The Research On Tax Law’s Regulation Of Thin Capitalization

The definition of thin capitalization is that it is a behavior which aims at taxavoidance by changing the capital structure of the corporation which leads tocreditor’s investment is much higher than shareholder’s investment without any goodreason. There are several theory bases for tax avoidance by thin capitalization. Fromthe view of economics, it includes the essence of corporation which is seekingprofits, the theory of capital structure that the increase of creditor’s investmentmeans the increase of the corporation’s value and the reason of the related design ofcorporation’s institution of accounting. From the view of law, reducing thecorporation’s amount of payable tax and the risk of bankruptcy are the motives of taxavoidance by thin capitalization, and the tax reason is the key point. From the viewof others, it mostly includes that thin capitalization can reduce the cost of theoperation which excludes tax cost, the risk of operation and strengthen the fluidity ofthe capital, and there are some other corporations which have to weaken the capitalbecause of no choice.Thin capitalization does great damage to country’s taxing power, corporation’soperation right and competition right, creditor’s right, shareholder’s right,employee’s right and so on. So, it is necessary to regulate thin capitalization. The taxlaw’s regulation of thin capitalization is based on the principle of ability-to-pay, theprinciple of material imposition and the principle of tax neutrality.In the course of regulating thin capitalization, the subject of the appliance, therange of the appliance, the method of the appliance and the result of the applianceare the aspects which are deserved to be discussed deeply.From the angle of subject, in order to avoid a wide regulation scope, we shouldlimit it in related sides. And we should draw up a proper standard for relatedrelationship according to different national conditions. Laws in our country have setthree standards which are the percent of stock, the relationship of the people and other standards on it. But most people think the standard is too strict for thetaxpayers, and it is not good for corporation’s operation. Concerning the scope ofrelated sides, most countries have already expanded it from foreign investors to allinvestors. They do not treat domestic investors and foreign investors differently.From the angle of range, the different limitation of creditor’s investment andshareholder’s investment means the dynamics of regulation. The definition ofcreditor’s investment is that the loaner lends money to the corporation, and getsinterest regularly, and gets capital back at last. It not only includes mid-term andlong-term loans and bonds, but also includes the creditor’s investment which isguaranteed by related sides, back-to-back loans, the payable fund of financial leasingin the situation that the ownership of the lease belongs to the lessee and the subjectsare related and so on, but it excludes interest-free loans and short-term loans. Thedefinition of shareholder’s investment is that it is a kind of investment which aims atpossessing the corporation’s net assets, taking part in corporation’s operationstrategy and having the right of profit distribution. It usually includes capital stock,accumulation fund, reserve, carry-over income and so on. According to the principleof material imposition, hybrid financing instruments and short-term equity should beincluded too.From the angle of method, it comprises arm’s length approach, fixes ratioapproach and profit stripping approach. Most countries use the first two approachestogether. In fixes ratio approach, countries use different methods to calculatecreditor’s investment, shareholder’s investment and the specific ratio. At the sametime, the specific ratio reflects the dynamics of regulation.From the angle of result, the interest is not deductible when it is not investedconforming to arm’s length principle or the ratio of creditor’s investment is muchmore than the statutory ratio. Most countries agree with that, but they haven’t drawna final conclusion on the nature of the surpassed interest. In international tax law’scategory, in order to avoid divergence of taxing power’s distribution, most countriesmake a clear rule on the nature of the surpassed interest in the tax convention. Whilein the domestic law’s category, countries regulate differently, and this leads to adivergence when it is carried out, especially in international trade. In China’s tax law, the subject is divided into two parts. One is domestic related sides whose tax burdenis higher than the corporation’s, and the other one is foreign related sides. It is easyto see that the situation of domestic related sides whose tax burden is not higher thanthe corporation’s is missing. At the same time, this classification violates theprinciple of discrimination, so it is the part we should improve.