European Commission proposes directive to address tax-induced debt equity bias

On 11 May 2022, the European Commission announced the release of a draft for a new directive laying down rules to address the tax-induced debt-equity bias. The proposal includes both a debt-equity bias reduction allowance (DEBRA) in the form of notional interest deduction on equity and a general limitation on the tax deductibility of debt-related interest payments.

The initiative was announced on 18 May 2021 by the European Commission in its Communication on Business Taxation for the 21st Century. The initiative of the European Commission is driven by the assumption that the asymmetry in the tax treatment of debt and equity financing encourages companies to accumulate debt which may lead to a high incidence of insolvency.

DEBRA is an allowance on equity by providing for the tax deductibility of notional interest on increases in net equity. The deductible amount would be computed by multiplying the allowance base (year-on-year increase in net equity) and applicable notional interest rate. The allowance shall be granted for 10 years (i.e. it would be deductible in the year it was incurred and the next successive nine years). The maximum amount of the allowance in one year shall not exceed 30 % of EBITDA. The excess allowance shall be carried forward indefinitely.

Limitation on interest deductibility will be introduced as an alongside rule to DEBRA. This rule would limit the deductibility of interest of 85 % of the taxpayer’s exceeding borrowing costs, i.e. the excess of interest paid over interest received. The new rule should apply in parallel with the interest limitation rule proposed by ATAD I.

The proposal will be now consulted by the European Parliament and European Economic and Social Committee. If approved, the directive shall be applicable as of 1 January 2024 with the proposed implementation deadline on 31 December 2023. We are monitoring the approval process and will bring you any news that unfolds.

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