Research On The Application Of Arm’s Length Principle In Thin Capitalization Regime

"Thin Capitalization" is an approach of international tax avoidance where inorder to give rise to the pre-tax deduction and reduce the tax burden; a corporationincreases the proportion of debt capital to weaken equity capital in its capital structure.Both tax factors and none-tax factors contribute corporations to take the approach,and the key factor of which is the interest payable to debt capital is allowed to bededucted before tax. Although thin capitalization belongs to a relative youngerapproach among various kinds of tax avoidance, the harm isn’t less. In principle, thebehavior violates the principles of fairness and neutrality; and in practice, it alsoseverely damages the legitimate rights and interests of some parties which concludethe source country and the resident country etc. Some effective rules have been madeto regulate the behavior all over the word, such as the “ratio approach” and the “arm’slength approach”. In the meanwhile, there leaves much room for improving all therules. Research on thin capitalization has been a key direction in the field ofinternational taxation.Many outstanding achievements have been achieved in the field of researchingthin capitalization regime, while most of the results are based on an overallframework, which makes these achievements too general. Many specific points ofthin capitalization regime is rarely researched. For example, taking the application ofarm’s length in thin capitalization regime as a sole perspective is hardly been found, but it is a very important issue in thin capitalization regime. Although there still existssome questions about whether arm’s length principle can be applied to regulate thincapitalization behavior, its effect has been examined in the actual practice of anti thincapitalization. Therefore, the author will pay the research to the application of arm’slength in thin capitalization regime and attempts to achieve some further results.This article consists of three parts. The first part will start with an overview ofthin capitalization, which concludes the definition, the cause, the damages and themain regulations. The second part will specifically introduce some major theoriesabout the application of arm’s length principle in thin capitalization regime, whichwill refers to the definition, source, the merit and disadvantages of arm’s length, somequestions about its application, the main applying ways and its tax treatment. Thethird part will elaborate some specific regime where applying the arm’s lengthprinciple to regulate thin capitalization including OECD, English, Germen, France,Australia and China. In the meanwhile, the author will cite some typical cases tofurther examination. Based on these, the author will put forward some suggestions inorder to promote the application of arm’s length principle in thin capitalization regime,such as advance thin capitalization agreements etc.