**5. Corporate finance and capital structure vs. CCCTB concept**

Issues relating to the effect that income tax has on capital structure are very complex. Attention should be paid to fundamental questions regarding tax solutions suggested in CCCTB concept

<sup>12</sup>Calculations made with reference to multinational enterprises operating in the EU indicate that about 50% of multinational financial groups and 17% of multinational nonfinancial groups may receive direct compensation for cross-border losses.

<sup>13</sup>Cf. Council directive on a common consolidated corporate tax base (CCCTB); Brussels, COM (2011) 121/4, 2011/0058 (CNS){SEC(2011) 315}{SEC(2011) 316}. According to the estimates made by the European Commission, a new regulation would enable to save about 700 million Euro annually in the European Union on the costs associated with adjusting to other fiscal systems, circa 1.3 billion Euro as a result of the consolidation of calculation rules, and nearly 1 billion Euro on cross-border activity. Experts are inclined to believe that such a solution would increase the attractiveness of the EU as a location of large-scale investments.

in the context of corporate finance theory. As far as research on capital structure and its impact on goodwill are concerned, major breakthrough was achieved by Franco Modigliani and Merton H. Miller. In 1958 they published an article entitled *The Cost of Capital, Corporation Finance and the Theory of Investment* [7]. Publications has been started discussion that is held up to the present day. The discussion centres on the consequences of the capital structure imposed by the company for its finance and goodwill [8]. According to the theory developed by Modigliani and Miller, in the world without taxes, both the goodwill and weighted average costs of capital (WACC) do not depend on capital structure.

corporate tax regulations. The possibility of direct consolidation of profits and losses for the purpose of calculating the EU tax base is a major step towards reducing overtaxation in a cross-border context. At the same time, it is a step towards improving the existing conditions, namely, in the scope of tax neutrality of domestic and cross-border activity. This will lead to

The main advantage of implementing CCCTB for enterprises is the reduction of costs associated with observing tax regulations. Data published by the European Commission indicates that the introduction of the aforementioned concept may lower such costs by circa 7%. Actual reduction of the costs under discussion may have a major impact on enterprises' potential and willingness to expand their business and enter foreign markets (especially the companies that

The directive under consideration provides a complete set of corporate tax regulations. It specifies which entities may select tax system, method of determining tax base, relief scope and methods. Furthermore, it introduces regulations on combating fraud, proposes a method for the apportionment of consolidated base and specifies how CCCTB system is to be admin-

Optional implementation of CCCTB entails that it will be the 28th tax system adopted by the 27 member states. In other words, certain enterprises or individual taxpayers will choose fiscal regime referred to in the directive or follow their domestic tax systems. Therefore, the proposal is a major step towards the harmonization of corporate income tax which, by improving

In the context of following the principles of income tax, and particularly the principle of tax system coherence and transparency, it should be emphasized that the directive under discussion provides a complete regulation on CCCTB. Directive on CCCTB and related issues should be implemented only when all the aspects to determining the tax base and its apportionment are known and so are the mechanisms that underlie the functioning of administration in such

Issues relating to the effect that income tax has on capital structure are very complex. Attention should be paid to fundamental questions regarding tax solutions suggested in CCCTB concept

12Calculations made with reference to multinational enterprises operating in the EU indicate that about 50% of multinational financial groups and 17% of multinational nonfinancial groups may receive direct compensation for cross-border

13Cf. Council directive on a common consolidated corporate tax base (CCCTB); Brussels, COM (2011) 121/4, 2011/0058 (CNS){SEC(2011) 315}{SEC(2011) 316}. According to the estimates made by the European Commission, a new regulation would enable to save about 700 million Euro annually in the European Union on the costs associated with adjusting to other fiscal systems, circa 1.3 billion Euro as a result of the consolidation of calculation rules, and nearly 1 billion Euro on cross-border activity. Experts are inclined to believe that such a solution would increase the attractiveness of the EU

the internal competitiveness of the EU, is to restrict harmful internal competition.

the new system. Needless to say, the system has to be comprehensive and coherent.

