Brussels, 11 May 2022
The European Commission has today proposed a debt-equity bias reduction allowance, or DEBRA, to help businesses access the financing they need and to become more resilient. This measure will support businesses by introducing an allowance that will grant to equity the same tax treatment as debt. The proposal stipulates that increases in a taxpayer’s equity from one tax year to the next will be deductible from its taxable base, similarly to what happens to debt.
This initiative is part of the EU strategy on business taxation, which aims to ensure a fair and efficient tax system across the EU, and contributes to the Capital Markets Union, making financing more accessible to EU business and promoting the integration of national capital markets into a genuine single market.
The current pro-debt bias of tax rules, where businesses can deduct interest attached to a debt financing – but not the costs related to equity financing – can incentivise companies to take on debt rather than increase equity to finance their growth. Excessive debt levels make companies vulnerable to unforeseen changes in the business environment. The total indebtedness of non-financial corporations in the EU amounted to almost €14.9 trillion in 2020 or 111% of GDP. Against this background, it is worth stressing that businesses with a solid capital structure may be less vulnerable to shocks, and more prone to make investments and innovate. Therefore, reducing the over-reliance on debt-financing, and supporting a possible rebalancing of companies’ capital structure, can positively affect competitiveness and growth. The combined approach of equity allowance and limited interest deduction is expected to increase investments by 0.26% of GDP and GDP by 0.018%.
Valdis Dombrovskis, Executive Vice-President for an Economy that Works for People, said:
“Europe’s companies should be able to choose the financing source that is best for their growth and business model. By making new equity tax-deductible, just as debt is at present, this proposal reduces the incentive to add to their borrowing and allows them to make financing decisions based on commercial considerations alone. As part of the EU’s agenda to ensure a fair and efficient tax system, it will make financing more accessible for EU businesses, particularly start-ups and SMEs, and help to create a genuine single market for capital. This will be important for the green and digital transitions, which require new investments in innovative technologies that could be funded by increased equity.”
Paolo Gentiloni, Commissioner for Economy, said:
“In these dark and uncertain times, we must act not only to help our companies cope with their immediate challenges, but also to support their future development. Today we are taking action to make the tax advantages of equity comparable to those of debt for firms wanting to raise capital. We want to give a shot in the arm to innovative start-ups and SMEs throughout the EU. This harmonised solution to the debt-equity bias will make Europe’s business environment more predictable and competitive, spurring the development of our capital markets union. Our proposal will help companies build up more solid capital, making them less vulnerable and more likely to invest and take risks. And that will be good news for jobs and growth in Europe.”
The green and digital transition requires new investments in innovative technologies. Taxation has an important role to play in encouraging and enabling businesses to develop and grow sustainably. An allowance for equity financing can facilitate bold investments in cutting-edge technologies, notably for start-ups and SMEs. Equity is particularly important for fast-growing innovative companies in their early stages and scale-ups willing to compete globally.
DEBRA is a follow-up to the Communication on Business Taxation for the 21st Century, which sets out a long-term vision to provide a fair and sustainable business environment and EU tax system, as well as targeted measures to promote productive investment and entrepreneurship and ensure effective taxation. The proposal also contributes to the EU’s Capital Markets Union Action Plan (CMU), which aims at helping companies raise the capital they need, particularly as they navigate the post-pandemic period. The CMU incentivises long-term investments to foster the sustainable and digital transition of the EU economy.
For more information
Questions and Answers on the Commission’s proposal to tackle the debt-equity bias in taxation (DEBRA)
11 May 2022
What is the debt-equity bias?
Most countries, including in the European Union, treat debt more favourably than equity from a tax perspective. They do so by allowing interest payments to be deducted from their taxable income, while not offering the same allowance to equity. This gives businesses a major incentive to borrow, rather than to fund new investments by increasing capital.
Why is the debt-equity bias a problem?
The debt-equity bias can encourage companies to make their business decisions based on the related tax treatment, rather than on commercial considerations. This can lead to some companies choosing debt financing over equity, even if it is not the best option for them. Equity should receive similar tax treatment as debt, so that companies can consider both options on an equal footing and choose the source of financing that is best for their business-model.
What are the advantages of tackling the debt-equity bias?
Addressing the debt-equity bias could contribute to the re-equitisation of companies, making them stronger and more resilient to shocks. Equity is also particularly important for fast-growing innovative companies in their early stages and for companies that wish to expand globally.
The green and digital transitions require new investments in innovative technologies. More than 50% of green investment in the coming years is estimated to come from new technologies, requiring more risk financing. Equity will therefore have an important role in fostering the sustainable transition towards a greener economy and in Europe’s overall growth and economic stability.
What is the European Commission proposing?
The Commission’s proposal will create a level playing field for debt and equity, from a tax perspective, thereby removing taxation as a factor which can influence companies’ funding decisions. The proposal would make new equity tax deductible, just as debt currently is.
