handbook-tb

Peter A. Barnes‣ ¾ In order to secure contracts, especially from governments butalso from non-government customers, an enterprise often mustprovide a balance sheet and other financial information thatdemonstrates financial fitness;‣ ¾ Lenders often impose financial covenants that limit an enterprise’sability to borrow;‣ ¾ Rating agencies review creditworthiness with a view towardsassessing excessive debt.These non-tax limitations on debt are consistent with, but separatefrom, any tax rules that limit the ability of an enterprise to take atax deduction for interest payments on excessive debt. In some cases,the non-tax considerations will be significantly greater factors thanthe tax concerns in a taxpayer’s decision regarding how to capitalize anew investment.3. Tax considerations regarding thin capitalization andrelated concerns“Thin capitalization” is the preferred term for the condition in which ataxpayer is determined to have excessive debt and therefore excessiveinterest expense. In most cases, tax rules regarding thin capitalizationfocus on the debt owed and the interest paid to non-residents. Sincethe global financial crisis in 2008, non-tax regulators increasingly arefocused on thin capitalization without regard to whether the debt isowed to residents or non-residents.Participants in the OECD project on BEPS and outside commentatorshave identified a wide range of issues to consider withrespect to thin capitalization and related concerns. But, at core, thereare five primary areas for inquiry:(a) What is the best way to determine whether a taxpayerhas excessive debt, such that some portion of the interestexpense incurred should be disallowed either temporarilyor permanently? This is the classic problem of defining thincapitalization and is discussed in section 3.1 below;(b) A related question is how to identify interest expense thatarises in connection with exempt or deferred income. This164