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Debt-equity bias reduction allowance (DEBRA)

Insight 15 June 2022

Debt-equity bias reduction allowance (DEBRA)


On 11 May 2022, the European Commission issued a draft Directive focusing on Debt-Equity Bias Reduction Allowance (“DEBRA”). The proposal aims at rectifying an asymmetry in use of debt instead of equity when considering financing decisions, mainly due to the comparative advantages related to the tax deductibility of debt interest payments compared to the non-deductibility of dividends. A targeted objective is to promote an increased use of equity to reduce insolvency risks, especially in light of more vulnerable businesses since the triggering of the COVID-19 pandemic.

This initiative was announced by the European Commission in its May 2021 Communication on Business Taxation for the 21st century.


The Directive applies to taxpayers that are subject to corporate income tax in one or more Member States[1]. The European Commission included a list of entities which will be excluded from the scope of DEBRA, including AIFMs/AIFs, UCITS/UCITS management companies, investment firms (under MiFID II) or securitisation vehicles. The detailed list is provided further down in Appendix 1.

The Directive has two areas of focus:

Equity Allowance

Under the proposed Directive, the equity allowance would be calculated in two steps:

  1. Base allowance=net equity at end of tax period-net equity at end of previous tax period
  2. Equity allowance=base allowance*(10 year risk free rate[2] +risk premium[3])

The equity allowance will then be deductible for up to 30% of the taxpayer's EBITDA for 10 consecutive tax periods.

Anti-Abuse Rules

The equity allowance is however subject to certain anti-abuse rules. The below measures would not contribute to the increase of the equity allowance base:

  • granting loans between associated enterprises;
  • a transfer between associated enterprises of participations or of a business activity as a going concern;
  • a contribution in cash from a person tax resident in a jurisdiction that does not exchange information with the Member State in which the taxpayer seeks to deduct the allowance on equity.

Other anti-abuse measures focus on:

  • Contributions in kind or investments in an asset: ensuring asset valuations are only considered when such asset is necessary for the performance of the taxpayer’s income-generating activity.
  • Reorganisation of a group resulting in equity increase: equity created as the result of a reorganisation of a group only taken into account to the extent that it does not result in converting the equity that already existed in the group before the re-organisation into new equity.

Limitation on Interest Deduction

The second main proposal behind the Directive is the introduction of a limitation on the deductibility of interest to 85% of the exceeding borrowing costs (i.e., interest expenses minus interest income). In other words, the 15% left would be non-deductible.

A link to ATAD

Interest limitation rules already apply in the EU under Article 4 of ATAD. As such, there may be situations under which the interest deduction calculations will differ under ATAD vs DEBRA. 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.

Implementation and next steps

At the time of the writing of this article, the DEBRA proposal, if adopted by the European Council, would need implementation into Member States’ national law by 31 December 2023 and come into effect on 1 January 2024.

The introduction of the equity allowance will be welcomed by the funds industry when considering financing options, although the blanket limitation on debt interest deduction will likely come as a bad surprise for many, especially given the lack of distinction between internal and external intercompany financing.

The proposed rules do not factor in that many financing decisions are impacted by macroeconomic aspects (e.g., interest rates) as well as the stage in an investment lifecycle (seed and early-stage investments will not have the same equity/debt structure as mature businesses or infrastructure projects) rather than pure tax avoidance. The proposed rules may also affect financing linked to ESG, such as the recent European Green Bond Standard.

Appendix 1 – Entities excluded

a) credit institution;

b) investment firm;

c) alternative investment fund manager;

d) undertaking for collective investment in transferable securities’ management company;

e) insurance undertaking;

f) reinsurance undertaking;

g) institution for occupational retirement provision;

h) pension institutions operating pension schemes as well as any legal entity set up for the purpose of investment in such schemes;

i) alternative investment fund;

j) undertakings for collective investment in transferable securities;

k) central counterparty;

l) central securities depository;

m) authorised special purpose vehicle;

n) securitisation special purpose entity;

o) insurance holding company;

p) payment institution;

q) electronic money institution;

r) crowdfunding service provider;

s) crypto-asset service provider

[1] including permanent establishments in one or more Member State of entities resident for tax purposes in a third country.

[2] the 10-year risk-free interest rate for the relevant currency shall be the risk-free interest rate with a maturity of 10 years for the relevant currency

[3] 1% or, where the taxpayer is an SME, 1.5%.

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Paul Séjournant Director, Product Development - United Kingdom
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David Fowler Global Co-Head of Product - Private Equity - United Kingdom
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Graeme Rate Head of Sanne, Ireland - Ireland
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