Under The Thin Capitalization Of The Enterprise Income Tax

Thin capitalization is currently a more subtle way to avoid tax both internationally and domestically. It refers to the following circumstance: in the choice of corporate financing, companies or other investors, in order to achieve the purpose of tax avoidance, reduce the proportion of share capital, raise the proportion of loans, and offer alternative ways of loans to finance the investments. The aim is to take advantage of the interest and dividends tax differential treatments in tax laws. The dividend distribution tax generally cannot be deducted before the payment of corporate income tax, but interest is generally deductible in a pre-tax manner. Although the interest payments include withholding tax, it is generally lower than the dividend withholding tax, moreover, interest withholding tax could be exempt according to the domestic tax laws or the countries bilateral tax. The utilization of thin capitalization has greatly affected the interests of the host country, and deteriorated the host country's investment environment. As a result, many countries have introduced policies and regulations for such behaviors. China's thin capitalization has reached a new height in 2007 after the merger of two tax legislative.In 1987, the OECD's Committee on Fiscal Affairs released a report on thin capitalization, listing the thin capitalization rules adopted by countries in different forms, and categorizing the methods into two, namely the "Safe Harbor Rule " and "normal trading principles."In 1996,the 50th International Fiscal Association (IFA) proposed that the development of thin capitalization rules should be as clear as possible; it should include safe harbor rules to create a legal environment; it should allow companies to demonstrate the actual debt/ equity ratio is reasonable; thin capitalization rules should not be used as an artificial source of fiscal revenue; tax rules should be adapted to the economic conditions; high taxes and regulations should not impede the capital investments by non-residents; no discrimination is allowed when applying the laws. 2007 witnessed the development of funded enterprises in China: in this year, the domestic and foreign income taxes were finally merged into a "Corporate Income Tax Law, "while"Chapter VI of Enterprise Income Tax Law"included"Special Tax Adjustments" in the first time to regulate the thin capitalization. This means that the tax authorities have pay great attention to the issues of thin capitalization, and raised it to the height of legislation.In September the 19th, 2008, the Ministry of Finance and State Administration of Taxation issued "the corporate tax deduction standards for related party interest expense related to tax policy issues, " (Cai Shui [2008] No. 121, referred to as "No. 121".) This document provides more details in the debt / equity ratio and the exceptions: if an enterprise could provide relevant information in accordance with the"Enterprise Income Tax Law "and its implementing regulations, and prove the relevant transactions are reasonable, or if the enterprise could justify its actual tax burden is lower than that of the domestic related parties, then the amount of taxable income is deductible in the calculation.We should know that capital controls associated with thin capitalization is still not enough: because of the limited cognitive ability and infinity nature of evolving practice, the existing rules could not exhausted all the specific situations in practice, i.e., the content of the specific debt capital requirements, and the timing of determining the amount of debt capital and equity capital, and etc. It raises problems in the practice of the operation. This article is based on the present situation in China as well as the theories and experiences from other countries on this issue, and put forward a number of recommendations on thin capitalization rules.