Abstract
Since the current financial and economic environment presents many challenges for most economic agents, financial transactions and their instruments are likely be one of those challenges. Hereby, this thesis deals with the treatment of hybrid financial instruments for corporate income tax purposes in an international and cross-border context. But, before focusing on the relevant tax aspects on this matter, it is essential to depict a more detailed overview of what hybrid financial instruments are, the extent to which they influence or are influenced by the environment from an economic and legal perspective, and the general tax consequences of financial instruments in a cross-border context. This outline is necessary to assess how hybrid financial instruments affect the design of tax rules as well as how the given fundamental corporate income tax treatment limits this design.
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Based on the following distinction both instruments can be labeled as non-mezzanine and non-structured financial instruments.
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- 4.
- 5.
- 6.
- 7.
Cf. Sect. 3.2.1.
- 8.
Figure 2.1 presents a classification of financial instruments with a focus on hybrid financial instruments. However, since each kind of classification is purpose-driven, there is no universally correct classification. With regard to the scope of this thesis the emphasis is on the demarcation of such hybrid financial instruments which are affected by the debt/equity distinction. In simple terms see also Krause 2006: 79 et seq. Regarding an exchange market segment-based classification see also Krause 2006: 79 et seq.; Bogenschütz 2008b: 51 et seq. For another classification with a focus on derivative components see e.g. Laukkanen 2007: 18 et seq.
- 9.
- 10.
Cf. inter alia MacNeil 2005: 108 et seq. See also IAS 32 Para. AG15 and IAS 39 Para. 9; Herzig 2000: 482.
- 11.
Yet, their terms are not used consistently in practice and theory. Cf. inter alia Briesemeister 2006: 14 et seq., with further references.
- 12.
Cf. Briesemeister 2006: 14 et seq., with further references; Schulz 2006: 9; Natusch 2007: 22 et seq.; Bogenschütz 2008b: 51 et seq.; Mäntysaari 2010: 283. See further Lang 1991: 14; Drukarczyk 1993: 581; Eber-Huber 1996: 8; Haun 1996: 7 et seq., with further references; Herzig 2000: 482; MacNeil 2005: 209; Eilers and Rödding 2007: 84 et seq.; Helminen 2010: 164 et seq.; Lampreave 2011: Footnote 67. However, the term ‘hybrid financial instrument’ will be used oftentimes synonymously for mezzanine financial instruments in practice and theory. See e.g. Eber-Huber 1996: 8; Haun 1996: 10; Wagner 2005c: 499; Laukkanen 2007: 37; Bogenschütz 2008a: 533; Bogenschütz 2008b: 50; Bock 2010: 65 et seq.; Helminen 2010: 164.
- 13.
Cf. Dombek 2002: 1065 et seq.; Briesemeister 2006: 17 et seq., with further references; German Institute of Public Auditors 2008: 455; Schaber et al. 2008: 1; Reiner and Schacht 2010: 387; Murre 2012: 25 et seq. See further also Luttermann 2001: 1901. These financial instruments fulfill the definition of financial instruments in accordance to IAS 39 Para. 8 and IAS 39 Para. 11.
- 14.
- 15.
Cf. e.g. Storck 2011: 29 et seq. Although the focus is on the capital market as a part of the financial markets, both are used synonymously here.
- 16.
- 17.
Other developments, which are not within the scope of the further analysis, are in particular the proliferation of derivative instruments (representative for many see Warren 1993: 460 et seq.; Hull 2009: 1 et seq.; Hartmann-Wendels et al. 2010: 271 et seq.; Valdez and Molyneux 2010: 381 et seq.) and securization transactions (see e.g. Allen and Santomero 1998: 1474; Hartmann-Wendels et al. 2010: 207 et seq.; Valdez and Molyneux 2010: 273 et seq.).
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Cf. Herman 2002: 9 et seq.; Allen and Santomero 1998: 1464 et seq.; Teichmann 2001: 652; Brealey et al. 2008: 390 et seq., 396 et seq., 400 et seq., 946; Hartmann-Wendels et al. 2010: 18. When markets were complete and perfect, the allocation of resources is efficient, so that there is no need for intermediaries to improve welfare. Cf. Fama 1980: 39 et seq.; Franke and Hax 2009: 501; Hartmann-Wendels et al. 2010: 123. However, markets are characterized by asymmetric information and transaction costs. Cf. Allen and Santomero 1998: 1464 et seq.; Hartmann-Wendels et al. 2010: 123 et seq., both with further references.
- 31.
