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Corporate Taxation in Developing Countries: Facts, Principles, and Competition


Title: Corporate Taxation in Developing Countries: Facts, Principles, and Competition Author: LAPUNOVA Tatjana (TAXUD) Last modified by: LAPUNOVA Tatjana (TAXUD) – PowerPoint PPT presentation

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Title: Corporate Taxation in Developing Countries: Facts, Principles, and Competition

Debt Bias Conceptual Analysis of the Issue
EC IMF Conference on Corporate Debt Bias 23
24 February 2015 Brussels Ruud de
Mooij Views are authors alone, and should not
be attributed to the IMF, its Executive Boards,
or its management
  • Corporate debt bias
  • What is the issue?
  • How big is the bias?
  • Why do we have a bias?
  • Should we care?
  • Policy options
  • Specifics of debt bias in the financial sector
  • How different is it?
  • Should we care more?
  • Policy options

Debt Bias
  • Two distinct issues
  • Bias in corporate financial structures
  • Multinational debt shifting

Bias in corporate financial structures
Corporate Level Personal Level
Debt Tax deductible for CIT Exempt Taxable at PIT
Equity Not tax deductible for CIT Exempt Taxable at PIT - dividend tax - capital gains tax
Cost of Capital Debt versus Equity
PIT Exempt Investor
PIT Taxed Investor (top PIT)
Multinational Debt Shifting
Parent (home) Subsidiary (host)
Debt Interest taxable at home-country CIT Interest deductible
Equity Dividend exempt (most EU countries) Profit taxable at host-country CIT
Coefficient of variation in CIT rates
Debt Bias
  • How big is effect on
  • corporate financial structures?

Multinational Debt Shifting
Source Hebous and Ruf (2015)
Empirical literature debt bias / debt shifting
  • Studies usually estimate D/A aßt?Xe
  • Variation in t over time, among firms within a
    country, or cross-country variation
  • Usually for non-financial firms only
  • Both internal and external debt
  • Summary of 19 studies 267 estimates
  • Most report marginal effect of t on D/A (ß)
  • Elasticity better comparable e d?(D/A)/d ta
  • R.A. de Mooij, The Tax Elasticity of Corporate
    Debt A Synthesis of Size and Variations, IMF WP

Summary of empirical findings
Main findings of literature
  • Consensus of marginal impact coefficient is 0.28,
    i.e. raising CIT rate by 10 pt will increase
    debt/asset ratio by 2.8 pt, e.g. from 50 to 52.8
  • Effect increasing over time, e.g. effect today is
    50 percent larger than in mid 1990s
  • Response of intracompany debt not significantly
    different from external debt

Debt Bias
  • Why do we have a bias?
  • Accounting
  • Administrative
  • Legal
  • Economic

Its the accountants fault!
  • Interest on debt is seen as genuine cost of doing
    business deductible from income
  • Equity returns are no business costs, but reward
    for owner should not be deductible
  • Intracompany debt under separate accounting, for
    each transaction within a MNC there is an
    equivalent external arms length

Administration why CIT in the first place?
  • One could tax corporate returns at individual
  • Interest taxed at PIT deductible for CIT
  • Dividends taxed at PIT imputation of CIT
  • Capital gains can be taxed at PIT, but
  • CIT administratively appealing as WHT, yet
  • imputation systems disappeared
  • internationalization breaks links

Legal what distinguishes debt from equity?
  • Debt
  • yields fixed return
  • has limited maturity
  • has prior claim
  • has no voting right
  • Equity
  • yields variable return
  • has unlimited maturity
  • has residual claim
  • gives voting right
  • But
  • No dichotomy between debt equity hybrids blur
    distinction demarcation rules vary
  • Intracompany debt is there any difference
    between debt holder and equity owner?

Economic theory of second best
  • Modigliani-Miller
  • Firm value independent of debt/equity ratio no
    unique optimal choice of debt
  • Imperfect capital markets
  • Information asymmetries bankruptcy cost, agency
    costs signaling ? debt bias raises risk premia
  • Imperfections in debt markets might be worse than
    in equity markets?
  • Debt might be more/less mobile than equity?
  • ? No general direction for the required
    correction in second-best

Summing up
  • Discrimination between debt and equity originate
    from accounting principles, but
  • have no administrative appeal on the contrary
  • have an increasingly problematic legal base
  • induces significant arbitrage risks
  • have no clear economic rationale perhaps the
    opposite (too high risk premia)

Debt Bias
  • Should we care?

