The Impact of Thin Capitalization Rule on Capital Structure

Abstract

Debt financing is more favorable than equity financing due to the deductibility of the interest while the dividend is nondeductible in corporate taxation. This paper analyzes the impact of the implementation of Thin Capitalization Rule, that limits the deductibility of the interest expense through limiting the debt to equity ratio, on the choice of capital structure of the company. In this study, we use corporate tax return data (SPT) from the fiscal year 2010 to 2017. Using panel data regression, the results of the study show that the Thin Capitalization Rule reduces the use of debt in the capital structure. This study also shows an indication that the enactment of this rule increases the use of related party debt in the capital structure.