Florida proposal to limit the corporate deduction for interest.

Tax Executives Institute urges the rejection of a proposal to limit the deduction for interest expense, which is contained in FT 92-10 in the House version. A similar proposal has been introduced in the Senate. The proposal would --

* violate longstanding and legitimate tax law principles;

* retroactively penalize taxpayers; and

* discourage business investment in Florida.

BACKGROUND

Tax Executives Institute (TEI) is the principal association of corporate tax executives in the United States and Canada. Our 4,800 members represent more than 2,000 of the leading corporations in the United States and Canada. The Institute's Florida members represent more than 60 corporations in nearly all industry sectors. In addition, a large number of our non-Florida members work for corporations that, while not headquartered in Florida, have substantial operations or sales in the State. The Institute's membership represents a cross-section of the business community in Florida and, indeed, all of North America.

Because of the diversity of the Institute's membership, TEI does not take positions on parochial or industry-based issues. Rather, we dedicate ourselves to educational endeavors, to promoting the uniform and equitable enforcement of the tax laws, and to minimizing the costs of tax administration and compliance to the common benefit of government and taxpayers. In the United States and Canada, TEI meets with tax administrators at all levels to advance these principles and, where appropriate, submits comments to state legislatures. That we have undertaken to prepare these comments is a measure of our serious concern over the enactment of legislation limiting the deduction of a corporation's interest expense.

DISCUSSION

The House and Senate bills include a proposal to limit the interest deduction for corporations by requiring a percentage of a corporation's interest expense to be added back in computing Florida taxable income. (1) TEI opposes the proposal to deny a full deduction for interest paid for the following reasons:

1. The proposal violates longstanding and legitimate tax law principles. Under current law, taxpayers are properly accorded a deduction for ordinary and necessary business expenses. Interest paid on business-related indebtedness is one such expense. Thus, if a company borrows to purchase equipment that is used in its business, the interest on the loan should be deductible as a legitimate cost of acquiring and utilizing that asset in the business. There is no valid tax policy justification for the proposals. The proposals illogically seek to deny a deduction for a recognized, legitimate business expense (interest), while failing to provide parallel relief to corporate taxpayers in respect of their interest income; interest income is obviously the "flip side" of the same coin. The Summary Description to FT 92-10 links the proposal to a decline in Florida's tax receipts, which its proponents claim is attributable to an increase in corporate debt. In point of fact, however, the decline in corporate tax receipts -- in Florida as well as throughout the United States -- is largely due to a recessionary decline in pre-interest corporate profits. Florida cannot properly assume that it is disadvantaged by increased interest expense while denying that it benefits from taxation of increased interest income earned by corporations.

To restrict the corporate deduction for interest payments would be a denial of a deduction for a legitimate cost of operations -- a violation of a basic principle underlying the Florida net income tax system. Net income tax systems are typically predicated on the matching of income and expense, with the tax rate applying to the resulting profit. Alternatively, a gross-profits system imposes taxes without permitting offsetting deductions, but the applicable tax rate is only a fraction of the tax rate that would apply under a net income tax system. What Florida seeks to achieve under the current proposals is a melding of these two approaches to taxation -- denying basic deductions while retaining a net income tax system tax rate. We believe the result is wholly improper.

2. The proposal is inappropriately retroactive with respect to debt outstanding prior to its stated effective date. The proposal would deny corporations a deduction for a percentage of their interest expenses without regard to when the underlying indebtedness was incurred. Thus, as to be debt extant at the time of enactment, the after-tax consequences to the borrower would be significantly more adverse than what was anticipated at the time of the borrowing.

3. The proposal will create a tax structure that discourage business investment in Florida. Denying corporations deductions for legitimate business expenses would taint the business climate in Florida and discourage business investments by both in-state and out-of-state businesses. In addition, the proposals would inject a large measure of uncertainty into the tax system because taxpayers would have legitimate questions concerning further deviations from good tax policy. Thus, the proposal to deny a legitimate deduction to the corporate sector exacerbates the negative perception that arose in the business community from Florida's previous efforts to impose a tax on services. The ensuing climate cannot help but impair the State's long-term financial outlook.

For the foregoing reasons, Tax Executives Institute recommends the rejection of the House and Senate proposals to limit the interest deduction. If you should have any questions about the Institute's position, please do not hesitate to call Mary L. Fahey of the Institute's professional staff at [phone] or [Henry G. Marchman, President of TEI's Florida Chapter] at [phone].

(1) FT 92-10 would require 20 percent of a corporation's interest expense to be added back, whereas the Senate version would limit the add-back to 10 percent.