**5. Corporate finance and capital structure vs. CCCTB concept**

a more effective fulfilment of internal market potential.<sup>12</sup>

16 Taxes and Taxation Trends

have operated only on regional markets so far).13

losses.

as a location of large-scale investments.

istered by the member states in line with "one-stop shop" principle.

In 1963 Modigliani and Miller published an article which was a correction to the capital structure irrelevance proposition. It was then that they addressed the problem hitherto explored by corporate finance. **Major difficulty lays in defining the role of tax in shaping the financial policy to be pursued by the company** [9]. The authors under discussion presented a different view on the effect that the capital structure had on the goodwill. Having in mind corporate income tax, they were inclined to believe that under such circumstances the level of foreign funding to the enterprise was optimum and therefore the capital structure was optimum. Taking into account the tax differentiation (**tax asymmetry**) was a key to the analysis. The asymmetry is between income generated by shareholders and creditors at the company level [10]. Costs associated with interest on foreign capital reduce income tax base, unlike retained dividends and profits [11]. Hence, the utilization of outside capital involves interest tax shield. If interest is subtracted from corporate tax base, the goodwill of business entity which utilizes debt financing exceeds the goodwill of the company which does not utilize foreign capital (by the compound value of tax shield).

Introducing the tax system allowing to reduce the tax base by expenses such as interest on debt, Modigliani and Miller proved that less expensive foreign capital (due to interest tax shield) increased the goodwill. At the same time, they were the first to stress the importance of tax for financial policy pursued by the company and aimed at increasing its goodwill.

The theory formulated by Modigliani and Miller in 1963 highlighted **the role of tax in corporate finance**. They proved that it was possible to shape the capital structure and goodwill through tax policy. It is worth emphasizing that this aspect to tax has not yet been noticed by employees responsible for tax management in enterprises. Nowadays, tax is often treated as a fiscal burden and not a flow that may be managed in order to exert an influence on the goodwill. **With reference to the concept of CCCTB, the aforementioned theory states reasons for introducing one corporate tax system in the entire European Union so that all entities have equal opportunities for developing their goodwill through tax policy**.

As for factors determining the capital structure in a given company, attention was also paid to the role of the other, namely, non-debt tax shields, resulting from depreciation and investment allowances, that may lessen the effect of interest of tax shield. Non-debt tax shields enabled to modify the research conducted by Miller by adding the concepts framed by DeAngelo and Masulis. They highlighted the role of investment tax shield in determining optimum tax structure. Furthermore, they proved that the goodwill of company with high non-debt tax shield may be the same as the goodwill of entity with high debt and thereby high interest tax shield. The higher the depreciation tax shield, the lower the interest shield. Such a conclusion was drawn by Masulis. In other words, the variety of tax shields enables one to create capital structure optimum for every company and the economy. Capital structure is optimum at a certain debt level, when the total value of tax shields (interest and depreciation) is a maximum allowance under certain fiscal conditions [12].

Based on the theory developed by Modigliani and Miller as well as the research conducted by DeAngelo and Masulis, it can be stated that **taking into account income tax and depreciation costs enables the companies to increase their goodwill through tax benefits**. Therefore, the optimum capital structure of the company does not stem only from the share of equity and outside capital in the aforementioned structure but is also a consequence of financial system solutions adopted as far as income tax is concerned.

The analysis of the theories referred to in the present paper suggests that debt and interest tax shield are particularly relevant to shaping the optimum structure of capital. So are system solutions for recognizing tax effects of debt financing. Solutions aimed at determining the level and structure of capital have been included in the proposal for the directive on CCCTB. It would be a simplification to put into practice an assumption that interest lessens the debt cost by recognizing it as a deductible expense.

According to Corporate Income Tax Act, tax-deductible expenses do not include loan (credit) repayment, except for capitalized interest on the loan (credit). In other words, interest is recognized as a deductible expense once it has been capitalized. In legal terms, in the case of contract relationship, payment is one form of discharging the liabilities by a debtor due to which the debt is amortized.

