The debt-equity bias reduction allowance (‘DEBRA’): the removal of the tax driven debt-equity bias?

Monique Pisters
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On May 11, 2022, the European Commission published an EU Directive proposal introducing a debt-equity bias reduction allowance (‘DEBRA’). The proposal aims to address the asymmetric tax treatment between debt and equity financing. To assure a more level playing field between debt and equity financing DEBRA introduces an allowance on equity as well as a further limitation on interest deduction.


The European Commission initially announced the DEBRA proposal during the COVID-19 pandemic on May 18, 2021. According the European Commission, the global pandemic led to a significant increase in higher deficits and debt financing in Europe. Currently, debt financing is regarded as more favorable for businesses as most EU tax systems allow for a deduction of interest payments when calculating the tax base for corporate income tax purposes, while costs related to equity financing are mostly non-deductible. To support Europe’s recovery from the global pandemic, the European Commission aims to help companies raise capital and improve their equity position by addressing the asymmetrical tax treatment between debt and equity financing through the DEBRA proposal. Simultaneously DEBRA supports the development for a single corporate tax rulebook for the EU under the "Business in Europe: Framework for Income Taxation" (BEFIT) proposal.


The DEBRA proposal is aimed at all taxpayers that are subject to corporate income tax in one or more EU Member States, including permanent establishments in one or more EU Member States of an entity that is resident for tax purposes in a third country.

Exemption for financial undertakings

Certain financial undertakings (as defined in the proposal) are excluded from the scope of DEBRA as these undertakings are subject to regulatory equity requirements that prevent under-equitization.

Allowance on corporate equity

The proposed Directive encourages the use of equity by ways of a deductible allowance on equity from the taxable base for corporate income tax purposes for 10 consecutive tax years. The deductible allowance is calculated by the allowance base multiplied by the notional interest rate (NIR). This results in the following equation:

Allowance on equity = Allowance Base X Notional interest rate (NIR)

Calculating the allowance base

The base of the allowance on equity is calculated as the difference between the level of net equity at the end of a tax year and the level of net equity at the end of the previous tax year. The proposal defines equity and net equity as follows:

  • Equity: the sum of the taxpayer’s paid-up capital, share premium accounts, revaluation reserve and other reserves and profit or loss carried forward.
  • Net equity: the difference between the equity of a taxpayer and the sum of the tax value of the taxpayer’s participation in the capital of associated enterprises and the taxpayer’s own shares.

The notional interest rate (NIR)

The applicable notional interest rate depends on the 10-year risk-free interest rate for the relevant currency and is increased by a risk premium of 1% (1.5% in case of SMEs).

Decrease in the taxpayer’s equity

If there is a decrease in equity of a taxpayer that benefitted from an allowance on equity increase, an amount calculated the same way as the allowance would become taxable for 10 tax years. However, this rule shall not apply if the taxpayer provides evidence that this decrease is exclusively due to losses incurred during the tax year or due to a legal obligation.

Limitations on the deductible allowance

The allowance on equity is deductible from the taxpayer’s taxable base for corporate income tax purposes for up to 30% of the taxpayer’s earnings before interest, tax, depreciation and amortization (EBITDA).

The amount of deductible allowance on equity that exceeds the taxpayer’s net income in a tax period may be carried forward without limitation in time.

Any unutilized amount of deductible allowance on equity due to the maximization of 30% of the EBITDA of the taxpayer can be carried forward for a maximum period of five tax years.

Further limitation on interest deduction

Besides encouraging the use of equity, the proposal simultaneously aims to discourages the use of debt. A proportional restriction will limit the deductibility of interest up to 85% of the exceeding borrowing costs (i.e. interest paid minus interest received). Thus, 15% of the exceeding borrowing costs will not be deductible from the taxpayer’s tax base.

Important to point out is that the interest limitation of 15% applies before the earnings stripping rule of ATAD1. If the application of the earnings stripping rule of ATAD1 results in a lower amount than 85% of the exceeding borrowing costs, the taxpayer will be entitled to carry forward or back the difference in accordance with the rules of ATAD1.

By way of example, if a taxpayer has exceeding borrowing costs of 100, it should:

  • First: apply the limitation on interest deduction of the DEBRA proposal that limits the deductibility to 85% of the exceeding borrowing costs of 100: 15 and thus renders a non-deductible amount of 15. This results in an amount of 85 of deductible interest under the DEBRA proposal.
  • Second: apply the earnings stripping rule of ATAD1. If under ATAD1 the deductible amount is lower, e.g. 80, the difference of the deductibility, i.e. 85-80= 5, would be carried forward or back in accordance with ATAD1.

Important to note: ATAD1 provided Member States the option to implement certain carve-outs such as the group ratio rule and the equity-escape rule, whereas DEBRA introduces a permanent non-deductible interest restriction up to 15% of the exceeding borrowing costs without any carve-outs. The lack of carve-outs in the DEBRA proposal should lead to a more harmonized treatment of deductible interest in the EU and thus leading to less disparities between Member States. Consequently, one could say that DEBRA results in a more level playing field between Member States in respect to the treatment of deductible interest.

Anti-abuse rules

To avoid the misuse of the deduction of the allowance on equity, the proposal provides for certain anti-abuse rules. In particular the anti-abuse rules focus on schemes put in place to circumvent the conditions on which an equity increase qualifies for an allowance under this proposal Directive.
The first anti-abuse rule stipulates that the base of the allowance on equity does not include the amount of any increase which is the result of:

  1. Granting loans between associated enterprises;
  2. Transfers between associated enterprises of participations or of a business activity as going concern;
  3. Contributions in cash from a person resident for tax purposes in a jurisdiction that does not exchange information with the Member State in which the taxpayer seeks to deduct the allowance on equity.

The second anti-abuse rule sets out conditions for taking into account equity increases originating from contributions in kind or investments in assets. The proposal stipulates that Member States shall take the appropriate measures to ensure that the value of the asset is taken into account for the calculation of the base of the allowance only where the asset is necessary for the performance of the taxpayer’s income-generating activity.

The third anti-abuse rule targets the re-categorization of old capital as new capital, which for example could be achieved through a liquidation and the creation of start-ups. Member States shall take the appropriate measures to ensure that where an increase in equity is the result of a reorganization of a group, such increase shall only be taken into account to the extent that it does not result in converting the equity (or part thereof) that already existed in the group before the reorganization into new equity.

If however the taxpayer is able to provide sufficient evidence that the relevant transaction has been carried out for valid commercial reasons and does not lead to a double deduction of the defined allowance on equity, the anti-abuse rules should not apply.

Way forward

The DEBRA proposal comes as a double-edged sword for taxpayers. While the deductible allowance on equity incentivizes taxpayers to finance investments with equity, the limitation on interest deduction further restricts the taxpayer in its debt financing abilities. As such companies may have to reassess their financing structure taking into account the allowance on equity and the further restriction on interest deduction.

For DEBRA to move forward unanimity from all 27 EU Member States is required. If adopted the DEBRA proposal should be transposed into national law by December 31, 2023 and should take effect as of January 1, 2024.