handbook-tb

Limiting interest deductionspartially or wholly exempt. The country from which the dividend ispaid may levy a withholding tax on the dividend, representing a taxon the shareholder.Although it is often clear that a particular instrument shouldbe classified as debt or equity — and, therefore, the proper tax treatmentfor payments on that instrument can be readily determinedunder the applicable tax laws — there are some instruments in respectof which the classification is less certain. For instance, an instrumentmay provide for fixed payments of interest but also provide for a shareof profits, in the event the profits exceed a certain level. It is beyond thescope of this chapter to discuss the variations in financial instrumentsthat exist today (and new instruments are being designed regularly byfinancial engineers), but it is important to acknowledge that determiningwhether a particular payment is “interest” for tax purposes is notalways easy.A most difficult issue for tax officials seeking to preventimproper tax base erosion and profit shifting is the proper treatmentof hybrid instruments: financial instruments that are treated as debtby one taxing authority but as equity by another. Hybrid instrumentsare the subject of Action 2 of the OECD Action Plan on BEPS andare dealt with in chapter V on neutralizing effects of hybrid mismatcharrangements.1.2 Use of debt by taxpayersThe availability and use of debt is widely recognized as an importantelement of a healthy business environment. Indeed, a lack of creditcan deter economic growth. This point is illustrated by the efforts ofgovernments today to ensure that increased regulation of financialinstitutions is balanced against the need for these institutions to lendreadily to growing businesses. The importance of credit is also illustratedby the wide support for microlending and other programmes toextend credit markets to small businesses (including individuals) indeveloping countries as a means for generating economic growth.For a business, the availability of debt is often essential togrowth. There are several reasons why an investor may need to borrowfunds to grow a business (and, accordingly, make interest payments).157