Welfare costs of debt bias
  • Using trade-off theories
  • Triangles might be small Weichenrieder-Klautke
    (2008) Sorenson (2014)
  • Externalities can magnify them rectangles
  • Business cycle magnify shocks
  • Externalities of excess debt ? Financial Sector
  • Arbitrage administration and compliance

Debt Bias
  • Policy Options
  • Treat all returns as we currently treat equity
  • Treat all returns as we currently treat debt

Comprehensive Business Income Tax
  • Deny interest deductibility
  • Consistent with comprehensive income tax
  • Base-broadening allows for rate reduction
  • Problems complexities
  • Higher cost of capital
  • Requires special regime for banks
  • International mismatches
  • Transitional regime for pre-existing debt

Restrictions to mitigate debt shifting
  • Deny deductibility of certain types of interest
  • Arms length
  • Thin cap rule (TCR) D/E ratio
  • Earning stripping rule interest cap
  • Do not generally address debt bias
  • 2/3 of all TCRs apply to internal debt only
  • Usually a (very) high threshold
  • Often do not apply to financial sector

ACE the love baby in public finance
  • Neutrality properties
  • Consumption tax neutral to investment
  • Neutral to debt/equity depreciation rules
  • Practically feasible
  • Experiences in Croatia, Austria, Italy
  • Now operational in Brazil, Belgium, Italy
  • Potentially costly
  • 10 15 percent of CIT revenue of full ACE, but
  • not in short-run if incremental (Italy)
  • not in long-run if economic benefits are large

ACE Design
  • Base of the ACE
  • Initial equity base zero (BEL) or base year
  • taxable profit - CIT payable
  • dividends received - dividends paid
  • net new equity issues
  • net revenue from sale/purchase of shares in
    other companies
  • x
  • Rate of the ACE
  • (risk-free rate of return)

Debt Bias in the Financial Sector
  • How different is it?
  • Should we care more?
  • Policy options

Debt Bias in the Financial Sector
  • How different is it?

How different do we expect banks to be?
  • M. Keen Ruud de Mooij, 2015, Debt, Taxes and
    Banks, JMCB (forthcoming)
  • Banks face regulatory capital requirement
  • Hybrids are particularly important for banks
  • Banks enjoy (implicit) insurance
  • Yet
  • Banks generally hold buffers well above
    regulatory minima room for tax bias
  • Banks may already exploit hybrids fully
  • Unclear how corporate governance affected

Findings from (small) recent literature
  • Response average bank average non-bank
  • But
  • Effect is on hybrid debt negligible
  • Response banks with higher buffers bigger
  • Response by largest banks is smaller (Fig)
  • MNC banks shift debt to low-tax affiliates
  • Should we care (more) about all this?

Empirical findings banks of different size
Source Jost H. Heckemeyer and Ruud A. de Mooij
Should we care more?
  • R.A. de Mooij, M. Keen and M. Orihara, 2014,
    Taxation, Bank Leverage and Financial Crisis,
    Volume MIT Press
  • Three-stage estimate of the macro-economic cost
    of debt bias in financial sector
  • Impact of bias on aggregate bank leverage
  • Impact of average bank leverage on probability of
    financial crisis (highly non-linear see Fig)
  • Impact of crisis on GDP / Public debt

Social cost of debt bias in financial sector
But a lots of unknowns still
  • on taxation and bank behavior
  • E.g. MNC choice of subsidiaries vs branches
  • Why does size matter?
  • Importance of shadow banks
  • on taxation and financial stability
  • Small response big effects?
  • Hybrids effects on risk?
  • Interaction regulation taxation
  • Cross-border spillovers of taxation

Debt Bias
  • Policy Options ?
  • Bank levies EU experiences
  • Thin-cap / regulatory cap
  • ACE for banks e.g. UK debate
  • Radical reform CBIT RF base