Thin capitalization pdf

Tax savings in high-tax countries can exceed the increased tax paid in low-tax countries, decreasing worldwide tax liability. To discourage this form of international debt shifting, many countries have implemented so-called thin-capitalization rules thin-cap rules , which limit the amount of interest a multinational business can deduct for tax purposes.

Interest paid on debt exceeding this set ratio is not tax-deductible. Earnings stripping rules limit the tax-deductible share of debt interest to pretax earnings. Four of 27 countries covered have only a debt-to-equity ratio in place. Most of the European countries covered have interest-to-pretax-earning limits in place. It is important to keep in mind that thin-cap rules not only limit international debt shifting but can also impact real economic activity , such as investment and employment.

Czech Republic CZ. Slovak Republic SK. United Kingdom GB. Log in with Facebook Log in with Google. Remember me on this computer. Enter the email address you signed up with and we'll email you a reset link. Need an account? Click here to sign up. Download Free PDF. Concept of Thin Capitalisation - An overview. Karnik Gulati. A short summary of this paper. Source of Financing cost Tax treatment for Typically, a finance mix of capital structure depends finance the payer upon various factors like economic factors, Equity Dividend Non-deductible commercial factors, ease of availability, etc.

It is mainly applied to bourn the debt financing cost interest which is a tax-deductible expenditure in most countries. India, at present, does not have any specific thin The anti-avoidance mechanisms are capitalisation mechanism.

However, recently introduced mainly applied, either by introducing a GAAR mechanism though not yet implemented , vide specific anti-avoidance rule SAAR or Section 98 of the Income-tax Act, , mentions: one of the six consequences of impermissible avoidance by introducing a general anti- arrangement is that the transaction may be re- avoidance rule GAAR.

The above characterized from equity to debt or vice-versa; which mentioned countries have denotes that thin capitalisation mechanism would implemented thin capitalisation indirectly come within the ambit of GAAR. Karnik Gulati Concept of Thin Capitalisation- An overview have introduced specific thin capitalisation legislation. An entity is typically financed through a mixture of debt and equity.

This is the praxis in most countries around the world, including India. Author of this article can be reached at cakarnikgulati yahoo. Karnik Gulati Concept of Thin Capitalisation- An overview Impact of capital structure on taxable profits — Comparison Following example brings to light the impact that a capital structure has on taxable profits: Debt-equity Ratio S.

It is often seen that entities located in high-tax jurisdictions, for gaining tax advantages, borrow more than necessary, or borrow at higher interest rates, from their affiliates located in no-tax or low-tax jurisdictions, so as to indirectly shift the profit in such no-tax or low-tax jurisdictions.

Countries implementing this approach include the United Kingdom. B Fixed ratio approach: Under this approach, the maximum amount of debt, In nutshell, the allowable debt on which interest may be deducted for tax purposes, portion shall be calculated using a pre-determined ratio, fixed by the is established by a pre-determined ratio, such as the tax authorities on some reasonable ratio of debt to equity.

The ratio s used may or may basis. Thus, interest on debt portion, which is in excess of thrice the level of equity, shall not be allowed for tax purposes. Therefore, on application of thin capitalisation rules of Country A, the interest on debt of 20 will be disallowed, i. Assume there is no depreciation and amortisation charge in the current year.

The resultant taxable profit of Company Y thus becomes 14