Interest is deductible; dividends aren't. So if an investor funds a blocker or a US portfolio company partly with a loan instead of all equity, the interest on that loan cuts the company's 21% corporate tax. A company with very little equity and lots of shareholder debt is “thinly capitalised”.
The US has no single bright-line ratio. Instead several rules squeeze from different sides: Section 163(j) caps the deduction (see 163(j)); the IRS can treat “debt” that doesn't look like real debt as equity (Section 385 and decades of case law — fixed maturity, real interest, a creditor who'd actually sue); interest paid to a 10%+ owner doesn't qualify for the portfolio interest exemption, so withholding may apply; and anti-hybrid rules block deductions where the other side doesn't pay tax. Tax teams model all of these together.
Worked example
A blocker earns $10 of profit. Funded all-equity, it pays $2.10 of tax. Fund it with a $60 shareholder loan at 8% instead, and $4.80 of interest comes off the top: tax drops to about $1.09. But the $4.80 paid offshore to a 10%+ owner may face 30% withholding unless a treaty cuts it — which is why the lender's location matters as much as the ratio.
Where you'll see it: Blocker capitalisation memos, shareholder loan agreements, transfer-pricing support for the interest rate.
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This glossary is general information, simplified for learning. It is not tax, legal or investment advice, and real structures turn on facts and documents not shown here.