Proposed Directive to Reduce Debt-Equity Bias

Proposed Directive to Reduce Debt-Equity Bias

On 11 May 2022, the European Commission (EC) published a proposed Directive that set out rules to level the playing field between debt and equity financing for corporate income tax purposes.

The proposed Directive is designed to reduce the bias in the tax system in favour of debt financing over equity. In order to achieve this, the Directive proposes to introduce an equity allowance, as well as a limitation on the deductibility of debt financing costs.  


Debt-equity bias reduction allowance (DEBRA) will apply to all taxpayers subject to corporate income tax in an EU member state, including permanent establishments of non-EU companies. However, certain financial undertakings will fall outside the scope of the Directive including credit institutions, AIFs, UCITS, AIF/UCITS managers, insurance and reinsurance undertakings, pension funds, and certain securitisation entities.

Allowance on equity

The equity allowance will provide a deduction that is computed over the allowance base and multiplied by a notional interest rate. The allowance will be limited to 30% of the taxpayer's earnings before interest, tax, depreciation and amortization (EBITDA), which is similar to the earning stripping rules in ATAD 1.

The allowance base will be the difference between the taxpayer’s net equity at the end of the financial year and the net equity at the end of the previous year. Equity will be defined by reference to the EU Accounting Directive. Net equity will be the difference between the taxpayer’s equity and the sum of the tax value of the taxpayer’s participations in associated enterprises and its own shares.

The relevant notional interest rate will be based on two components: the risk-free interest rate and a risk premium. The notional interest rate will be calculated based on the 10-year risk-free interest rate as determined under the EU Solvency II Directive, plus a 1% risk premium. A higher risk premium of 1.5% will apply in the case of small and medium-sized enterprises.

The equity allowance will be deductible for 10 consecutive tax years, i.e., in the current year and the following nine financial years, which the EC equates to the approximate maturity date of most debt.

The deduction of the allowance will be limited to 30% of fiscal EBITDA. However, any allowance exceeding 30% of fiscal EBITDA will be available for carry forward without time limitation. If the equity allowance is lower than 30% of fiscal EBITDA due to insufficient taxable profit, the unused allowance capacity will be able to be carried forward for five years.

If the taxpayer’s net equity at the end of the financial year is lower than the net equity of the previous financial year, a proportionate amount will be taxable in the following 10 years, although the taxpayer will be permitted to produce evidence that the reduction occurred as a result of losses incurred during the tax period or a legal obligation.

The Directive includes a number of anti-abuse measures aimed at ensuring that the rules on the deductibility of an equity allowance are not used for unintended purposes.

Further restriction on interest deductions

To further reduce the debt-equity bias, the Directive proposes to limit the tax deductibility of debt-related interest payments to 85% of the net interest balance (interest payments minus interest income). This rule is similar to the ATAD 1 earnings stripping rules, under which interest is deductible only if the net interest balance does not exceed 30% of fiscal EBITDA. As these rules are similar, the proposed Directive contains specific rules on the interaction of the two sets of rules, whereby deductible interest under the DEBRA Directive is first calculated, followed by a calculation of deductible interest under the ATAD 1 rules. The lower of the two amounts may be deducted, while the difference between the two amounts may be carried forward for a period that is governed by that member states’ implementation of the ATAD 1 earnings stripping rules. However, it would appear that the amount disallowed under this Directive is permanently disallowed.

Effective dates and transition rules

EU member states would be required to implement the DEBRA Directive into their domestic law by 31 December 2023, so that it would be effective as from 1 January 2024.


The adoption of the Directive is subject to unanimous agreement by all EU Member States, and the proposal is currently subject to a consultation process which runs until 12 July 2022. BDO will be working with relevant industry groups in relation that consultation process.

If adopted, DEBRA is intended to apply as from 1 January 2024. Therefore, we would encourage, clients to consider their current financing structure, as well as their financing mix going forward.

For more information please contact our tax team 01 470 0000. 

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