Limiting Base Erosion

S. 3301. Introduction

Several studies reveal that in most countries interest is treated as tax deductible whilst profit distributions are non-deductible. As money is a fungible and mobile asset, companies may be strongly incentivized to finance themselves through debt (generating deductible interest) rather than equity (generating non-deductible dividends) in order to improve their tax position. It is also clear that MNEs may achieve favorable tax results by adjusting the amount of debt in a group entity.

In this regard and in order to prevent abusive practices, many countries have imposed complex interest deduction limitation rules and anti-avoidance regulations so as to both address distortions and arbitrage, and counteract the effect of those financial instruments often adopted to make economic payments equivalent to interest (in a different legal form) in order to avoid limitations on interest deductibility.

In this context, Base Erosion Profit Shifting (BEPS) risks may arise in three areas:

• groups placing higher levels of third-party debt in high-tax countries;

• groups using intragroup loans to generate interest deductions in excess of group actual third-party interest expense;

• group using...