Thin Capitalisation Rules: A Second-Best Solution to the Cross-Border Debt Bias?

Abstract

One of the most significant trends in the evolution of global tax systems has been the rise from relative obscurity of thin capitalisation rules, which are perceived as anti-avoidance rules which limit tax base erosion from cross-border interest deductions. However, over the same timeframe, innovations to financial instruments have challenged the traditional financial and legal distinctions between debt and equity, which in the cross-border setting has exposed the prevalence of economic inefficiencies in the design of the international tax system.

Implementing OECD BEPS Action Plan 4 in Indonesia, a comparative study with Malaysia

“…Limiting interest using a fixed ratio benchmark based on EBITDA according to OECD recommendations is considered more effective in preventing tax avoidance through deducting interest (Jayasupana, 2017;Kayis-Kumar, 2015;Rulman, 2017;Zaina, 2017) . However, currently, Indonesia still applies restrictions on interest based on thin capitalization.…”

“…However several other studies assume that the thin capitalization rule method currently in force in Indonesia is not effective in preventing tax avoidance practices through interest deduction (Faisal & Rosid, 2022;Sari et al, 2023). This could be because the use of a thin capitalization rule based on the DER ratio will simply encourage companies to maximize debt levels up to the specified DER limit, instead of preventing the erosion of the tax base (Kayis-Kumar, 2015). Several existing studies also show that limiting interest based on OECD recommendations in BEPS Action Plan 4 is a more effective approach in preventing tax avoidance (Jayasupana, 2017;Kayis-Kumar, 2015;Rulman, 2017;Zaina, 2017).…”

“…This could be because the use of a thin capitalization rule based on the DER ratio will simply encourage companies to maximize debt levels up to the specified DER limit, instead of preventing the erosion of the tax base (Kayis-Kumar, 2015). Several existing studies also show that limiting interest based on OECD recommendations in BEPS Action Plan 4 is a more effective approach in preventing tax avoidance (Jayasupana, 2017;Kayis-Kumar, 2015;Rulman, 2017;Zaina, 2017).…”

“…In the ASEAN region, Malaysia is one of the countries that has implemented OECD recommendations in BEPS Action Plan 4 since 2019. Limiting interest using EBITDA based on OECD recommendations is considered more effective in preventing tax avoidance through deducting interest (Jayasupana, 2017;Kayis-Kumar, 2015;Rulman, 2017;Zaina, 2017). In 2019, the effective rate of Corporate Income Tax in Malaysia was 24% (PWC Malaysia, 2023) .…”

“…On the one hand, existing research results show that limiting interest based on OECD recommendations in BEPS Action Plan 4 is a more effective approach in preventing tax avoidance ( Jayasupana, 2017;Kayis-Kumar, 2015;Rulman, 2017;Zaina, 2017) . However, on the other hand, there are still several obstacles faced by Indonesia in implementing the method as recommended by the OECD (Puspitasari, 2022;Rosid & Dahli, 2019) .…”