Cf. Bodie 1989: 107; Gebhardt et al. 1993: 10 et seq.; Allen and Santomero 1998: 1482; MacNeil 2005: 7; Hartmann-Wendels et al. 2010: 18. Nevertheless, there is also a trend towards the market (instead of the intermediaries) allowing borrowers to occupy the financial markets directly for fund raising, inter alia due to recent technological developments as well as financial innovation (disintermediation). Cf. Horne 1985: 621; Gebhardt et al. 1993: 14; Herman 2002: 17 et seq.; Hartmann-Wendels et al. 2010: 18; Valdez and Molyneux 2010: 170. However, financial intermediaries have not become obsolete (in fact, quite the reverse has happened), but rather their role has moved from between lender and borrower to between lender and market since financial instruments and markets have become more complex and riskier. Cf. Allen and Santomero 1998: 1483.
- 32.
Cf. Allen and Santomero 1998: 1464; Alworth 1998: 509; Brealey et al. 2008: 390 et seq., 396 et seq.; Valdez and Molyneux 2010: 235 et seq. See further also Bulow et al. 1990: 139; Eilers and Rödding 2007: 83; Kalss 2007: 523. See also Board of Governors of the Federal Reserve System 2010: 10, for the United States; OECD 2009: 72, for OECD Member States. For a distinction between bank and non-bank financial intermediaries see in more detail e.g. Valdez and Molyneux 2010: 73 et seq., 235 et seq.
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Cf. e.g. Allen and Santomero 1998: 1464, 1474.
- 34.
Cf. further Valdez and Molyneux 2010: 469.
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- 37.
Cf. Pratt 2000: 1075 et seq.; Hillier et al. 2008: 53 et seq. See further also Jacobs and Haun 1995: 405; Bundgaard 2010a: 442. Besides the introduction of new financial products, this includes also pure derivative instruments which are, however, not within the scope of this thesis. Cf. Allen and Santomero 1998: 1464. With regard thereto see fundamentally Hull 2009: 1 et seq.; Hartmann-Wendels et al. 2010: 271 et seq. The dynamic development is attributed in particular to both the increase in economic uncertainty and rapid technological developments. Cf. Ramsler 1993: 434 et seq.; Herman 2002: 19 et seq. See further also Horne 1985: 630; Bodie 1989: 116.
- 38.
Cf. Allen 1989: 12; Bulow et al. 1990: 135; Cerny 1994: 333; Polito 1998: 778. However, this dichotomy constitutes merely a simplification, since already in history an array of financial instruments has been issued albeit at a slower pace. Cf. Allen 1989: 14 et seq.; Allen and Gale 1994: 11 et seq. Against it, recent past’s as well as today’s pace and volume of financial innovation has no equal in history. Cf. Miller 1986: 459 et seq.; Allen and Santomero 1998: 1464; Alworth 1998: 509; Edgar 2000: 25; Hillier et al. 2008: 53 et seq.
- 39.
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Cf. e.g. Allen 1989: 16 et seq.
- 43.
Cf. also Hariton 1988: 775; Kopcke and Rosengren 1989: 1 et seq., 11; Hariton 1994: 501 et seq.; Santangelo 1997: 332. See further also Elschen 1993: 586; Ramsler 1993: 439; Edgar 2000: 25, 93 et seq.; Hillier et al. 2008: 25, 52 et seq. From the market perspective, financial innovations may make financial markets more efficient and complete in terms of enhanced prospects for risk sharing between investors. Cf. e.g. Horne 1985: 621 et seq. For the development of equivalent cash flows under the use of the put-call parity theorem see Warren 1993: 465 et seq.; Shaviro 1995: 652 et seq.; Edgar 2000: 21 et seq., 94 et seq.
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Cf. Cerny 1994: 330 et seq.; Lothian 2002: 723; Hillier et al. 2008: 26; Arouri et al. 2010: 148, 151; Zodrow 2010: 866; Martínez Bárbara 2011: 270. See further also Alworth 1998: 509; Herman 2002: 56; Eidenmüller 2007: 487; Kalss 2007: 523. For the main advantages and disadvantages of an enhanced international financial integration see e.g. Arouri et al. 2010: 152 et seq.
- 47.
Cf. Fukao and Hanazaki 1986: 6, 13; European Commission 2004b: 9; Heathcotea and Perri 2004: 207 et seq.; Hillier et al. 2008: 74 et seq.; Arouri et al. 2010: 145; Zodrow 2010: 866. See also Jacobs and Haun 1995: 405. In practice, see e.g. Siemens 2010b: 104. This development is by no means a new phenomenon, but reaches back much further in history. Cf. Herman 2002: 30; Lothian 2002: 700 et seq. However, the financial integration today is more complete and more geographically ubiquitous and the number of financial markets has grown enormously. Cf. Lothian 2002: 700, 723. For instance, today’s emerging countries have started to participate effectively in international integration of financial markets since only the 1990s. Cf. Haggard and Maxfield 1996: 35 et seq.; Arouri et al. 2010: 147.
