handbook-tb

Limiting interest deductionsissue most frequently occurs in connection with a taxpayerthat earns foreign source income that is taxed favourably inthe taxpayer’s home country. Although the interest expensemay not be excessive, allowing a current deduction for theinterest expense may improperly erode the tax base. Thisissue is discussed in section 3.2 below;(c) Should certain types of debt (and the associated interestexpense) be treated differently from other types of debt withrespect to tax deductibility? Or, should all of a taxpayer’sdebt and interest expense be considered as a single tax itemfor deductibility or limitation? These issues are discussed insection 3.3 below;(d) Is related-party debt particularly susceptible to abuse, suchthat related-party debt and the associated interest expenseshould be subject to special limitations? If limitationsare deemed appropriate, how should those limitations bedesigned? This concern is discussed in section 3.4 below;(e) What role can withholding taxes play in preventing erosionof a country’s tax base in connection with cross-borderpayments of interest? This matter is discussed in section3.5 below.In discussing these important issues, this chapter seeks toemphasize the competing considerations that could be taken intoaccount to prevent erosion of the tax base while ensuring availabilityof credit to support and grow business activities.3.1 Determining whether a taxpayer has excessive debtTax laws in a country generally do not — indeed, cannot — forbid anenterprise from having an excessive level of debt, however that limitmay be defined. Rather, other government agencies may impose (andmeasure whether an enterprise exceeds) acceptable levels of debt.Tax rules, however, frequently limit the amount of interest thatmay be deducted by an enterprise in determining its taxable income.These limitations are valuable, because they backstop and help enforcenon-tax rules that restrict excessive debt. Moreover, they prevent taxpayersfrom incurring so much debt that the relevant tax base is eroded.165