Debt Shifting and Thin-Capitalization Rules – German Experience and Alternative Approaches

Abstract

This paper presents the general design of thin-capitalization rules and summarizes the economic effects of such rules as identified in theoretical models. We review empirical studies providing evidence on the experience with (German) thin-capitalization rules as well as on the adjustment of German multinationals to foreign thin-capitalization rules. Special emphasis is given to the development in Germany, because Germany went a long way in limiting interest deductibility by enacting a drastic change in its thin-capitalization rules in 2008, and because superb German data on multinational finance allows for testing several aspects consistently. We then discuss the experience of the Nordic countries with thin-capitalization rules. Briefly reviewing potential alternatives as well, we believe that the arm’s-length principle is administratively too costly and impracticable, whereas we argue that controlled-foreign-company rules might be another promising avenue for limiting internal debt shifting. Fundamental tax reforms towards a system with either "allowance for corporate equity" (ACE) or a "comprehensive business income tax" (CBIT) should also eliminate any thin-capitalization incentive.

On the Interdependency of Profit Shifting Channels and the Effectiveness of Anti-Avoidance Legislation

“…Existing studies in this area consider profit shifting channels separately and find that thin capitalization rules or transfer pricing regulations are strongly effective at limiting profit shifting via the respective channel. It is puzzling, however, that the measured effectiveness and the suspected increase in the cost of capital (Ruf and Schindler, 2015) does not seem to entail negative side effects on investment (Weichenrieder andWindischbauer, 2008, Buslei andSimmler, 2012). One exception is Buettner et al (2017) who identify negative investment responses for thin capitalization rules but not for transfer pricing rules.…”

The impact of thin‐capitalization rules on the location of multinational firms’ foreign affiliates

“… Ruf and Schindler () as well as Dourado and De la Feria () provide surveys on TCRs. They distinguish between different types of TCRs: some countries have implemented specific, others have implemented non‐specific TCRs.…”

Double tax discrimination to attract FDI and fight profit shifting: The role of CFC rules

“…Typically, CFC rules stipulate a minimum effective tax rate τ j that must be levied in a host country, in order to avoid additional taxation in the parent country. This instrument applies to both the internal debt within 14 See Ruf and Schindler (2015), sections 2.1 and 3.1 for a detailed discussion of these strategies. In line with these arguments, empirical studies indicate that many MNCs are able to deduct interest payments in excess of the limitations imposed by thin-capitalization rules; see, e.g., Blouin et al (2014).…”