• Draft directive aims to reduce bias that favours debt financing (DEBRA)

Draft directive aims to reduce bias that favours debt financing (DEBRA)

30 June 2022

Recently, the European Commission published a proposed directive that set out rules to level the playing field between debt and equity financing for corporate income tax purposes.

Tax rules in most countries allow businesses to deduct interest expenses on debt in computing their taxable income, but the same rules do not apply to expenses incurred in the context of equity financing. This creates an incentive for businesses to make their financing decisions based on the tax treatment instead of commercial considerations, even if taking on debt may not be the best option for the business.

To reduce this bias, the European Commission proposes a debt-equity bias reduction allowance (‘DEBRA’).

In summary, the proposal works as follows:

  • If in a year the net equity (equity minus value of participations) of a taxpayer increases, this increase forms the allowance base;
  • The allowance base is multiplied with a notional interest rate, being the 10 year risk free interest rate plus a risk premium of 1% (1.5% for SMEs), to determine the allowance on equity;
  • The allowance may only be deducted up to 30% of the fiscal EBITDA of the taxpayer and is deductible for the respective fiscal year and the 9 fiscal years following;
  • Any non-deductible allowance may be carried forward indefinitely.

The deduction of interest under DEBRA will be further limited, it is proposed that a maximum of 85% of the net interest balance (interest expenses minus interest income) may be deducted.

A detailed overview of these measures can be found in the following article.

Stay tuned for future updates!