Empirical Evaluation of Interest Barrier Effects

Abstract

Die Dis cus si on Pape rs die nen einer mög lichst schnel len Ver brei tung von neue ren For schungs arbei ten des ZEW. Die Bei trä ge lie gen in allei ni ger Ver ant wor tung der Auto ren und stel len nicht not wen di ger wei se die Mei nung des ZEW dar.Dis cus si on Papers are inten ded to make results of ZEW research prompt ly avai la ble to other eco no mists in order to encou ra ge dis cus si on and sug gesti ons for revi si ons. The aut hors are sole ly respon si ble for the con tents which do not neces sa ri ly repre sent the opi ni on of the ZEW. Non-Technical SummaryAs of 2008, Germany has severely changed its thin capitalization rule by introducing the so-called interest barrier. This new rule aims at prohibiting tax avoidance of multinational rms by means of cross-border internal loans. For reasons of non-discrimination, the rule is, however, equally attributable on the national level and it is applicable to both internal and external debt. Since its beginning, the German interest barrier has had a very poor reputation as it was believed to distort nancing decisions and hereby harm production eciency.Four years after its introduction, the time has come to empirically evaluate the interest barrier. In this paper, we trace to what extent the interest barrier impacted rms' nancing decisions. We distinguish between national and multinational rms as well as between the eects on internal debt to assets and external debt to assets.Thin capitalization rules prevent rms from deducting excessive interest expenses from their tax base. Before 2008, the interest on internal debt going beyond 1.5 times the equity of the respective shareholder was not deductible. As of 2008, interest payments exceeding the interest earnings are generally only deductible at the amount of 30% of EBITDA once the exemption limit of an initial EUR 1 million is exceeded. In our empirical setup, we identify rms which would have been aected by the new interest barrier, had it already been in place in the years 2005 to 2007, i.e. before its actual coming into force. Then we analyze empirically how these rms adjusted their debt to assets ratios and their net interest payments as compared to the control group.Our regressions show that the interest barrier drove rms to lower their debt to assets ratios and their net interest payments. Opposing its original intention, it seems to be, however, also the national rms which adjusted their capital structure and it was external rather than internal debt which was reduced. Therefore, we conclude that the interest barrier does indeed aect nancing decisions, but predominantly not in the intended way and not of the intended rms. In sensitivity analyses, we examine highly leveraged and low protable rms, which are likely to be subject to the interest barrier. The results suggest a debt-reducing interest barrier eect for these companies as well.Our empirical evidence does not provide a positive evaluation of the new interest barrier. The legislator might have focused too much on the task of counteracting exc...

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