Summary and Background

On 11 May 2022, the European Commission (the “Commission”) published its draft proposal for a debt-equity bias reduction allowance (“DEBRA” or, the “Directive”), which forms part of the Commission’s Communication on Business Taxation reforms which were first outlined on 18 May 2021.  The Directive seeks to remove tax as a weighted factor in the choice of funding for companies and encourage the use of equity investments.  The perceived view of the Commission is that debt is usually favoured over equity due to the fact that most tax systems allow for the deduction of interest on debt, while costs relating to equity financing are usually non-tax deductible.

Application of the Directive

The Directive, as currently drafted, would apply to all undertakings in the EU that are subject to corporate income tax in one or more Member States, with certain exceptions for certain types of financial undertakings (including investment firms, alternative investment funds and credit institutions). It includes two separate measures which seek to: (i) apply a notional interest allowance on changes in equity levels; and (ii) apply a limitation on interest deduction to 85% of the “exceeding” borrowing costs (i.e. interest paid minus interest received).

1. Allowance on Equity

How it works

The proposal would allow taxpayers to deduct an amount (the allowance on equity), limited to 30% of EBIDTA from their tax base for corporate income tax purposes for 10 consecutive tax periods.  Any excess of the allowance is available to carry forward indefinitely if the deductible allowance on equity is higher than the taxpayer’s net taxable income in that period.  Any part of the allowance on equity which exceeds 30% of EBITDA in a period can also be carried forward for a maximum of five years.

The allowance on equity is calculated by multiplying the allowance base by the relevant notional interest rate.  The base of the equity allowance is the year-on-year difference in the amount of equity between tax periods, so that the proposed rules would reward taxpayers that increase their equity from one tax period to the next.  Equity is defined as the sum of paid up capital, share premium account, revaluation reserve and reserves and profits or losses carried forward.

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


A clawback of the allowance can occur in certain circumstances where the difference in the net equity for a tax year is negative, and where the taxpayer has previously obtained the deduction.  The clawback operates adding a proportionate amount to the taxpayer’s taxable income for 10 consecutive tax periods unless the taxpayer can demonstrate that the negative allowance arose 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 equity increases resulting from:

a) (i) loans between associated enterprises; (ii) transfers of participations or existing business contributions between associated enterprises; and (iii) certain cash contributions,   unless the taxpayer can show that the increase arises from a valid commercial reason and that   no double deduction arises;

b) contributions in kind or investments in assets; and

c) a reorganisation of the taxpayer’s group.

2. Limitation on interest deduction

The Directive also proposes a limitation on the tax deductibility of debt-related payments to 85% of exceeding borrowing costs.  This proposal would interact with Article 4 of the anti-tax avoidance directive (“ATAD”) which has been broadly implemented by all Member States.  The current drafting of the Directive results in the taxpayer only being authorised to deduct the lower of the two amounts in a tax year, with the calculation under the Directive taking precedence, and in circumstances where the exceeding borrowing costs calculation 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 in order to reach publication, and it is therefore expected that amendments will be made to the proposed text during the negotiation stage.

The Commission’s current proposal, should it be adopted envisages a transposition date of 31 December 2023 with the rules coming into effect on 1 January 2024.  Transitional rules would apply to the Member States that already apply a tax allowance on equity funding under their domestic tax regimes, including a deferral of the implementation of the Directive for up to ten years.