The DEBRA proposal applies to all taxpayers subject to corporation tax in one or more Member States, with the exception of financial companies.
On May 11, 2022, the European Commission published a draft directive proposing a provision for reduction of the bias of debt on equity (the “DEBRA Proposal”). The DEBRA proposal establishes rules (i) to provide, under certain conditions, the tax deductibility of notional interest on capital increases and (ii) to limit the tax deductibility of excess borrowing costs. It applies to all taxpayers subject to corporation tax in one or more Member States, with the exception of financial undertakings.
The DEBRA proposal is expected to be implemented and enforced by Member States from 1 January 2024 and is expected to have a significant impact on EU corporate taxpayers.
The DEBRA proposal follows the EU proposal Communication on business taxation for the 21st century of May 2021, which sets out a long-term vision to ensure a fair and sustainable EU business environment and tax system, as well as targeted measures to promote productive investment and entrepreneurship and guarantee effective taxation. DEBRA is one such measure.
Summary of Proposed Rules
The DEBRA proposal includes two separate measures that apply independently: (i) an equity deduction and (ii) a limit on the interest deduction.
The DEBRA proposal applies to all taxpayers subject to corporation tax in one or more Member States.
It does not apply to financial companies, such as credit institutions, investment companies, AIFs, AIF managers, UCITS, UCITS management companies, insurance and reinsurance companies , pension institutions, securitization vehicles (covered by Regulation (EU) No 2017/2402) and cryptocurrencies. -asset service providers.
The equity provision is calculated by multiplying the provision basis by the relevant notional interest rate.
The tax base is the difference between equity at the end of the tax year and equity at the end of the previous tax year. Equity includes paid-in capital, share premium, reserves and deferred profit or loss. Net equity is the difference between a taxpayer’s equity and the sum of the tax value of its equity interest in associated companies (roughly requiring a 25% equity interest) and its own shares. According to the explanatory memorandum to the DEBRA proposal, this definition aims to prevent the cascading of allocation through participations.
The notional interest rate is the 10-year risk-free interest rate for the relevant currency plus a risk premium of 1% (1.5% for SMEs). The Commission will have the power to change the risk premium rate under specific conditions by adopting delegated acts.
The allowance is granted for ten years, ie it will be deductible in the year in which it was incurred and in the following nine successive years.
If the deduction base of a taxpayer who has already benefited from an allowance on equity is negative over a given taxable period (decrease in equity), a proportional amount will become taxable for ten consecutive tax years, up to a maximum of the total increase in equity for which the allowance was obtained, unless the taxpayer demonstrates that this is due to losses incurred during the taxable period or to a legal obligation.
The allowance deduction is capped at 30% of the taxpayer’s EBITDA (earnings before interest, taxes, depreciation and amortization) for each tax year.
A taxpayer will be able to carry forward, without time limit, the part of the capital allowance which could not be deducted during a tax year due to insufficient taxable profit.
In addition, the taxpayer will be able to carry forward, for up to five years, the unused deduction capacity (when the deduction for own funds does not reach the maximum of 30% mentioned above).
The calculation basis will not include capital increases resulting from any of the following transactions:
– Intra-group loans, intra-group transfers of existing shareholdings or business activities and cash contributions from a person residing in a jurisdiction which does not exchange information with the Member State of the taxpayer. This anti-abuse measure targets abusive schemes that would cascade the rebate within a group, and will not apply where the transaction was made for valid business reasons and does not result in a double deduction of the rebate for equity.
– Contributions in kind or investment in property, when the property is not necessary for the exercise of the taxpayer’s income-generating activity. This measure aims to prevent the overvaluation of assets or the purchase of luxury goods with the aim of increasing the tax base.
– Reorganization of a group having the effect of converting into new equity the equity which already existed in the group before the reorganization.
Interest deduction limitation
The DEBRA Proposal provides for an interest limitation rule, which would operate alongside the existing interest limitation rule provided for in Article 4 of Council Directive (EU) 2016/1164 (the “ATAD”). The DEBRA proposal rule would apply first, meaning that where the ATAD rule produced a lower interest deduction, the taxpayer would have the right to defer or reverse the difference in accordance with section 4 of the ‘ATAD.
The DEBRA proposal must now be approved unanimously by the Member States in the Council.
As the rules would apply from 1 January 2024 (with the exception of Belgium, Cyprus, Italy, Malta, Poland and Portugal, six Member States with similar rules which would benefit from a 10-year grandfathering period), corporate taxpayers operating in the EU have a relatively short time to assess the impact on their operations.
These taxpayers should also bear in mind other initiatives that the European Commission has recently published or intends to publish in the months and years to come. These include the Unshell proposal and the Pillar II proposal issued in December 2021 (see our Newsflash for more details), the presentation of a new initiative to address the challenges of non-EU shell entities, another proposal requiring large groups to publish their effective tax rates, and the new framework for corporate taxation in the EU ( BEFIT).