So, what happens if we eliminate tax deductibility of interest for companies?

There’s some tax bods who actually know their stuff who read here. And so, what’s the opinion?

Jeb Bush has in his tax proposal said two things.

1) Abolition of capital allowances: all investments get fully expensed in the first year.

So, the way I read that you buy $ squillion worth of machinery for the factory, machinery that will last 30 years, and $squillion is a cost in this first year to deduct from revenues to lead to taxable profits.

OK, interesting but that should only affect the timing of tax bills (ie, delay them) rather than anything else. True, a highly profitable and swiftly expanding business will pay no profits tax until it stops expanding, but perhaps that’s no bad thing.

2) Eliminates the tax deductibility of interest. Now, the plan says this is necessary as part of 1) because allowing deductibility would be a double benefit to a corporation or business. And that’s where I’m mystified. I can’t see the double benefit. And more, ending the deductibility seems to me to be a wrenching change. Leasing gets hit pretty hard, real state development is pretty much all debt funded isn’t it?

Further, if interest paid is not deductible then it shouldn’t be taxed at the recipient end either. But they’ll tax it at 20%.

Now, I don’t actually know enough here to work it out. But that looks like a huge change to me. And it’s also a change that no one seems to be talking about. So, would any of you tax bods care to explain to me why it’s nothing much, something huge, what the effects are?

Sure, in theory whether business is funded by debt or equity is a wash. But in reality?

12 thoughts on “So, what happens if we eliminate tax deductibility of interest for companies?”

  1. The result of non-deductibility of interest would be to discourage the 10,000% gearing which would be attractive if you had all investment tax-deductible in Year one.

  2. Wasn’t it the tax deductibility of interest that made it advantageous for companies to gear up, at least according to Modigliani and Miller. To remove the tax advantage of debt is more of a corporate treasury effect. All those leveraged buy-outs and private equity firms are going to have a whole new risk profile. Corporate bond markets and take over activities will be radically altered. Companies will have to reassess their capital structures, probably reducing bond issues and increasing equity. This flows through into the pension funds.

    The impacts are probably going to be massive.

  3. I’ve heard a fair few people musing over the idea. It seems to be broadly about levelling the playing field between debt and equity funding.

    Income from equity, of course, is taxed on the recipient without there being any tax relief for the payer, so there’s no distinction there between the proposed asymetric treatment of debt interest.

    I’m nowhere near qualified to say whether it’s a good or bad idea. But if you want companies to raise more money on equity markets than debt markets then it’s a good plan. But as an investor I rather like that there are large (albeit expensive) markets for both. I wouldn’t want the only option for a secure return to my portfolio to be government debt.

    On the other hand, if I am invested in a company and it wants to do something stupid (e.g. buy a massive Dutch bank to compensate for some CEO’s tiny penis issues) then I quite like the idea that they might be more reliant on going back to their shareholders and asking nicely if they want to fund the deal.

  4. I don’t know anything about tax but I do about real estate. It would certainly hurt developers’ margins and be more damaging to smaller firms but it would cripple real estate private equity funds which typically run with 40-70% leverage (sometimes more).

  5. “Now, the plan says this is necessary as part of 1) because allowing deductibility would be a double benefit to a corporation or business.”

    They are completely separate. This is obvious if one considers that a company might borrow simply to fund working capital rather than to purchase assets. Ie, one would have the hit relating to 2) but without any benefit from 1).

    If it’s carried out standalone by one country, it could be a material enough disincentive to investing in that country versus another.

    In that it’s not unreasonable for a company to want to borrow in the same jurisdiction / currency in order to manage risk and currency exposures. Are the Canadians supporting Jeb on this one?

    And, if it is intended to be linked, then unless this was going to be introduced purely for new lending transactions, there is a potential mismatch in terms of part of it being retrospective, ie the historic borrowing decision creates a current tax charge (no interest relief), unless the historic capital allowances are going to be reworked to compensate?

    The lending bit is the same as the Conservatives are doing in restricting interest relief on BTL in the UK – in terms of retrospective effect – and the Conservatives / Republicans are supposed to be more financially literate?

  6. given the way companies currently use offshore holding companies to channel profits through management/brand fees isn’t this likely to just add asset purchases to the list of charges. So holding company buys asset then sells to US arm, interest is effectively charged through management fee so still deductible in U.S., plus they have a reduction in U.S. Tax bill
    Of course this may make investment in U.S. More attractive I suppose which would be to aim of the policy after all.

  7. Fortunately, Jeb Bush will never be remotely close to being in a position to get this sort of nonsense enacted. Even if he was elected president, these proposals would be DOA as soon as they got to Congress. And rightfully so.

    These proposals do function, however, as a useful barometer of Bush’s (and his team’s) lack of economic/taxation/business literacy. And intelligence.

    The scary thing is that Bush is the flower of the Republican Establishment… Which tells you exactly why Trump, Carson and Fiorina are running 1-2-3 in Iowa and Jeb Bush is in a pack that includes Lindsey Graham, Mike Huckabee, Rick Santorum and Chris Christie.

  8. The capital allowances one is interesting, as I believe that the US only allows losses to be carried forward for a limited amount of time. This means that if you make a big investment in long-lasting plant ( a new nuclear reactor, say) you run the risk of having more losses than you can use, so you’d miss out on relief.

    You’d be OK in the UK, as losses don’t expire, though it would mess up some group tax planning (not such an issue in the US, where they consolidate things more).

  9. On the interest side, a general rule of thumb is that having one country treat something differently from everyone else is what leads to nifty tax avoidance schemes. It’ll lead to people complaining that companies have changed their behavior for tax reasons…

  10. “Now, I don’t actually know enough here to work it out. But that looks like a huge change to me. And it’s also a change that no one seems to be talking about. So, would any of you tax bods care to explain to me why it’s nothing much, something huge, what the effects are?”

    The point isn’t whether it would have a huge impact if enacted, the point is that it never will be enacted. That’s why nobody in the U.S. is talking about it… It’s the sort of proposal everyone shakes their heads about as they walk off. It would be vigorously opposed by most of the core constituencies of the Republican Party… Large business, small business, manufacturers, real estate developers, drug companies, Silicon Valley tech companies, and on and on and on.

    Chirst, not even Bernie Sanders is suggesting anything like this.

    All this does is confirm what many Republicans already suspected: Not only is Jeb Bush a Democrat in Republican clothing, he’s also dumber than shit.

  11. Dennis
    says

    Those guys voted Obama TWICE

    ASSHOLES…but they are unable to stick their fingers up their bums. That’s why they have to play play games no one else anywhere in the world is interested in. Perverts

Leave a Reply

Your email address will not be published. Required fields are marked *