As a result of a DEBRA initiative (Debt-equity bias reduction allowance) which aims to motivate companies to finance their investments through equity instead of debt financing, in May 2022 the European Commission published a legislative proposal "Directive on laying down rules on a debt-equity bias reduction allowance and on limiting the deductibility of interest for corporate income tax purposes" regulating the rules for the application of the tax deduction related to financing through equity from the corporate income tax base.

The directive will mainly concern taxpayers subject to corporate income tax in one or more EU Member States, including permanent establishments of entities which are tax residents of a third country. Certain financial institutions are excluded from the scope of the directive.

The basis for calculating the tax deduction should be the difference between the level of net equity at the end of the tax year and the level of equity at the end of the previous tax year. Such value should then be multiplied by the 10-year risk-free interest rate for the relevant currency plus a risk premium of 1 %. In case of a small or medium-sized company, the risk premium will be increased to 1,5 %.

The calculation of the tax deduction will be as follows:

DEBRA=(〖net Equity〗_((TY))-〖net Equity〗_((TY-1)) )×(Risk free rate+1% or 1,5% of Risk Premium)

The taxpayers will be entitled to use the tax deduction for 10 consecutive taxable years up to the limit of 30 % of EBITDA. Part of the deduction exceeding the limit of 30 % EBITDA should be deductible in future years without time limitation. Also the “non-used” part of the 30-per-cent EBITDA limit on which the deduction has not been applied should be transferrable to the following periods (up to 5 years). On the other hand, there are also rules for additional taxation of the applied deduction in case the base for the deduction achieves negative balance.

The directive also introduces further limitation on tax deductibility of financial costs whereas the interest costs above 85 % of net interest costs (interest costs – interest revenues) should be considered tax non-deductible. This rule needs to be taken in joint consideration with the current rules for tax deductibility of excessive borrowing costs according to the ATAD Directive as well as local rules (e.g. thin cap rules).

The directive is proposed to take effect from 1 January 2024. 

For more information regarding DEBRA and other tax matters, please contact us.

Author: Zuzana Kalincová