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May 11, 2022

European Commission proposes Directive to tackle debt-equity bias in taxation

Executive summary

On 11 May 2022, the European Commission (the Commission) published a legislative proposal on the Debt-equity bias reduction allowance (DEBRA) initiative. The proposal sets forth rules to address the tax-related asymmetry in treatment of debt and equity, with the aim to encourage companies to finance their investment through equity contributions rather than through debt financing (the draft Directive or DEBRA). This initiative was announced by the Commission in its Communication on Business Taxation for the 21st century published in May 2021.1

The draft Directive applies to all taxpayers that are subject to corporate income tax in one or more European Union (EU) Member States, with the exception of financial undertakings. It includes two separate measures that apply independently: (i) a notional interest allowance on changes in equity levels; and (ii) a limitation on interest deduction to 85% of the exceeding borrowing costs (i.e., interest paid minus interest received). The proposal requires Member States to provide specific data to the Commission on an annual basis in order to allow monitoring of the implementation and effects of the new rules. The proposal also includes anti-abuse provisions to prevent tax-driven changes in equity levels.

The draft Directive will now move to the negotiation phase among Member States with the aim of reaching a final agreement. In the EU, adoption of tax legislation requires unanimity between all 27 Member States. The Commission proposes that the Member States shall transpose the Directive into their national laws by 31 December 2023 for the rules to come into effect as of 1 January 2024.

Detailed discussion


On 18 May 2021, the Commission published the Communication on Business Taxation for the 21st Century (the Communication) that sets out the Commission’s short-term and long-term vision to provide a fair and sustainable EU business tax system and support the recovery. Among the corporate tax reforms proposed in the Communication, the Commission  announced its plans to table a legislative proposal in Q1 2022 setting out EU rules to “address the debt-equity bias in corporate taxation, via an allowance system for equity financing, thus contributing to the re-equitization of financially vulnerable companies.”

Following that, on 1 July 2021, the Commission launched a public consultation on such proposal consisting of a questionnaire and the opportunity to submit a position paper. The consultation closed on 7 October 2021 with a total of 67 replies.

On 11 May 2022, the Commission published the draft DEBRA proposal that includes two separate measures that apply independently: (i) a notional interest allowance on changes in the levels of equity; and (ii) a limitation on interest deduction to 85% of exceeding borrowing costs (i.e., interest paid minus interest received).

According to the explanatory memorandum to the draft Directive, the proposal complements a number of other policy initiatives promoted by the Commission in parallel, including a proposal for Business in Europe: Framework for Income Taxation (BEFIT), which is expected to be published in 2023.

The draft Directive


The proposed rules would apply to all undertakings in the EU that are subject to corporate income tax in one or more Member States. Financial undertakings are excluded from the scope of this Directive as some are subject to regulatory equity requirements already preventing under-equitization. In addition, the Commission asserts that many are unaffected by interest limitation deduction rules. According to the Commission, if the proposed rules to address the tax related debt-equity bias were to apply to them, the economic burden of the measures would be unequally distributed at the expense of non-financial undertakings.

Allowance on equity

The proposed allowance on equity would be computed based on the difference between net equity2 at the end of the current tax year and net equity at the end of the previous tax year, multiplied by a notional interest rate. The notional interest rate is the 10-year risk-free interest rate for the relevant currency,3 and increased by a risk premium of 1% or, in the case of Small and Medium Enterprises (SMEs), a risk premium of 1.5%. If the difference between the above-mentioned equity levels is a negative amount (loss), then the computation will lead to a positive amount being added to the taxable income of the company unless the taxpayer provides sufficient evidence that this is due to accounting losses incurred during the tax period or due to a legal obligation to reduce capital.

To prevent tax abuse, the deductibility of the allowance is limited to a maximum of 30% of the taxpayer’s EBITDA (earnings before interest, tax, depreciation and amortization) for each tax year. If the allowance on equity is higher than the taxpayer's net taxable income, the taxpayer may carry forward the excess of allowance on equity without a time limitation. In addition, taxpayers will be able to carry forward their unused allowance on equity which exceeds the 30% of taxable income, for a maximum of five tax years.

The Directive includes a number of anti-abuse measures to ensure that the rules on the deductibility of an allowance on equity are not used for unintended purposes:

  • A first measure would exclude from the base of the allowance equity increases that originate from: (i) intra-group loans; (ii) intra-group transfers of participations or existing business activities; and (iii) cash contributions under certain conditions.

