1. Thin Capitalisation What is Thin Capitalisation.
Main forms of profit reduction.
OECD model convention.
China DTA network.
An example
Domestic law design issues.

2. Thin Capitalisation Main forms of profit manipulation
Transfer pricing: Serious risk to source country,
Thin Capitalisation: Serious risk to source country,
Leasing: Serious risk to source country
Capital allowances: serious risk to source country.

3. Thin Capitalisation OECD Model Convention No specific article
No specific prohibitions in domestic law
Article 9 Model Convention
Associated Enterprises
Article 24 Model Convention
Non Discrimination

4. Thin Capitalisation China DTA network Russia Hong Kong No article 9
Article 25: Nothing in this Arrangement shall prejudice the right of One Side to apply its domestic laws and measures concerning tax aviodance….[which ] includes any laws and measures for preventing prohibiting avoiding or resisting the effect of any transaction, arrangement or practice which has the purpose or effect of conferring a tax benefit on any person.

5. Thin Capitalisation China DTA network Singapore
Article 26: Nothing in this Arrangement shall prejudice the right of each contracting state to apply its domestic laws and measures concerning the prevention of tax avoidance whether or not described as such in so far as they do not give rise to taxation contrary to this agreement.
Netherlands, Switzerland, Luxembourg
Article 9 and nothing else.

6. Thin Capitalisation mine Source country Operating Co.
Source Country Parent Co.
Australian Holding Co.
AUSTRALIAN PUBLIC COMPANY
dividends
Australian Shareholders
Foreign Shareholders

7. Thin Capitalisation mine Labour Technical
Assistance Finance Essential inputs
exploration Capital
activities Research and equipment
development
mine
Source country Operating Co.
Source country Parent Co.
PROFIT TRAP TAX HAVEN: Hong Kong.
Australian group

8. Thin Capitalisation Conventional Result
Transfer Pricing, Thin capitalisation,
Leasing, capital allowances.
Difference
Revenue
100 75
(25)
Expenses
(50)
(75) 25
Net Profit Before Tax 50
NIL
Tax at 50%
Net Cash

9. Thin Capitalisation Financing interest withholding tax DTA 5%-10%
- Debt: lower tax: deduction/NRWT
- Equity: higher tax; company tax/NRWT
- Debt/Equity ratios: thin capitalisation
Intellectual Property DTA 0% - 5%
- royalties: lower tax; deduction/NRWT
- management fees: deduction/NRWT
- Expert employees: deduction no NRWT

10. Thin Capitalisation Cross boarder leasing domestic law- finance leases
DTA
PE substantial equipment
interest article
royalty article
RESULT
possible to avoid source country tax on lease payments to parent co.

11. 16. THIN CAPITALISATION DEBT EQUITY Profit before interest 100,000
Deduction for interest
(100,000)
nil
Taxable income
Nil
Tax payable at 50%
(50,000)
Dividend paid
50,000
Withholding 10%
(10,000)
(5,000)
TOTAL TAX
(55,000)

12. Thin Capitalisation Source Resources Source Sub MNC Third Party Source
100% debt
Source Sub
MNC
50% interest
100% debt
10% interest
Third Party
Source
Source Sub
Third Party
Parent
Difference
Revenue
100 -
Interest Expense
(10)
(50) 40
NPBT 90 50
Tax 50% 45 25
(20)

13. Thin Capitalisation Source Resources Source Sub MNC Third Party Source
100% debt
100% debt
50% interest
50% interest
Third Party
Source
Third Party
Parent
50%
Source Sub
Third Party
Parent
Difference
Revenue
100 -
Interest Expense
(10)
(50) 40
NPBT 90 50
Tax 50% 45 25
(20)

14. Thin Capitalisation The problem
interest is an expense but dividends are not,
source country taxation of interest paid to MNC LOWER THAN deduction to MNC SOURCE country subsidary
Design features to reduce this practice
non resident lenders,
domestic entities;
debt : equity ratio
debt : asset ratio
excessive interest 110%
back to back loans