handbook-tb

Peter A. BarnesFirst, debt may be incurred as part of the capitalization of theenterprise, in combination with equity:(a) Using debt, the initial investor increases the pool of availablecapital by bringing in additional sources of capital thatwant the comparative safety of being paid before equityinvestors receive a return;(b) Debt allows the owners to expand the business withoutdiluting control. If expansion can be funded only throughnew equity, the original owners will have a reduced stake inthe larger enterprise;(c) Economic studies have shown that the use of debt can bringdiscipline to the operation of an enterprise, resulting inlong-term improved profitability and operation.Second, debt may be incurred in connection with the purchaseof property or goods. For instance, real property may be purchasedwith a mortgage, or goods may be purchased with extended paymentterms that trigger interest on unpaid balances. In each of these situations,the lender typically has a priority right to the property or goodsas security for the loan, and therefore may be willing to extend theloan on favourable interest terms.Third, an enterprise will typically require a line of credit to provideor to support working capital. 2 This line of credit may be drawnupon, or it may simply be available for a future need.In each of these situations, the interest expense incurred in connectionwith the debt is generally treated as an ordinary and necessarybusiness expense and will be allowed as a deductible expense in computingthe taxable income of the enterprise. While these deductiblepayments “erode” the tax base of the enterprise, they are inherently nodifferent from any other ordinary or necessary deductible expenses,such as wages, rents or purchases of services and raw materials.Although the use of debt and the payment of deductible interestexpense are fully appropriate, governments are rightly concerned about2The term “working capital” generally refers to the readily availablefunds required to pay salaries, suppliers and other expenses in the ordinarycourse of business.158