Furthermore, the impossibility of reducing the tax base on accrued (but not paid or capitalized) interest is not a problem for Polish companies. For the few companies place a meaning on interest and commissions paid in the course of actual implementation investments, representing their original value, this is the case for interest on loans granted by shareholders. In other words, Polish entrepreneurs do not notice the role of deductible expenses in reducing the effective cost of raising foreign capital in the form of loans and credits. In addition, the entities responding to the survey do not consider it problematic that interest on debt can be recognized as a tax-deductible cost only if it is paid or capitalized. In this context, it can be stated that suggestions put forward by the European Commission could be adopted by Polish

**Table 3.** Significance of tax-deductible expenses associated with debt utilization in the opinion of Polish enterprises (0,

Interest on loans granted by shareholders 80.4 1.8 5.3 1.8 1.8 5.3 3.6 100

**0 1 2 3 4 5 Absence** 

46.4 21.4 8.9 8.9 1.8 7.2 5.4 100

62.5 16.1 1.8 3.5 8.9 1.8 5.4 100

73.2 7.1 3.6 1.8 3.6 7.1 3.6 100

**of answer**

Base of Corporate Income Tax and the EU Concept http://dx.doi.org/10.5772/intechopen.72530

**Total**

19

Developing the tax system as part of CCCTB concept, attention was paid to the balance between flexibility and standardization of regulations, particularity and generality and attractiveness of solutions proposed in the concept compared to domestic solutions. If the companies are free to choose the taxation system, they will be able to shape the structure and

The concept under consideration does not refer precisely to interest expenses as tax-deductible costs. According to a general definition, all the costs covered by the company to incur and service the debt are deductible expenses. The debt repayment (e.g. credit principal) will not be a tax-deductible expense. This solution is identical to the one proposed in Corporate

Analysing deductible expenses in line with CCCTB concept, accrual basis is of particular relevance. According to Corporate Income Tax Act in force in Poland, interest is recognized as taxdeductible expense in line with cash basis. Accrual basis is also used in MSR/MSSF. Therefore, it can be concluded that interest expenses would reduce the tax base once the tax has been calculated and not actually paid. Such a solution is favourable for enterprises and makes tax

enterprises within the scope under discussion.

Costs associated with repayment of loan (credit) except for capitalized interest on the

debt, including loan (credit)

investment during its realization

insignificant, 5, significant) (in %).

Accrued but unpaid or amortized interest on

Interest, commission and exchange differences between loans (credits) increasing the cost of

Source: Based on the questionnaire survey.

loan (credit)

principles similar to accounting solutions.

rate of the tax base.

Income Tax Act.

General principles formulated in the Act enable one to account for interest expenses by recognizing them as deductible costs. Obviously, there are exceptions to the rule (e.g. interest, calculated to date of handing over a fixed asset for use, is capitalized to its original value and effectively recognized as deductible cost through capital allowance). Therefore, according to the Act under discussion, the term "tax-deductible expenses" does not refer to "accrued but not paid or amortized interest, including interest on loan (credit)".

Other types of expenses associated with incurring a debt by the company are commissions and charges. As to the principle, commission is an expense not directly incurred to accomplish the goal for the sake of which the loan has been taken out but is a source of funding. As for the moment of recognizing commission as a deductible expense, one should pay attention to the regulation included in the Act according to which tax-deductible costs, other than costs directly associated with revenues, are deductible once they have been incurred (on such a date). In line with the Act under discussion, Polish companies can recognize paid and capitalized interest and costs associated with incurring the debt as tax-deductible costs. Therefore, it should be verified if solutions proposed by the legislator are significant to Polish enterprises. **Table 3** shows the survey results.

Polish companies do not attach considerable significance to tax solutions for recognizing costs associated with debt utilization as deductible costs. Over 45% of enterprises participating in the survey do not pay attention to the fact that costs associated with the repayment of loan (credit) are non-deductible. Only more than 7% of entities consider this as a major restriction.


