Unsatisfactory Response to the International Problem of Thin Capitalization: Can Regulations Save the Earnings Stripping Provision, An

Abstract

The Internal Revenue Code (the "Code") contains a bias toward financing a corporation with debt instead of equity. The Code subjects corporate distributions on equity to double taxation. The Code first taxes the corporation for the net income it earns.1 It then taxes the equity-holder for receipt of a dividend from the corporation.2 On the other hand, the Code imposes a tax on corporate distributions to debtholders only once. The debtholder pays tax on the inteiest income he receives, but the corporation may deduct the payment as an interest expense. 3 For this reason, an equityholder has the incentive to characterize additional contributions to a corporation as debt in order to minimize its tax burden.4 This tax incentive creates a problem as corporations are encouraged to finance their capital structure with excessive debt. Corporations with a