The European Commission is trying to remove the debt bias linked to taxation


Summary and background

On May 11, 2022, the European Commission (the “Commission”) released its draft proposal for a leverage bias reduction allowance (“DEBRA“or the”directive”), which is part of the Commission Communication on Corporate Tax Reforms which was first presented on 18 May 2021. The Directive aims to remove tax as a weighted factor in the choice of business financing and encouraging the use of equity investments. The Commission’s perceived view is that debt is generally preferred over equity, as most tax systems allow the deduction of interest on debt, while the costs of equity financing are generally not deductible fiscally.

Application of the directive

The Directive, as currently drafted, would apply to all EU businesses that are liable to corporation tax in one or more Member States, with certain exceptions for certain types of financial businesses ( including investment firms, alternative investment funds and credit institutions). It includes two distinct measures which aim to: (i) apply a notional interest deduction on changes in equity levels; and (ii) apply an interest deduction limit of 85% of “excess” borrowing costs (ie interest paid less interest received).

  1. Deduction from own funds

How it works

The proposal would allow taxpayers to deduct an amount (the equity allowance), limited to 30% of EBIDTA, from their tax base for corporation tax purposes for 10 consecutive tax periods. Any excess of the allowance can be carried forward indefinitely if the deductible equity allowance exceeds the taxpayer’s net taxable income during that period. Any portion of the equity deduction that exceeds 30% of EBITDA in any period can also be carried forward for up to five years.

The equity provision is calculated by multiplying the provision basis by the relevant notional interest rate. The basis for the equity deduction is the year-to-year difference in the amount of equity between tax periods, so the proposed rules would reward taxpayers who increase their equity from one tax period to the next. ‘other. Equity is defined as the sum of paid-in capital, share premium account, revaluation reserve, reserves and deferred profit or loss.

The relevant notional interest rate is calculated on the basis of the 10-year risk-free interest rate for the relevant currency (i.e. the EU-wide rates which are published for the purposes of Solvency II), increased by a risk premium of 1%, rising to 1.5% if the taxpayer is an SME.


A recapture of the deduction may occur in certain circumstances where the difference in net worth for a tax year is negative and the taxpayer has already obtained the deduction. Clawback works by adding an amount proportional to the taxpayer’s taxable income for 10 consecutive tax periods, unless the taxpayer can demonstrate that the negative deduction is due to accounting losses incurred during that period or as a result of a legal obligation to reduce capital.

Anti-abuse measures

The directive also proposes a number of anti-abuse measures which limit the amount of capital increases resulting from:

a) (i) loans between associated enterprises; (ii) transfers of existing interests or business contributions between associated companies; and (iii) certain cash contributions, unless the taxpayer can demonstrate that the increase is for a valid business reason and that there is no double deduction;

b) contributions in kind or investments in assets; and

(c) a reorganization of the taxpayer’s group.

  1. Interest deduction limitation

The directive also proposes a limitation of the tax deductibility of debt-related payments to 85% of excess borrowing costs. This proposal would interact with Article 4 of the Anti-Tax Avoidance Directive (“ATAD”) which has been widely implemented by all Member States. According to the current wording of the directive, the taxpayer is only allowed to deduct the lower of the two amounts in a tax year, the calculation under the directive prevailing, and in cases where the calculation of the Exceeding borrowing costs under ATAD results in a lower deductible amount, taxpayers will be entitled to carry forward or back the difference between the two calculations.

Next steps and conclusion

As the Directive moves through the next legislative stage, it will need the support of all 27 Member States to reach publication, and it is therefore expected that changes will be made to the proposed text during the course of the negotiation stage.

The current Commission proposal, if adopted, envisages a transposition date of 31 December 2023, with the rules entering into force on 1 January 2024. Transitional rules would apply to Member States which already apply a tax relief on financing by shares under their national tax regime, including a postponement of the implementation of the directive for up to ten years.

© 2022 Proskauer Rose LLP. National Law Review, Volume XII, Number 145


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