A more favourable rate of deduction is proposed for SMEs, given that they have more difficulty in accessing equity markets than larger companies.
How will this work in practice?
The equity allowance would be computed based on the difference between net equity 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. This means that the allowance would be granted only for the sum of equity increases over a specific year.
The notional interest rate is the 10-year risk-free interest rate for the relevant currency, and increased by a risk premium of 1% or, in the case of SMEs, a risk premium of 1,5%.
The allowance on equity is deductible for 10 consecutive tax years, as long as it does not exceed 30% of the taxpayer’s taxable income.
Moreover, 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.
Taxpayers will also be able to carry forward their unused allowance on equity which exceeds the 30% of taxable income, for a maximum of 5 tax years.
Lastly, the proposal introduces a reduction of debt interest deductibility by 15%, so to better mitigate the debt-equity bias, not only from the equity side but also from the debt side.
How does this fit into the wider Commission tax agenda?
In May 2021, the Commission published its Communication on Business Taxation for the 21st Century, which sets out a long-term vision to provide a fair and sustainable business environment and EU tax system, as well as targeted measures to promote productive investment and entrepreneurship and ensure effective taxation. DEBRA was one of the actions proposed to help businesses left vulnerable by the COVID crisis, preventing insolvencies and instability.
The proposal also contributes to the EU’s Capital Markets Union Action Plan (CMU), which aims at helping companies raise the capital they need, particularly as they navigate the post-pandemic period. The CMU incentivises long-term investments to foster the sustainable and digital transition of the EU economy.
For more information
Remarks by EU Commissioner Gentiloni at the press conference on the Debt-Equity Bias Reduction Allowance – DEBRA
11 May 2022
We live in uncertain and difficult times, but we try also to act and take decisions that are forward-looking and help our companies not only to cope with their immediate challenges, but also to create the conditions for them to grow, invest and create more jobs.
It is in this framework that we are today taking action to address a long-standing problem in corporate taxation: the so-called debt-equity bias.
We are proposing the Debt-Equity Bias Reduction Allowance – DEBRA – which is one of the key initiatives of the Business Taxation plan that we presented last year. It is also one of the important measures to strengthen our Capital Markets Union, our plan to build a true single market for capital in the EU.
Today, most countries’ tax systems, including in the European Union, treat debt more favourably than equity. They do so by allowing interest payments on loans to be deducted from the taxable base, without offering a similar allowance for financing through equity. This gives businesses looking to fund investments a major incentive to borrow, rather than to issue equity.
This is a problem because it encourages companies to make economic decisions based purely on their tax treatment, rather on commercial considerations. That may ultimately leave businesses more vulnerable to insolvency and financial instability. The total indebtedness of non-financial corporations in the EU amounted to almost EUR 14.9 trillion in 2020 or 111% of GDP.
Taxation should be a means to an end, and not a goal in itself. I want companies to be able to choose the source of financing that is best for their business model. But for that to happen, equity must receive a similar tax treatment as debt, so that companies can consider both options on an equal footing.
Today’s proposal will create a level playing field for debt and equity, by making equity tax deductible, just as debt currently is.
This measure will contribute to the re-equitisation of companies, making them stronger and more sustainable. This is our goal.
It will also support new, innovative businesses, which usually have more trouble securing loans than more established firms. This is also why we will be offering a more favourable rate of deduction for SMEs, given that they often have more difficulty in obtaining financing than larger companies do.
This initiative is important for individual companies, but also for the European Union as a whole. We know that the green and digital transitions can only be achieved through new and innovative investments. In fact, more than half of the green investments in the coming years should come from new technologies, and this will require sustainable financing. And equity has a key role to play in this effort.
Under our proposal, the equity allowance would be computed based on the difference between net equity 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 allowance on equity is deductible for ten consecutive tax years, as long as it does not exceed 30% of the taxpayer’s taxable income.
We already have similar schemes in place in six Member States: Belgium, Cyprus, Italy, Malta, Poland and Portugal. But an uncoordinated patchwork of rules can create room for harmful tax practices, by attracting businesses purely for tax motives. So we will have a transition period for these six Member States to build this common framework.
With DEBRA, we can ensure that EU businesses are treated equally in terms of taxation concerning their financing choices, regardless of where they are located or whether they choose to finance themselves through equity or debt instruments.
A harmonised solution to the debt-equity bias will make the business environment in Europe more predictable and more globally competitive, boosting our equity markets, if you compare them, for example, with the United States
Our proposal aims to help companies build up more solid capital, which means they will be less vulnerable and more likely to invest and take risks.
In fact, we expect the combined approach of equity allowance and limited interest deduction to increase investments by around a quarter-point of GDP, according to our impact assessment.
And that will also be good news for growth and jobs in the EU.