The impact of thin capitalization rules on capital structure and tax avoidance

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Abstract

This study aims to examine the effect of the thin capitalization rules on capital structure (leverage) and tax avoidance. This is quantitative research using the difference-in-difference (DID) method, with multiple linear regression models. The sample used in this research is companies listed on the Indonesia Stock Exchange (IDX). The type of data used in this study is secondary data in the form of financial statements from 2013 up to 2018. The sample selection using the purposive sampling method with the number of samples amounted to 804 observations (firm-year). The regression method employs panel data with a period of six years (2013 to 2018). The results show that the thin capitalization rules reduced the leverage of companies with high and low debt-to-equity ratio (DER). Companies with high DER experience a decrease in leverage 2.3 times greater than companies with low DER. The results also show that the thin capitalization rules do not affect tax avoidance for companies with high and low DER. This research contributes to providing improvement in tax provisions. In practice, it provides recommendations to the Indonesian Tax Authority (ITA) to revise PMK-169/PMK.010/2015 and that ITA should consider using the best practice suggested by the Organization for Economic Co-operation and Development (OECD) in conducting interest limitation (i.e., the fixed ratio rule).

Keywords: Capital Structure, Tax Avoidance, Thin Capitalization, Thin Capitalization Rule

Authors’ individual contribution: Conceptualization — R.I.A. and F.I.; Methodology — R.I.A., F.I., and R.A.Q.; Software — R.I.A., F.I., and S.W.; Validation — S.W., J.S., and M.L.M.; Formal Analysis — R.I.A., F.I., and A.F.; Investigation — R.I.A., A.F.A., and M.L.M.; Resources — R.I.A., F.I., and A.F.; Data Curation — R.I.A. and S.W.; Writing — Original Draft — R.I.A. and F.I.; Writing — Review & Editing — R.I.A. and F.I.; Visualization — F.I., A.F., and S.W.; Supervision — A.M. and R.A.Q.; Project Administration — J.S., A.F.A., and M.L.M.; Funding Acquisition — R.I.A., F.I., and J.S.

Declaration of conflicting interests: The Authors declare that there is no conflict of interest.

Acknowledgements: The Authors thank the Ministry of Finance of the Republic of Indonesia for facilitating the research. We also thank Polytechnic of State Finance STAN for giving us motivation and a good opportunity to improve our research skills, especially in accounting and taxation.

JEL Classification: G32, H26, K34, K34

Received: 01.10.2021
Accepted: 23.03.2022
Published online: 25.03.2022

How to cite this paper: Anindita, R. I., Irawan, F., Firmansyah, A., Wijaya, S., Qadri, R. A., Sumantri, J., Andriani, A. F., & Mahrus, M. L. (2022). The impact of thin capitalization rules on capital structure and tax avoidance. Journal of Governance & Regulation, 11(2), 8–14. https://doi.org/10.22495/jgrv11i2art1