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Working Paper

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Recent developments – including greater taxpayer sophistication in structuring and locating international financing arrangements, increased government concerns with the role of debt in sophisticated tax avoidance techniques, and disruption by decisions of the European Court of Justice of member states' regimes limiting interest deductions – have stimulated new laws and policy controversies concerning the international tax treatment of interest expenses. National rules are in flux regarding the financing of both inbound and outbound transactions.

Heretofore, the question of the proper treatment of interest expense has generally been looked at from the perspective of either inbound or outbound investment. As a result, the issues of residence countries' limitations on interest deductions on borrowing to finance low-taxed, exempt or deferred foreign source income, on the one hand, and of source countries' restrictions on interest deductions intended to limit companies' ability to strip income from a higher-tax to a lower-tax country, on the other, have generally been treated as separate issues. A fundamental contribution of this essay is to demonstrate their linkage and to call for a multilateral solution that would address both of these problems.

The complexity, the incoherence, and the futility of countries acting independently to limit interest deductions are now clear. Worldwide allocation of interest expense by both source and resident countries would eliminate a host of problems now bedeviling nations throughout the world – problems that have produced varying, complex, and inconsistent responses among different countries, responses that frequently may result in zero or double taxation. Given the flexibility of multinational corporations to choose where to locate their borrowing and the difficulties nations have in maintaining their domestic income tax bases in the face of such flexibility, achieving a multilateral agreement for the treatment of interest expense based on a worldwide allocation should become a priority project for both source and residence countries.


Law | Law and Economics | Taxation-Federal | Taxation-Transnational | Tax Law