handbook-tb

Peter A. Barnesyear only to the extent the enterprise incurs interest expense in thefuture year that is less than the amount otherwise allowable in thatfuture year. Such a carry-forward rule would, of course, create administrativechallenges for both government tax examiners and taxpayers.In the event there is not a carry-forward rule, then a questionarises as to how to characterize the disallowed interest payment.Should the payment be treated as a dividend in the current year? If so,would the applicable withholding tax be the rate of withholding ondividends, rather than the rate on interest? What is the tax impact ofthe recharacterization in the recipient’s country?These issues can all be answered, but they require that explicitrules be issued in order to minimize tax disputes.3.1.3.5 SummaryAs a matter of policy, it is appropriate — and consistent with internationalnorms — to deny a deduction for interest expense that is “excessive”by some measure. This tax policy parallels and reinforces non-taxlimitations on the amount of debt that an enterprise may incur. Thereare two primary methods for determining whether interest is excessive:measuring the debt/equity ratio, or measuring the interest expense asa percentage of some financial measure such as pre-tax income. Eachmethod has strengths and weaknesses, but each approach can be usefullyadopted.3.2 Interest allocable to exempt or deferred incomeIn addition to a disallowance of interest on excessive debt — however“excessive” may be defined — a related issue arises in connectionwith income that is either exempt from taxation or on which the taxis deferred. The issue arises most frequently when a taxpayer earnsincome sourced outside of the home country and the income receivesfavourable tax treatment in the home country.This is a challenging topic that could usefully be discussed atlength elsewhere; in many countries, there has been a long, highoctanedebate on how best to allocate interest that may be attributableto deferred or exempt income, especially foreign source income such172