Policy Brief: Reforming Corporate Income Tax

How can countries create a business-friendly tax environment for investment? How can they minimise corporate tax-induced financial distortions? Or maintain current levels of corporate tax revenue? And how might countries make corporate tax less complex? These questions reflect the
major policy concerns in the OECD area with respect to corporate income tax.

Policy makers are concerned about the effects on companies’ financial health, notably their debt-equity ratios, of a system where interest payments on corporate debt are tax-deductible while the return on equity is taxed. This
favourable corporate tax treatment of debt can threaten macroeconomic stability by increasing the risk of bankruptcy.

Aggressive tax-planning strategies that depend on this asymmetric tax treatment of debt and equity also reduce corporate tax revenues. The manipulation of (transfer) prices and interest rates charged by multinationals
on their intra-group transactions and loans as well as lower corporate tax rates put corporate tax revenues further under pressure.

Some countries have tried to reduce the debt-equity distortion by taxing equity income at the shareholder level more favourably than interest income, but this is not a complete solution. Policy makers are also concerned about
the enormous complexity of the corporate income tax system, arising in part from efforts to counter tax planning, as it results in high compliance costs for corporations and administrative and enforcement costs for governments.
Given these major tax policy concerns, fundamental corporate income tax reforms have recently been put on the political agenda in some OECD countries. These reforms go beyond measures designed simply to broaden the tax base or changes in corporate tax rates. They might be an option to tackle
the debt-equity and the other corporate tax-induced distortions while at the same time improving a country’s investment climate and reducing corporate tax complexity.

This Policy Brief looks at recent trends in the taxation of corporate income in OECD countries and evaluates the different types of corporate income tax reforms.