The Fiscal Affairs Department of the IMF and the Directorate General for the Taxation and Customs Union held a conference on 23 and 24 February 2015 to discuss the corporate debt bias. This arises from the rule in most tax systems that interest on debt is tax deductible for companies while a dividend paid to an equity shareholder is not a tax deductible expense for the company paying the dividend.
Distortions in taxation systems tend to encourage businesses to finance their activities through debt rather than equity, creating inefficiencies. The experience of the financial crisis has increased concern that tax incentives to take on excessive amounts of debt may contribute to a crisis or make such crises more serious. The IMF Board Paper on Taxation and the Crisis came to the conclusion that the personal and corporate debt bias was not an immediate cause of the crisis but did not help matters.
Attention has also been given to corporate debt bias because interest deductibility has been identified as a significant tool used by multinationals for tax avoidance. Countries with high corporate income tax rates, which include many developing countries, are losing public revenue as a result of tax avoidance by multinationals. Also the “IMF Tax Spillover Paper in 2014” identified debt shifting as a significant element in corporate tax planning. The same line is being followed by the OECD in the action plan on base erosion and profit shifting (BEPS).
The problem of corporate debt bias is however not the same as the profit shifting being examined by the OECD. The OECD is looking mainly at the problem that multinationals can use related party debt to shift profits from one country to another, for example from a high tax to a low tax jurisdiction. This is a problem because of tax avoidance but related party debt does not make the overall group position more risky in terms of financial stability.
The problem of corporate debt bias, however, concerns the amount of third party debt taken on by a company or group. The more highly leveraged a company or group becomes in terms of third party debt the more risk there is of problems for the company during a downturn. The IMF’s Fiscal Affairs Department has been working on empirical studies concerning the impact of corporate debt bias on bank leverage. Also a book entitled “Taxation and Regulation of the Financial Sector” was published in December 2014, edited jointly by staff at the IMF and TAXUD. This looks at issues impacting finance and public finance, such as the issue that countries have capital requirements for banks to encourage equity finance but the tax system gives the banks an incentive to acquire more debt.
Many countries are looking at the issue of corporate debt bias in their own taxation systems. Belgium and Italy have already taken some legislative action to reduce the effects of debt bias by an allowance for corporate equity and other countries such as the US and Germany have introduced restrictions on interest deductibility. The G20 Finance Ministers are intending to discuss the issue of corporate debt bias in their meeting in September 2015.
Discussions at the conference concerned issues such as the possibility of an allowance for corporate equity to tackle debt bias, and how this could be framed so that there is no loss of tax revenue to the government. There is also the question of how taxes and regulatory provisions shape the structure of financial institutions when it comes to decisions such as the formation of a branch or subsidiary in a particular jurisdiction and in which jurisdictions to locate them. The influence of taxation and regulation on financial stability still requires study and is important for the design of tax policy.
