Treasury flags economic cost of business bias towards debt finance

One of the questions raised in Treasury's tax discussion paper that could have a direct bearing on the business banking sector is whether the tax system should provide a more neutral treatment of different financing arrangements.

In the chapter covering business tax issues Treasury notes that for businesses, interest payments on debt are tax deductible, while returns on equity are not.

"The economic costs of tax-induced bias toward debt finance could potentially be significant," the paper says.

Treasury is concerned that the allocation of taxing rights means that a bias towards debt could have the effect of eroding Australia's corporate tax base, particularly in the international context where interest deductions are being claimed in Australia, while interest income is being taxed overseas.

Thin capitalisation rules seek to limit the extent of the potential erosion but it is still a concern.

"In addition, providing a deduction for debt and not equity introduces biases against small businesses and knowledge based industries, which often face difficulties access debt finance," the paper says.