  • Another measure sets out specific conditions for taking into account equity increases originating from contributions in kind or investments in assets.

  • A third measure targets the re-categorization of old capital as new capital, which would qualify as an equity increase for the purpose of the allowance. Such re-categorization could be achieved through a liquidation and the creation of start-ups.

Limitation to interest deduction

The allowance on equity is accompanied by a limitation to the tax deductibility of debt-related interest payments. The aim is to better mitigate the debt-equity bias. Accordingly, the Directive proposes the introduction of a limitation on the deductibility of interest to 85% of exceeding borrowing costs (i.e., interest paid minus interest received).

Given that interest limitation rules already apply in the EU under Article 4 of the anti-tax avoidance Directive (ATAD), the Directive provides that the taxpayer will apply the rule under this proposal as a first step and then, calculate the limitation applicable in accordance with Article 4 of ATAD. If the result of applying the ATAD rule is a lower deductible amount, the taxpayer will be entitled to carry forward or back the difference in accordance with Article 4 of ATAD. This article of the ATAD, adopted on 12 July 2016 at the EU level, has been broadly implemented by Member States.

Monitoring and reporting

Member States will have to provide specific data to the Commission on an annual basis in order to allow monitoring of the implementation and effects of the new rules by the Commission. According to the Directive, each Member State will need to report within three months from the end of every tax period:

  1. The number of taxpayers that have benefited from the allowance on equity in the tax period

  1. The number of SMEs that have benefitted from the allowance in the tax period

  1. The total amount of expenditure incurred or tax revenue lost due to the deduction of allowance on equity allocated to the allowance on equity as compared to the national gross domestic product of the Member State

  1. The total amount of exceeding borrowing costs

  1. The total amount of non-deductible exceeding borrowing costs

  1. The number of taxpayers to which anti-abuse measures have been applied in the tax period including the related tax consequences and sanctions applied

  1. The data on the evolution in the Member State of the debt/equity ratio.

Next steps

Article 115 of the Treaty on the Functioning of the European Union is the legal basis for the draft Directive. Proposals put forward under this special legislative procedure are subject to the Council’s unanimity, while the European Parliament only has an advisory role. The next step will therefore be for the proposal to be discussed by the 27 EU Member States.

As with previous Directives with respect to direct taxation, it is expected that many changes will be made to the proposal during the negotiation process. Consequently, the final Directive, if adopted at all, could differ significantly from the current proposal.

Once unanimity is achieved, the next step would be the publication of the Directive in the Official Journal of the European Union. The Commission proposes that the Member States shall bring into force the laws, regulations, and administrative provisions necessary to comply with the provisions of the final Directive by 31 December 2023 and that they shall apply these provisions from 1 January 2024.


Adoption of the proposed Directive would mark a significant step towards addressing the tax-induced debt-equity bias across the single market in a coordinated way. Currently, only six Member States address the debt-equity bias from a tax perspective and the relevant national measures differ significantly. While the notional interest allowance on equity would create benefits for business, the proposal is accompanied by a proposal to significantly limit the deductibility of interest, which may have a relevant negative impact.

While it is not yet known whether Member States will embrace the Commission’s initiative, it is recommended that businesses and investors closely monitor the adoption process for any changes or clarifications to the proposal. Businesses that are in scope should carry out an initial analysis on their corporate structures based on the current draft. After all, individual Member States may opt to introduce the rules proposed in the draft Directive unilaterally if the 27 Member States fail to adopt the rules unanimously.


For additional information with respect to this Alert, please contact the following:

EY Société d’Avocats, Paris

Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft, Munich

Ernst & Young Belastingadviseurs LLP, Rotterdam

Ernst & Young Belastingadviseurs LLP, Amsterdam

Ernst & Young LLP (United States), Global Tax Desk Network, New York



  1. See EY Global Tax Alert, European Commission publishes Communication on Business Taxation for the 21st century, dated 18 May 2021.

  2. Equity is defined by reference to Directive 2013/34/EU (Accounting Directive), meaning the sum of Paid-up Capital, Share premium account, Revaluation reserve and Reserves and Profits or Losses carried forward.

  3. The risk-free interest rates are laid down and published for each currency by the European Insurance and Occupational Pensions Authority in the implementing acts to Article 77e(2) of Directive 2009/138/EC.


The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting or tax advice or opinion provided by Ernst & Young LLP to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader's specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The reader should contact his or her Ernst & Young LLP or other tax professional prior to taking any action based upon this information. Ernst & Young LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.


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