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- 51.
- 52.
Cf. Brealey et al. 2008: 487.
- 53.
Cf. Modigliani and Miller 1963: 433 et seq.; Myers 2001: 86 et seq.; Brealey et al. 2008: 497 et seq.; Hillier et al. 2008: 516 et seq.; Ross et al. 2008: 441 et seq., 465. More controversially see Miller 1977: 268 et seq. Regarding the prevailing concept of the tax deductibility of debt financing costs see in more detail Sect. 2.3.
- 54.
- 55.
Cf. Baxter 1967: 396 et seq. Such costs include, for instance, legal and administrative costs as well as the interrupted ability to conduct business and to make appropriate investments. Cf. Brealey et al. 2008: 487, 503 et seq.; Ross et al. 2008: 455 et seq. See further Miller 1977: 262 et seq.; Edgar 2000: 99 et seq., with further references; Hillier et al. 2008: 569 et seq.
- 56.
Considering company law, obligations derived from financial instruments classified as debt differ from those derived from financial instruments classified as equity as, for instance, the latter do not legally entitle a company to remuneration payments in the way the former provides legal entitlement. Cf. Sect. 3.2.1.
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- 61.
Cf. Wald 1999: 161 et seq.; Brealey et al. 2008: 516 et seq. See also Noulas and Genimakis 2011: 384 et seq. Moreover, there are critics pointing out that costs of financial distress seem to be much smaller than the tax benefits. Cf. e.g. Miller 1977: 262 et seq. However, the pure threat of bankruptcy can be also cost-increasing with regard to stakeholders, who do not have capital stakes in the corporations such as e.g. customers and suppliers, since such stakeholders are increasingly reluctant to do business with financially distressed corporations. Cf. in more detail Hillier et al. 2008: 607 et seq.
- 62.
- 63.
Cf. Myers 1984: 581 et seq.; Graham and Harvey 2001: 215; Myers 2001: 91 et seq.; Brealey et al. 2008: 519 et seq.; Hillier et al. 2008: 622 et seq.; Ross et al. 2008: 473 et seq. However, this theory could be observed only conditionally. Cf. Graham and Harvey 2001: 219 et seq. See further also Helwege and Liang 1996: 457.
- 64.
- 65.
- 66.
Cf. also Sect. 2.2.1.1.
- 67.
- 68.
Cf. also Sect. 4.2.4.3 “First Test Layer: International Financial Accounting Purposes”.
- 69.
Cf. Baetge et al. 2004: 228 et seq.; Coenenberg 2009: 1054 et seq.; Franke and Hax 2009: 113 et seq.; Küting and Weber 2009: 135 et seq. Furthermore, the classification of financial instruments for financial accounting purposes also affects the judgments of external financial analysts. Cf. Hopkins 1996: 33 et seq.
- 70.
Cf. Rüßmann and Vögtle 2010: 208.
- 71.
Cf. in more detail Sect. 4.2.4.3 “Debt/Equity Test”.
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- 73.
- 74.
Cf. Santos 2001: 46 et seq.
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Cf. e.g. Lühn 2006a: 27.
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- 78.
However, Iceland and Israel will be neglected due to the limited scope of this thesis and the limited information basis.
- 79.
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Cf. Bird 1996: 1 et seq.
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- 85.
Cf. Bird 1996: 9 et seq.
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Cf. Avi-Yonah 2004: 1202 et seq.
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Cf. Mintz 1996: 25.
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Cf. Avi-Yonah 2004: 1207.
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Cf. Bird 1996: 5.
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Cf. Mintz 1996: 35.
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Cf. Avi-Yonah 2004: 1208, with further reference.
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Cf. Avi-Yonah 2004: 1212 et seq., 1231 et seq.
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Avi-Yonah 2004: 1210.
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Bird 1996: 13.
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Cf. inter alia Endres et al. (eds.) 2007: 17.
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Across the globe national GAAP converges to a considerable extent. Cf. Schön 2005a: 112 et seq.
- 106.
Cf. Schön 2005a: 111 et seq., 115 et seq.; Endres et al. 2007: 25 et seq.; Wendt 2009: 55; Ault and Arnold 2010: 18 et seq., 38 et seq., 61, 87 et seq., 107 et seq., 164 et seq.; IBFD 2011a: Sect. 1.1.2, 1.2. See also Grimes and Maguire 2006: 577 et seq., for the Republic of Ireland; IBFD 2011a: Sect. 12.1, for the Republic of Korea. Iceland and Israel will be neglected here and in the following due to limited information.
