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Directive on Debt-Equity Bias Reduction Allowance

  • Ireland
  • Tax planning and consultancy


The Debt-Equity Bias Reduction Allowance (‘DEBRA’) Directive, published by the European Commission, proposes to introduce a debt-equity bias reduction allowance and a limitation of the tax deductibility of exceeding borrowing costs. The aim of this initiative is to encourage companies to finance their investment through equity contributions rather than through debt financing. As interest payments on debt-financing are generally tax deductible in most corporate tax systems, a bias towards debt-financing is often created, to mitigate tax exposure.

In order to reduce dependence on debt-financing an allowance will be introduced, permitting a company to claim back on their investments that are equity lead, instead of debt loans. Over-indebtedness could threaten the stability of the financial system and increase the risk of bankruptcies, which could in turn, according to the Commission increase unemployment. In most corporate tax systems, interest is tax deductible whereas no comparable deduction in relation to equity finance generally exists.

DEBRA is proposed to apply to all taxpayers subject to ‘corporate income tax’ in EU Member States. A number of exclusions are proposed, including exclusions for AIFs, UCITS, AIFMs, credit institutions, insurance undertakings, certain securitisation entities and other taxpayers. These are not dissimilar to the exclusions available under the EU ATAD Interest Limitation Rule.

Debt-level concerns

The European Commission’s underlying concern regarding the bias towards debt financing over equity financing has been heightened in light of the overall increase in debt burden of companies across the EU following the COVID-19 pandemic. The commission would prefer to see growth and investment in the single market that favours higher equity ratios, thereby reducing risks associated with high levels of debt (including risks associated with insolvency).

Allowance on Equity

The allowance on equity would be computed by multiplying the allowance base with a notional interest rate. The allowance base corresponds to the difference the net equity at the end of the current tax year and the net equity at the end of the previous tax year. The Notional Interest Rate corresponds to a 10-year risk-free investment for the relevant currency, increased by a risk premium of 1 %( 1.5% for SMEs).

Limitation on Interest Deduction

The Directive would also introduce a new restriction of 15 percent on the deductibility of exceeding borrowing costs, in order to address the debt-equity bias simultaneously in respect of both equity and debt and preserves the sustainability of Member States’ public finances. The new interest limitation rule proposed in the Directive would interact with the existing interest limitation rule under Article 4 of ATAD. Taxpayers would be required to first calculate the deductibility of exceeding borrowing costs under this Directive and then apply the interest limitation rule under ATAD. The Directive would require Member States to ensure that the taxpayer is entitled to deduct only the lower of the two amounts in a tax year. The Directive would also provide for transitional rules in respect of those Member States, which currently already apply a tax allowance on equity funding under national law where the latter is shorter than 10 years.

Anti-tax avoidance rules

The allowances for equity could be abused if not coupled with an adequate anti-tax avoidance framework. Increases in equity that originate from intra-group loans, intra-group transfers of participations or existing business activities and under certain conditions cash contributions would be excluded from the calculation of the increase in net equity. Similarly certain contributions in kind as well as equity increases following a re-characterization of old capital into new capital through, e.g., liquidation transactions would be excluded from the increase in net equity.

Given the relatively recent introduction of the existing ILR, it is surprising to see a further proposal from the European Commission to further limit the deductibility of interest expenses. The existing ILR provides a framework to limit excessive interest deductions and as such it is not clear why a further restriction is required. While the introduction of an allowance is a welcome proposal, albeit the notional interest rate is somewhat low.

Overall, the Commission’s proposal entails a significant degree of complexity, both in terms of coordination and entails a high level of cooperation by all levels. The proposal is currently in draft form, and a consultation period will run until 12 July 2022. The Commission proposes that Member States should transpose the rules into domestic law by December 31, 2023 and that the provisions of the directive should apply as of 1 January 1, 2024.

For more information, please contact: 

Tim Kiely, Partner, Tax -

Robert Dever, Senior Associate, Tax -

Melissa Daly, Senior Associate, Tax -