Taxing multinationals: preventing tax base erosion through the reform of cross-border intercompany deductions

Abstract

Thin capitalisation rules are widely perceived as an anti-avoidance mechanism that limit tax base erosion from cross-border intercompany activities. Despite this perception, the legal basis for these rules does not reconcile with the economic basis, because these complex and ad-hoc rules present only imperfect solutions to the problem of the debt bias . The economic literature generally assumes that a fundamental reform eliminating the debt bias would also eliminate the need for thin capitalisation rules. However, the current paradigm of the debt/equity all-or-nothing approach overlooks the fungibility of intercompany capital flows. Accordingly, this thesis introduces the concept of cross-border funding neutrality , which is utilised in conjunction with other criteria as a rubric for the subsequent practical- and conceptual-level analysis. In doing so, this reform-orientated thesis bridges the gap between pure economic theory, practical optimisation modelling and applied legal research. This research consists of both a legal comparative analysis featuring case studies of the Belgian and Italian ACE-variants and the Australian thin capitalisation rules, as well as a simulation analysis of a tax-minimising multinational enterprise s behavioural responses to existing and proposed tax regimes. By simulating cross-border intercompany tax planning scenarios the model developed makes the invisible visible . This leads to the novel finding that, in order to minimise opportunities for cross-border tax planning by MNEs, it is necessary for governments to equalise the tax treatment of fungible intercompany funding activities. Even though obtaining full tax neutrality is nearly impossible without international tax coordination, the measures proposed and tested in this thesis provide second-best alternatives that may be more effective at eliminating opportunities for cross-border tax planning than existing policy responses even when applied unilaterally. This dissertation makes a significant contribution to both tax law and policy analysis. The challenge it presents to conventional understandings of thin capitalisation rules, and the tax treatment of cross-border intercompany activities in general, reveals new insights into the importance of applying economic first-principles in tax design. The law in this dissertation is at December 2016.