Islamic financing and bitcoin are among the alternatives to the loss of the interest deduction under tax reform.
If the Administration’s tax reform proposal contains an immediate write-off of business investments, it will likely also include the elimination of the interest deduction, as promised in the Republican “Better Way” Blueprint for Tax Reform.
“With U.S. corporate debt levels at $51 trillion, taking away the corporate interest deduction, which is the third largest corporate tax deduction, may eventually lessen the tax incentive for debt financing in favor of equity funding,” observed international tax attorney and CPA Selva Ozelli. “But it also could send corporations into a panic looking for new financing alternatives, which became popular since the credit crisis.”
“Among these could be Islamic Financing, which doesn’t allow taking interest on loans since it is prohibited under Islamic law,” said Ozelli. “Transactions involving these banks have been growing in the U.S. and worldwide. Bitcoin transactions and new derivative products are other possibilities.”
Salim Omar, CPA, explained that Islamic financing is structured in ways so that no interest, or usury, is generated. “That is prohibited,” he said.
Omar, president of Morganville, N.J.-based Straight Talk Accounting and author of The Million Dollar CPA Firm, said that loans are made so that no interest is charged. “The loan is structured so the bank has an equity interest of sorts in the transaction. It comes into play in all types of financing.”
Such loans may be an increasingly attractive form of financing for businesses that can no longer deduct interest payments, Omar observed. “They may not be as competitive as other financing, so they may require a cost-benefit analysis of the tax benefits they enable,” he said.
During the campaign, President Trump proposed to allow companies engaged in manufacturing in the U.S. to elect to immediately expense capital investments rather than depreciate them, with companies that chose to expense foregoing the deductibility of interest. Under the House blueprint, capital investments would be immediately deductible without the requirement of an election, although the blueprint would disallow deductions for net interest expense.
The blueprint states, “Allowing investments to be immediately written off provides a greater incentive to invest than is provided through interest deductions under current law; allowing both together would be distortive as it would result in a tax subsidy for debt-financed investment.”
The blueprint explains that the elimination of deductions for net interest helps to equalize the tax treatment of different types of financing and reduces tax-induced distortions in investment financing decisions. “Providing neutrality takes the tax code out of marginal business decisions, letting market forces more efficiently allocate investment where it is most productive,” it says. “It also eliminates a tax-based incentive for businesses to increase their debt load beyond the amount dictated by normal business conditions. A business sector that is leveraged beyond what is economically rational is more risky than a business sector with a more efficient debt-to-equity composition.”
Ozelli believes the proposals bear watching. “Given the numerous sections addressing interest in the code, regulations and tax treaties, the proposed changes to corporate interest deductions may need careful consideration,” Ozelli cautioned.