the uninterrupted operation of important subsidiaries by increasing capital requirements on banks and critical functionally-regulated affiliates ― not parent holding companies; (ii) reforming the deposit insurance bank resolution process to mandate the break-up of large failing banks; (iii) removing the regulatory structure that creates TBTF investor expectations; and (iv) requiring SIFI parent companies to reorganize or liquidate using a judicial bankruptcy process in which similarly situated creditors are treated equally. The alternative approach of higher capital requirements at operating subsidiaries does not require OLA or new regulations to operationalize OLA — rules requiring minimum total loss absorbing capacity or contingent convertible debt. If higher capital requirements at critical subsidiaries are funded with debt issued by the parent holding company, there will be no reduction in SIFIs’ consolidated interest tax shields and consequently no increase in the cost of commercial and consumer credit. These reforms will simplify regulation, improve transparency, protect taxpayers from the expense of future SIFI bailouts and eliminate the TBTF subsidy without abridging property rights and legal protection for parent SIFI creditors.

Ongelijk woonvermogen: hoe de stimulering van het eigenwoningbezit uitpakt in Nederland, Duitsland en Zweden

Homeownership rates have increased in the Netherlands since the 1980s. An extensive mortgage interest tax deduction scheme and a reregulation of the mortgage- and credit market indulged low- and middle-class households to move into this tenure. Cross-country comparisons have shown that housing policies influence which social groups reside in homeownership. Surprisingly, it is never researched whether this enables different social classes to accumulate housing wealth. This becomes ever more relevant, since wealth inequality has become one of the central challenges of our time. After all, housing wealth is the largest source of wealth for most households. This article focuses on housing wealth inequality between social classes in the Netherlands, Germany and Sweden. On the basis of the first and the fifth wave of the SHARE (Survey of Health, Aging and Retirement in Europe) (2004/2013), it is investigated which dimensions play a role in the realization of housing wealth inequality among households (aged 50+) in three countries with a different housing regime and a different price development on the housing market. The results suggest that an expansion of homeownership can result in a relatively equal housing wealth distribution when the construction of owned homes is stimulated in a non-financialized way. A financialized expansion of homeownership leaves more room for housing wealth inequalities between social classes to arise.

Using distance functions to understand interest taxation

AbstractOne of Terence Gorman's insights was that if one wants to derive rules about optimal commodity tax rates (or prices) one should treat quantities consumed as the instruments. This paper builds on Angus Deaton's development of this idea using distance functions. I identify necessary and sufficient conditions for uniform commodity taxation in a static model and the efficiency of various tax structures in a life‐cycle model. One implication is that the optimal interest tax rate may be higher when ordinary or compensated labour supply elasticities are lower.

Housing Tax Reform and Foreclosure Rates

Since the housing market collapse of 2008 and the ensuing economic recession were amplified by rising foreclosure rates, we study the potential impact of housing taxation reform on foreclosures. Two ways in which housing receives preferential treatment are the tax deductibility of mortgage interest payments and the non-recognition of imputed rents. We employ a recursive equilibrium model in which heterogeneous agents make housing tenure choices and in which mortgage default occurs in equilibrium. We calibrate the model and use the calibration results to quantify the effects of reforming these parts of the tax regime. We find that elimination of the mortgage interest tax deduction reduces the foreclosure rate by 12.4 percent. Alternatively, taxing imputed rents would reduce it by 32.5 percent.

Debt and Taxes: Evidence from Foreign versus Domestic Subsidiaries in an Emerging Market

AbstractForeign subsidiaries in Korea operate under a classical system where double taxation of corporate and personal income provides interest tax shields, while domestic subsidiaries are under an imputation system where preference for debt is largely eliminated. We find that foreign subsidiaries’ overall leverage is not higher than domestic subsidiaries, while the former's internal leverage is higher than the latter's. Moreover, foreign subsidiaries with excess foreign tax credit use more internal debt when home corporate tax rate is low. These findings suggest that taxes have a first order impact on internal debt when parent companies hold both debt and equity, but not on external debt.