Should we end tax deductibility on business interest payments? FT readers respond


Two legal experts, Victor Fleischer and Jonathan Blake, went head-to-head last week on the question of whether we should scrap the tax deductibility of business interest payments. 

Mr Fleischer argued for ending the relief as a way of cracking down on growing leverage in the corporate sector. He stressed that debt-financed investments encourage the funding of wasteful projects and increase the risk of bankruptcy in bad times. Mr Blake countered that companies benefit from employing prudent levels of debt, and it makes more sense for companies to pay taxes on their profits, after deduction of legitimate expenses including interest payments.

Dozens of FT readers joined the debate in anonymous online comments and emails to the editor. They largely supported abolishing the relief, and suggested reforms to make borrowing less attractive relative to equity, ranging from more accessible company share schemes to creating a notional interest deduction that creates tax benefits for equity.

Here’s an edited selection of what you had to say. 

Avoid ‘imprudent’ levels of debt

Claiming that companies are well-advised to have “prudent levels of debt” recognises that there can be “imprudent” levels of debt, writes The Guv’nor.

The problem is that extraordinarily low interest rates, artificially depressed since before the 2008 financial crisis and further artificially influenced since Covid-19, have encouraged many companies to take on imprudent levels of debt. The lack of resilience that this has led to is resulting in corporate collapses, and more will go under in future years, or survive but only as zombies without the ability to reinvest and succeed.

Building what needs to be a future that favours resilience and offers prosperity for the long term must include tackling issues that disincentivise prudent management and encourage resilient capital structures.

READ  Electric vehicle study sees opportunity for utilities

That would require removing tax deductibility of interest payments, or at least much more robust capitalisation regimes. These would address the extraction of profits through interest payments and similar mechanisms such as royalties and licensing fees. It would also necessitate a return to a more rational interest-rate regime.

A question of big and small government

Small business owners see profit as what’s left after you pay all expenses, including interest, says Common Sense. They’re worried about borrowing, because they’re afraid of the bank. To them, interest should be a deductible, as it is now.

Big business — especially public companies — doesn’t see it that way. Especially since the 1980s, they have wanted to leverage the value of equity by optimising the “tax shield” that accompanies debt payments, conveniently renamed “leverage”.

To them equity, debt and taxes are just different ways of sharing the value created by the operating profit. It makes no sense to [tax companies differently based on their ownership structure]; thus, this reasoning justifies taxing profit before interest, and not after.

This doesn’t imply paying more taxes as long as the tax rate is readjusted. So, it’s a discussion about big/small government.

Ending the tax deductibility of interest payments, forbidding companies that have too much debt to pay dividends, banning share buybacks, and taxing profits in the country in which the service is offered (and not in some shady headquarter jurisdiction) are necessary to sanitise the financial markets.

Apply universal gearing limits with caution

According to iota, we have to be careful in applying gearing limits universally. Infrastructure assets are often highly geared but at no risk to the business since they have [long-dated] contracts with creditworthy counterparts. The use of high debt levels has the effect of reducing the cost to the consumer of building these assets and is wholly beneficial.

READ  The 5 best weekend deals you can get on Amazon

This reader believes the article goes astray in talking about writing down allowances (or tax depreciation) and the fact that these occur faster than their accounting equivalents. That has nothing to do with debt levels, and it is entirely within the purview of a country’s tax authorities to amend as they see fit (which they do quite frequently).

Open up company shares 

One key point is missed in the experts’ debate, says Nigel Mason. Tax-deductible interest is a direct subsidy from taxpayers (in foregone tax revenue) to existing owners of capital (in magnified returns to shareholders).

Subsidised debt is one of the main drivers of the ever-concentrating ownership of company shares. In his reviews of the tax system, UK chancellor Rishi Sunak should look at policies to reverse this trend. Encouraging broad-based employee ownership schemes and increasing mandatory company contributions to workers’ pensions are but two candidates.

Driving global wealth inequality

Vito Tanzi lists several reasons why the question of interest as a tax-deductible expense for enterprises is so important right now.

First, the global financial market, the existence of tax havens and the trillions of money held in anonymous foreign accounts has made it far easier than in the past for an enterprise to borrow from connected entities located in tax havens.

Second, the pandemic has made it clear that holding more equity reduces risk and leads to lower unemployment rates in difficult times. A corporation with a lot of debt is more exposed to the risk of bankruptcy, and is more prone to adjusting its workforce, creating more unemployment.

READ  The Jobs We Need

Third, very cheap credit, made available by central banks, disproportionately helps large corporations more than small non-corporate enterprises, distorting the nature of investment.

Fourth, the compensation contracts created by chief executives of large corporations often tie the compensation to the value of the shares. This encourages managers to borrow in order to buy back the shares of their own companies [boosting the price of the remaining shares], rather than to make real investments.

Finally, creating untaxed capital gains contributes to the growing wealth inequality that exists today.

Introduce a notional-interest deduction

Timo Leiter believes that while it’s true that dividends are a major cost factor of equity, there is one crucial difference. A company’s decision on whether to pay dividends — and how much — is far more flexible than interest payments on debt.

A more balanced approach, where equity cost is tax deductible, may level the playing field. One option is being discussed in the EU is a notional-interest deduction. This allows companies to deduct a market-based percentage of its equity from its taxable profits, giving them an incentive to increase their [use of equity versus debt] and thus strengthening their resilience.

The principality of Liechtenstein introduced a NID-regime 10 years ago and research by [Mr Leiter’s] former thesis adviser, Simon Busch, has shown that the desired effects have occurred since then. Switzerland adopted it, as have some EU-states, including Belgium. Others should, too.



READ SOURCE

LEAVE A REPLY

Please enter your comment!
Please enter your name here