One of the most fundamental universal questions in company taxation is the distinction between debt and equity and the consequent classification of investors’ returns as interest or dividends. According to general principles, the costs of financing with equity capital, i.e. dividends, are non-deductible for the purpose of calculating taxable income while the costs for financing with debt capital, i.e. interest, are deductible. Therefore, the distinction between debt and equity and the classification of their returns have a great impact on tax liability.
The question regarding the fiscal treatment of equity and debt and the issues of different treatments mainly arises when transferring interest and dividend between associated companies. Above all, this is of great importance in cross-border situations in a case where the transfer includes participation exemptions for dividends, excessive interests and/or hybrid instruments. Universally, there are a range of different practices applied in order to distinguish debt from equity including statutory definitions and the application of different methods neutralizing the bias towards debt.
This paper provides a brief comparative analysis of two of these national approaches, Sweden and Australia which represent two extremes in this area. At this stage, Australia has perhaps the world’s most comprehensive and detailed definitions of debt and equity, while Sweden has a tax system without any statutory rules for classification. The purpose of this paper is to analyze both the different approaches taken in the two tax systems and the consequences that may occur when the different models intersect in cross-border transactions with hybrid instruments in general and convertible notes in particular.
Stockholm: Norstedts Juridik AB, 2013. no 5, 393-411 p.