Such a conclusion was drawn by Masulis. In other words, the variety of tax shields enables one to create capital structure optimum for every company and the economy. Capital structure is optimum at a certain debt level, when the total value of tax shields (interest and depre-

Based on the theory developed by Modigliani and Miller as well as the research conducted by DeAngelo and Masulis, it can be stated that **taking into account income tax and depreciation costs enables the companies to increase their goodwill through tax benefits**. Therefore, the optimum capital structure of the company does not stem only from the share of equity and outside capital in the aforementioned structure but is also a consequence of financial system

The analysis of the theories referred to in the present paper suggests that debt and interest tax shield are particularly relevant to shaping the optimum structure of capital. So are system solutions for recognizing tax effects of debt financing. Solutions aimed at determining the level and structure of capital have been included in the proposal for the directive on CCCTB. It would be a simplification to put into practice an assumption that interest lessens

According to Corporate Income Tax Act, tax-deductible expenses do not include loan (credit) repayment, except for capitalized interest on the loan (credit). In other words, interest is recognized as a deductible expense once it has been capitalized. In legal terms, in the case of contract relationship, payment is one form of discharging the liabilities by a debtor due to

General principles formulated in the Act enable one to account for interest expenses by recognizing them as deductible costs. Obviously, there are exceptions to the rule (e.g. interest, calculated to date of handing over a fixed asset for use, is capitalized to its original value and effectively recognized as deductible cost through capital allowance). Therefore, according to the Act under discussion, the term "tax-deductible expenses" does not refer to "accrued but

Other types of expenses associated with incurring a debt by the company are commissions and charges. As to the principle, commission is an expense not directly incurred to accomplish the goal for the sake of which the loan has been taken out but is a source of funding. As for the moment of recognizing commission as a deductible expense, one should pay attention to the regulation included in the Act according to which tax-deductible costs, other than costs directly associated with revenues, are deductible once they have been incurred (on such a date). In line with the Act under discussion, Polish companies can recognize paid and capitalized interest and costs associated with incurring the debt as tax-deductible costs. Therefore, it should be verified if solutions proposed by the legislator are significant to Polish enterprises.

Polish companies do not attach considerable significance to tax solutions for recognizing costs associated with debt utilization as deductible costs. Over 45% of enterprises participating in the survey do not pay attention to the fact that costs associated with the repayment of loan (credit) are non-deductible. Only more than 7% of entities consider this as a major restriction.

ciation) is a maximum allowance under certain fiscal conditions [12].

solutions adopted as far as income tax is concerned.

the debt cost by recognizing it as a deductible expense.

not paid or amortized interest, including interest on loan (credit)".

which the debt is amortized.

18 Taxes and Taxation Trends

**Table 3** shows the survey results.

**Table 3.** Significance of tax-deductible expenses associated with debt utilization in the opinion of Polish enterprises (0, insignificant, 5, significant) (in %).

Furthermore, the impossibility of reducing the tax base on accrued (but not paid or capitalized) interest is not a problem for Polish companies. For the few companies place a meaning on interest and commissions paid in the course of actual implementation investments, representing their original value, this is the case for interest on loans granted by shareholders. In other words, Polish entrepreneurs do not notice the role of deductible expenses in reducing the effective cost of raising foreign capital in the form of loans and credits. In addition, the entities responding to the survey do not consider it problematic that interest on debt can be recognized as a tax-deductible cost only if it is paid or capitalized. In this context, it can be stated that suggestions put forward by the European Commission could be adopted by Polish enterprises within the scope under discussion.

Developing the tax system as part of CCCTB concept, attention was paid to the balance between flexibility and standardization of regulations, particularity and generality and attractiveness of solutions proposed in the concept compared to domestic solutions. If the companies are free to choose the taxation system, they will be able to shape the structure and rate of the tax base.

The concept under consideration does not refer precisely to interest expenses as tax-deductible costs. According to a general definition, all the costs covered by the company to incur and service the debt are deductible expenses. The debt repayment (e.g. credit principal) will not be a tax-deductible expense. This solution is identical to the one proposed in Corporate Income Tax Act.

Analysing deductible expenses in line with CCCTB concept, accrual basis is of particular relevance. According to Corporate Income Tax Act in force in Poland, interest is recognized as taxdeductible expense in line with cash basis. Accrual basis is also used in MSR/MSSF. Therefore, it can be concluded that interest expenses would reduce the tax base once the tax has been calculated and not actually paid. Such a solution is favourable for enterprises and makes tax principles similar to accounting solutions.
