Draft DEBRA directive allows deducting notional interest on equity financing

The European Commission has published a proposal for a directive that should balance the tax disadvantages of equity financing compared to debt financing (debt-equity bias) by allowing taxpayers to deduct from the tax base notional interest on newly invested equity. The directive also proposes to further limit the tax deductibility of exceeding borrowing costs.

The debt-equity bias reduction allowance (DEBRA) is to be calculated on the difference between net equity at the beginning and at the end of the taxable period. Net equity should represent the difference between the value of equity and the value of interests in subsidiaries recorded in the balance sheet. A notional interest rate should then be applied to this difference, calculated as a 10-year risk-free interest rate for the currency in question plus a risk premium of 1% (1.5% for SMEs).

The notional interest thus calculated shall be deductible from the tax base in the year of the equity increase and in nine subsequent taxable periods. It should be possible to deduct notional interest in the maximum amount of 30% of the taxpayer's taxable profits (i.e., tax EBITDA) in one taxable period.

Furthermore, if equity for which the allowance had been claimed is subsequently decreased, the directive stipulates the additional taxation of the previously claimed allowance. However, decreases in equity due to accounting loss or a legal obligation to reduce capital should be exempt from such additional taxation.

The directive also deals with possible abuses of the new legislation, laying down circumstances under which the allowance cannot be claimed: for instance, where the equity increase originates from intra-group loans or transfers of shares between related parties. Even in these cases, the taxpayer will have the opportunity to prove that the capital increase had economic justification and that it will not lead to a double deduction.

Limiting interest deduction

To further balance equity and debt financing, the directive proposes to further limit the deductibility of exceeding borrowing costs (i.e., the difference between borrowing costs and borrowing income from related and unrelated persons as defined by ATAD) to the lower of:

  • 85% of exceeding borrowing costs
  • the current limit on exceeding borrowing costs under ATAD.

If the result of applying the ATAD rule is a lower deductible amount, the taxpayer will be entitled to carry forward the difference (up to 85% of the exceeding borrowing costs) to future taxable periods.

The new rules should apply to all corporate taxpayers in the EU (except for some financial institutions), including the permanent establishments of companies from third countries. The directive is proposed to enter into effect on 1 January 2024.

 

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