Limits to Tax Planning

S. 281 1. Parameters for limiting the deduction of interest

1.1. The trade-off between debt and equity

In general, a shareholder has the choice of financing its company with equity, debt (loan) or by a combination of equity and debt. Financing decisions are in the first place an economic issue, which has to be solved by minimising capital cost, including the tax burden of the individual alternatives. The tax deductibility of financing cost for debt-financing is one of the central aspects of international tax planning. The capital structure of companies can be seen as a trade-off between the positive effects of income tax-reducing interest deductions from debt financing (tax shield) and the agency cost of debt, which go up with higher debt levels, thereby triggering the necessity that part of the activity is financed by equity.

In free market economies, there are almost no restrictions in corporate law on financing, except possibly of manageable minimum equity requirements, which typically triggers a tendency to use debt financing as the preferred type of financing.

1.2. Taxation of Interest and Dividends

1.2.1. Missing neutrality

There is no financial neutrality between the taxation of intere...