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Thin-Capitalization In The International Taxation

Posted on:2008-08-13Degree:MasterType:Thesis
Country:ChinaCandidate:Y LiFull Text:PDF
GTID:2166360215953717Subject:International Law
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The expression'thin capitalization'is commonly used to describe an approach of international tax avoidances where a corporation's debt to equity ratio exceeds certain limit, using an excessive proportion of debt capital financing in order to avoid income tax payable. At present, thin capitalization has become one popular approach of international tax avoidance used by international investors. The different tax treatment of interest and dividends creates an obvious incentive for the multinational investors to applying thin capitalization. Interest payable on debt funding used for income producing purposes is generally taxing deductible to the debtor. Returns on equity funding are not tax deductible generally. In addition, the lender will generally be allowed a foreign tax credit for the interest withholding tax paid under a lower tax rate than that of dividends in their home jurisdiction. International investors consider about the matters like commerce and economy when they choose to invest, but the different treatment makes them choose debt funding instead of equity funding. Thin-capitalization makes international investors escape or decrease the tax burden of the host country.Thin-capitalization affects each main body in International Tax Law materially, but the biggest casually of thin-capitalization undoubtedly is the governments of the host country and the shareholders of the corporation in that country. Non-resident shareholders and multinational investors derive advantage from tax avoidance of thin-capitalization, which is also a kind of erosion to the host countries'revenue and profit-bereavement for the other shareholders of that corporation. Incorporated in:On one hand, the thin-capitalization cuts down the tax revenue of the host country directly, and influences the effectiveness of tax control of the own country: Firstly, the loss of tax rights and interests, the deduction of high-proportional abroad interest reduces the tax payment of subsidiary company. Secondly, it disturbs the economy order of the host country, causes negative effect to the balance of foreign exchange. Thirdly, it could possibly form the feint of investment losses of the company, because of the transfer profit, then damages the image of invest environment of the country.On the other hand, thin-capitalization causes the improper the capital structure of the resident corporation, the high-proportional debt results in the capital absence of multinational company, or takes back the capital in the form of withdrawing corpus and interest, while obtaining the high-proportional income of debt and stock right, the multinational company takes social and economy responsibility in the low proportional capital stock.With respect to the damages and impacts on the tax revenue from thin capitalization, many countries have adopted specific thin capitalization rules that seek to limit the tax recognition of debt financing of entities controlled by non-resident investors. There are two approaches. The first one is the arm's length approach. Under this approach, investments are reviewed using a"substance over form"criterion on a case-by-case basis. The nature of the investment is reviewed in order to determine whether the transaction can be characterized as"arm's length", that is, whether an unrelated party would have provided funding on the same or a similar basis. If this is considered not to be the case, then the finance provided is re-classified as equity with the subsequent treatment of any repatriation of funds as a dividend for tax purposes. The disadvantage here is that the rules are somewhat subjective and no clear guideline is provided to taxpayers. It can also be difficult to identify normal arm's length practices in each specific circumstance. This makes an obvious lack of certainty. The second one is fixed ratio approach. As its name suggests, this method applies an inflexible fixed ratio of debt to equity. Where this method is employed, a breach of a specified debt to equity ratio will trigger certain counter measures, the most common being: a denial of income tax deduction for interest; or a re-classification of loans from non-residents as equity resulting in funds repatriated from the country of source being treated as dividends. The advantage of this approach is that it provides taxpayers with certainty in the determination and ongoing treatment of financing arrangements. However difficulties with it include the denial of an otherwise commercially acceptable level of debt funding.This paper makes an in-depth analysis of Thin-Capitalization rules in Australia, Canada, England, America, and Germany. Thin-Capitalization rules have become the most important part of the anti-tax avoidance system. To prevent the multinational corporations'tax avoidance, and to protect the host countries'tax revenue, it is necessary to draw up Thin-Capitalization rules. The extent of Thin-Capitalization rules should be decided by the whole economic environment and the policies to investment of the host countries. Otherwise, there may be some negative effects. It is to pay attention that although collecting taxes is the authority of each sovereign state, the incorporate process of the world's economy needs international coordinate in tax policies. Thin-Capitalization rules can not be exception. The differences of Thin-Capitalization rules of each country may bring disputes. The tendency of incorporate world indicates that Thin-Capitalization rules may tend to be same. The bilateral and multilateral coordinates make challenges to the differences of Thin-Capitalization rules.With the opening in the foreign capital field step by step after entering WTO, the foreign exchange under some capital items could be exchanged freely, it could also be predicted that the trend will last. The choice of foreign debt will be more, and the room of the thin-capitalization will be bigger than ever. Actually, there is a great deal of negative effectiveness due to the thin-capitalization. Firstly, it cuts down the tax revenue of our government badly, and influents the effectiveness of tax controlling. Secondly, it disturbs the economy order of our country, and causes negative result to the balance of foreign exchange. Thirdly, transferring profit makes fake recognition of foreign investor's losses in investment, then in the impression of bad invest environment. It will weaken the willingness of foreign investors'investment in China, which is against the opening policy of our country. Moreover, compared with the general tax avoidance method such as high input and low output, thin capitalization is more covert, and the damage is much bigger. So the writer thinks that the authorities of tax supervision should pay much attention to this, and adopt anti-tax avoidance measures accordingly.In certain circumstance, the rules of China on the capital of foreign corporations are complete. However, it just makes a fixed scale of the corporation, and it needs the corporation has enough capital. The existing rules have the effect of avoiding thin-capitalization, but they are not real Thin-Capitalization rules, because they are far away from the fixed ratio approach.Our country has taken part in WTO, what has created advantage for the international capital's flowage in a more broad area. Since a great deal of foreign capital has been introduced into China, and rational deployment of resource has been promoted, it is an inevitable problem for our revenue department to ensure after-tax income steady at the same time. There is not any rule about Thin-Capitalization at present in our country, and the experience to answer thin-capitalization is also defective. So we have to strengthen the practice of the multinational corporation's capital, and analyze related rules adopted by some foreign countries. We should draft out our own rules about the thin-capitalization, using foreign successful experience for reference and linking with the situation of our country.
Keywords/Search Tags:Thin-Capitalization
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