Sharing the Pie by Floris de Wilde Maarten;

Author:Floris de Wilde, Maarten;
Language: eng
Format: epub
Publisher: IBFD Publications USA, Incorporated
Published: 2017-08-15T00:00:00+00:00

5.6.2.3. Financing discrimination issues mitigated

Second, the numbers forwarded in the cash flow statement above tell us something about the effects of financing decisions.

The adoption of an ACE would mitigate the financing discrimination issues that arise under a conventional corporate income tax as explained earlier. The ACE operates neutrally to a great extent as regards the decision of how to finance a particular investment, i.e. both interest payments, which in this case equal EUR 240, and the opportunity costs of capital, which in this case equal EUR 160, constitute tax-deductible items. As is also the case with the CBIT, the ACE resolves the financing discrimination issue. Yet it achieves this outcome by exactly opposite means. Contrary to the CBIT mechanism, the costs of financing, regardless of whether debt or equity financing has been employed, affect the taxable base and, therefore, by the nature of the ACE, cannot influence the financing decisions. Had Johnson financed his dinghy sales activity entirely with equity, 993 the tax payable under an ACE would have accounted for EUR 25 994 (instead of a taxable amount of EUR 125 which would be the case under a conventional corporate income tax). 995 Had the dinghy sales activity been entirely financed with debt, 996 the ACE would also have produced a tax liability of EUR 25. 997 Johnson would be subject to a tax liability equal to EUR 25 regardless of whether his investment in the dinghy-selling activities is financed with debt, equity or a combination thereof. Hence, the ACE renders the financing decision immaterial for tax calculation purposes making this decision tax neutral in this respect. It would not subsidize debt financing relative to equity financing, as is the case under conventional corporate income tax systems today. The adoption of an ACE would therefore entail that the current tax incentives for excessive debt financing would disappear, or at least be robustly mitigated. The introduction of an ACE, accordingly, would render all interest deduction limitations that can be currently found throughout the international tax regime superfluous with one stroke of a pen. Thin capitalization issues would be rendered moot.

It should be mentioned, however, that the tax deduction for the opportunity costs of capital to be laid down in the tax legislation would equal a (perhaps annually set) fixed amount, e.g. the return on a long-term government bond with a mark-up for economic risk incurred. To the extent that this fixed amount does not correspond with actual normal return rates – a necessary effect of the adoption of a fixed tax deduction – differences between debt and equity financing in terms of tax burdens imposed would continue to occur. As mentioned in section 5.3.4., it would be quite difficult to decide on a “proper” interest rate for ACE purposes. Each amount chosen would constitute a proxy and would be arbitrary to some extent. However, if compared with current conventional corporate income taxation and its scope of subsidizing debt financing relative to equity financing, these differences in tax treatment between debt and equity financing under an ACE would be substantially mitigated.

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