thin capitalisation

thin capitalisation
In the UK (and in many other jurisdictions throughout the world) the tax regime differentiates between dividends and interest. Dividends are not tax deductible in computing the taxable income of a company whereas interest is. This influences the decision as to whether a company should be provided with equity capital or debt. Within multinational groups, in particular, there may be a limited commercial distinction between financing a company with debt or equity. If it is intended to reduce the tax liability of that company the tendency is for the company to be financed almost entirely with debt. A company that has a very low equity capital as compared to the amount of debt it owes is described as thinly capitalised.
Many tax regimes have rules to ensure that companies have a fair proportion of equity capital so that taxable profits cannot be minimised in this way. These may apply where the company has an inadequate debt: equity ratio or interest coverage.

Practical Law Dictionary. Glossary of UK, US and international legal terms. . 2010.

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