- 107.
Cf. e.g. IAS 32 Para. 35 et seq.
- 108.
Cf. e.g. IFRS Framework Para. 4.29; IAS 18 Para. 29 et seq.
- 109.
- 110.
For the notional interest deduction for equity implemented in Belgium see in more detail Heyvaert and Deschrijver 2005: 459 et seq.; Vanhaute 2008: 157 et seq.; IBFD 2011a: Sect. 1.9.6. In the past, this concept has been implemented also in Austria and Italy. Cf. inter alia de Mooij and Devereux 2011: 97. However, Italy has recently reintroduced this concept at least for newly contributed equity. Cf. Sect. 4.2.4.2..
- 111.
In Estonia, profits before taxes are distributed, but are subsequently subject to the distribution tax. Cf. IBFD 2011a: Chap. 1.
- 112.
Cf. Endres et al. 2007: 18 et seq.; IBFD 2011a: Sects. 1.2.3 and 6.1. See also IBFD 2011a: Chaps. 9 and 11, for Luxembourg. In addition, see McDaniel et al. 2005: 9 et seq.; IBFD 2011b: Sect. 2.2, both for the United States. Although with a partially differing division see further also de Wilde 2011: 67.
- 113.
Cf. IBFD 2011a: Chaps. 11 and 12, for Belgium and the Netherlands.
- 114.
Cf. Gutiérrez et al. 2010: Sect. 1.3.3.; HM Treasury 2010: 14; IBFD 2011a: Sect. 1.4.5. See also IBFD 2011a: Sect. 2.3.3.4, for Luxembourg. IBFD 2011a: Chap. 12, for the Republic of Korea. In addition, see McDaniel et al. 2005: 7 et seq., 11; IBFD 2011b: Sect. 1.3.3.1, both for the United States. See further also Wendt 2009: 82.
- 115.
Cf. Sects. 4.2.3.1 and 4.2.4.1. See also instead of many Wendt 2009: 82 et seq.; IBFD 2011a: Sect. 10.3; Jacobs et al. 2011: 980 et seq., 1008 et seq.; de Wilde 2011: 67 et seq. Nevertheless, these interest deduction limitation mechanisms are not within the scope of this thesis and will not be further considered.
- 116.
- 117.
- 118.
Cf. Sect. 2.3.2.2.
- 119.
- 120.
- 121.
For the mechanisms to avoid/mitigate the economic double taxation see also Sect. 2.3.1.2.
- 122.
Cf. Sect. 3.1.3.
- 123.
Cf. Sect. 2.3.1.2.
- 124.
Cf. IBFD 2011a: Sect. 7.2.1.
- 125.
Cf. Tables A.2 and A.3, both in the annex; IBFD 2011b: Sects. 6.3.1 and 6.3.5.
- 126.
Additionally, dividends paid to non-resident pension funds, investment funds and/or insurance companies may be exempted from withholding tax in some countries (e.g. in Poland and Slovenia).
- 127.
For the precise withholding tax rates on dividends (portfolio shareholding) of the agreed income tax treaties between all regarded EEA/EU/OECD Member States see Table A.2 in the annex.
- 128.
For the precise withholding tax rates on dividends (substantial shareholding) of the agreed income tax treaties between all regarded EEA/EU/OECD Member States see Table A.3 in the annex.
- 129.
- 130.
- 131.
Cf. IBFD 2011a: Chap. 7; IBFD 2011b: Chap. 6. See also Bieber et al. 2008: 583 et seq., for Austria; IBFD 2011a: Chap. 8, for Luxembourg. In Austria, from 2011 the tax exemption method for portfolio participations shall be extended to apply as well to Non-EEA/EU-situations. Cf. IBFD 2011b: Sect. 6.1 (Austria).
- 132.
Corporations in the United Kingdom may elect for a non-application of the tax exemption method, but contemporaneously for an avoidance of jurisdiction double taxation.
- 133.
Corporations in the United Kingdom may elect for a non-application of the tax exemption method, but contemporaneously for direct and indirect tax credits.
- 134.
- 135.
- 136.
Cf. IBFD 2011b: Sects. 6.3.2 and 6.3.5.
- 137.
For the precise withholding tax rates on interest payments of the agreed upon income tax treaties between all regarded EEA/EU/OECD Member States see Table A.4 in the annex.
- 138.
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Bärsch, SE. (2012). Background of Financial Instruments. In: Taxation of Hybrid Financial Instruments and the Remuneration Derived Therefrom in an International and Cross-border Context. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-32457-4_2
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