Internal Market, Industry, Entrepreneurship and SMEs

Study: Effects of tax systems on the retention of earnings and the increase of own equity

Study: Effects of tax systems on the retention of earnings and the increase of own equity
Published on: 15/02/2008
This 2008 study focuses on tax systems and regulations, and their impact on business owners’ decisions to retain earnings or distribute profits. Tax systems in 19 countries are presented and analysed. The perceptions that businesses have of these tax systems are examined.

The key objectives of the study were:

  • to identify and recognise those elements and provisions in tax systems which have an important impact on SME business owners’ decisions regarding the retention of earnings;
  • to understand how tax systems affect SME business owners’ decisions, describing and analysing the situation of business owners based on their understanding and perception of the relevant tax provisions;
  • to focus on the effects of taxation on the retention of earnings and the equity structure of SMEs.

The main findings of the study were:

  • almost all countries had an average debt-equity ratio over the 2002-2005 period of more than one;
  • in general, debt-equity ratios have fallen over the time period covered by the analysis (2002–2005);
  • the analysis suggested that different sectors of activity – manufacturing, distribution and services – had their own equity structure requirements;
  • business owners in most countries consider it more advantageous to retain earnings when only taxes are taken into consideration;
  • business owners in most countries consider the current tax treatment on retained earnings in comparison to debt financing to have no impact on the decision to retain earnings or distribute profits.

The following tax measures were recommended in the study as good practices to provide incentives for retaining earnings and increasing own equity:

  • deferral of corporation tax;
  • notional interest systems;
  • reduced tax rates for SMEs.

Annexes