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Useful Fictions: Debt and Equity Classification in Corporate Tax Law

38 Pages Posted: 7 Mar 2007  

Anthony P. Polito

Suffolk University Law School


This Article observes that the debt-equity distinction is premised upon a fiction that it is possible fully to distinguish corporate equity investors who share in risks of an enterprise from debt holders who do not. It is a fiction in service of a deeper fiction that it is possible correctly to identify corporate income with the return to equity. Corporation's have no income in an economic sense, yet the fiction that they do is a useful one. It allows the imposition of a corporate income tax that may serve policy goals that cannot be addressed directly.

All of the tax law is an artificial construct. The Article concludes that tax law should abandon the pretense that it can correctly distinguish true debt from true equity, but this Article does not advocate abandoning these useful fictions. Instead, the tax law should admit what finance theory teaches, that all investments in the corporation share in the risks and returns of the enterprise. The Article establishes a risk and return framework in which to decide how to make the fictional distinction between debt and equity. That framework would compel Congress explicitly to address the fictions and to construct them with a direct eye to the underlying policy goals of the corporate income tax.

Suggested Citation

Polito, Anthony P., Useful Fictions: Debt and Equity Classification in Corporate Tax Law. Arizona State Law Journal, Vol. 30, p. 761, 1998. Available at SSRN:

Anthony P. Polito (Contact Author)

Suffolk University Law School ( email )

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