On 11 May 2022, the European Commission proposed a debt-equity bias reduction allowance (or “DEBRA”) to support companies in making financing decisions based on commercial rationales instead of tax driven considerations. In effect, the measure will grant to equity the same tax treatment as debt. Concretely, any increase in the taxpayer’s equity from one tax year to the next will be deductible from its taxable base, similar to the interest expense treatment.
Currently, pro-debt bias exists in most of the EU Member States where economic operators can deduct interest expenses but not the costs related to equity funding. Effectively, companies are keen to take debt rather than increasing via equity, resulting in total indebtedness of non-financial corporations in the EU amounting to EUR 14.9 trillion in 2020 or 111% of GDP. 
One of the factors favoring the use of debt over equity in terms of financing investments is the fact that interest payments are tax deductible in all EU Member States, while costs related to equity financing do not enjoy the same treatment. 
To address the tax-driven debt-equity bias within the EU the EU Commission has proposed a Directive laying down certain conditions for the deductibility for tax purposes of notional interest on increases in equity.  The proposal, once adopted, should be implemented into national legislation by 31 December 2023 and be effective as of 1 January 2024.
The Directive will apply to all taxpayers subject to corporate income tax in one or more Member States. Out of scope are financial undertakings as defined in the instrument, inter alia, credit institutions, investment firms, insurance undertakings, collective investment vehicles, pension institutions operating pension schemes, alternative investment funds, special purpose vehicles, etc. That is because certain financial undertakings are subject to regulatory equity requirements that prevent under-equitization. 
Equity is defined by reference to Directive 2013/34/EU (Accounting Directive), concretely the sum of Paid-up Capital, Share premium account, Revaluation reserve and Reserves, and Profits/Losses carried forward.
Net equity is the difference between the equity of a taxpayer and the sum of the tax value of its participation in the capital of associated enterprises and of its own shares.
The objective pursued by the proposed Directive is to tackle the bias towards debt by allowing the deductibility of notional interest on the increase in equity and to limit the tax deductibility of exceeding borrowing costs. Thus, it includes two separate measures that apply independently:
i) An allowance on equity; and
ii) A limitation to interest deduction
If adopted, the Directive provides that the deductible expenses related to equity financing would be computed in the following way:
Allowance base: The first step would be to calculate the allowance base being the difference between net equity  at the end of the current tax year and net equity at the end of the previous tax year, that is the year-on-year increase in equity.
Notional interest rate: The second step would be to apply the notional interest rate to the difference in net equity. The notional interest rate would be the 10-year risk-free interest rate for the relevant currency and increased by a risk premium of 1% (1.5% in case of SMEs).
The pertinent allowance is granted for 10 years. Effectively, if an increase qualifies for the benefits laid down in the Directive, the allowance shall be deductible in the year it was incurred and in the next successive nine years. If in the following year a new increase in equity was performed, the new allowance will also be deductible in the tax year it was incurred and in the following nine years upon the increase.
If a taxpayer has benefitted from the allowance on equity under the Directive and within a tax period the said equity becomes negative (i.e. results in capital decrease), a proportionate amount will become taxable for 10 consecutive tax periods and up to the total increase of net equity for which such allowance has been obtained, unless there is evidence that the decrease has resulted due to losses incurred or due to a legal obligation.
(a) 30% of EBITDA on the allowance
The allowance on equity would be deductible for Corporate Income Tax (“ CIT”) purposes up to 30% of the taxpayer's Earnings before Interest, Taxes, Depreciation and Amortization (“ EBITDA”) for 10 consecutive tax years. This is the same limitation with respect to interest limitation rules applicable to exceeding borrowing costs. Any excess of available allowance on equity could be carried forward by the taxpayer without a time limitation. Additionally, any unavailable allowance due to the 30% EBITDA limitation could be carried forward for a maximum of five tax years.
(b) Out of scope capital
The proposal excludes from the allowance base equity increases originating from:
(i) Intra-group loans
(ii) Intra-group transfers of participations or existing business activities
(iii) Cash contributions under certain conditions
(c) In-kind contributions
Another measure lays down specific conditions to consider for equity increase stemming from contributions in kind or investment in assets. It aims to counteract overvaluation of assets or purchase of luxury goods for the purpose of increasing the allowance base.
(d) Re-categorization of capital
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.
In addition, the proposal includes a new interest limitation rule. It is proposed that 15% of the exceeding borrowing costs  be non-deductible for CIT purposes. The proposal provides for rules of interaction between this new limitation and the EU Anti-Tax Avoidance Directive’s interest deduction limitation rules, as well as for carry forward rules of unused amounts.
Kambourov & Partners - Tax Consulting will continue to follow the developments on DEBRA and will monitor the domestic implementation of the Directive.
European Commission press release: Corporate taxation: Commission proposes tax incentive for equity to help companies grow, become stronger and more resilient. Brussels, 11 May 2022.
There are 6 Member States that have introduced measures allowing equity deductions – Belgium, Poland, Malta, Italy, Portugal,Cyprus.
Proposal for a COUNCIL DIRECTIVE on laying down rules on a debt-equity bias reduction allowance and on limiting the deductibility of interest for corporate income tax purposes
The present allowance will be incremental.
As defined in the Accounting Directive.
Interest expense minus interest income