What is the debt-equity bias?

The debt-equity bias means that most tax regimes treat debt more favourably than equity by providing deductions from taxable income for interest payments on debt, but no similar deductions for equity.

The European Commission proposes to eliminate this debt-equity bias in taxation by introducing a new debt-equity bias reduction allowance (DEBRA). This is achieved by introducing two separate measures: (1) a new notional interest deduction for increases in equity; and (2) an additional limit on interest deductions.

The European Commission hopes that DEBRA will encourage the re-equitisation of companies, which they believe should in turn reduce insolvency risks and make companies stronger and more resilient to financial shocks, such as those caused by the Covid pandemic. It is also hoped that DEBRA will make it easier for SMEs to raise financing, particularly when SMEs are in the early stages of growth.

New deductible equity allowance

The proposed deductible equity allowance will apply to new equity only, i.e. the increase in net equity from one tax year to another. For these purposes, “equity” is defined by reference to the Accounting Directive[1] as the sum of paid-up capital, share premium account, revaluation reserve and reserves, and profits or losses carried forward.

The equity allowance is calculated by multiplying the increase in net equity by a notional interest rate. The notional interest rate is the 10 year risk-free interest rate for the relevant currency, combined with a risk premium of 1% (or 1.5% in the case of SMEs).

The equity allowance will be deductible against corporation tax for 10 consecutive tax years (the 10 year period is intended to reflect the maturity of most debt), up to a maximum of 30% of the taxpayer’s EBITDA in a given tax year (this 30% EBITDA limit mirrors the restriction under the interest limitation rule recently introduced under the Anti-Tax Avoidance Directive (the “ATAD ILR”)). Where the equity allowance exceeds the 30% EBITDA limitation, any unused equity allowance can be carried forward for a maximum of 5 years. Where the equity allowance is higher than the taxpayer’s taxable income, the equity allowance can be carried forward without a time limitation.

Where there is a reduction in net equity in a tax year after having previously obtained a deductible equity allowance, the taxpayer will be taxed on an amount equal to the reduction over the 10 following tax periods, unless the taxpayer can provide sufficient evidence that this decrease in equity is due to accounting losses incurred during the tax year or due to legal obligations to reduce capital. This rule is designed to encourage the retention of a level of equity.

New limitation on interest deductions

The proposed equity allowance will go hand in hand with a new limit on interest deductions (the “proposed DEBRA ILR”). Interest deductions (including deemed interest deductions under DEBRA) will be limited to 85% of exceeding borrowing costs as defined in ATAD (i.e. broadly the excess of deductible interest equivalent over taxable interest equivalent).

This new limitation on interest deductions will apply in conjunction with the ATAD ILR. The DEBRA ILR rule is applied first, and then the final limitation is calculated under the ATAD ILR. In a situation where the ATAD ILR provides for a lower deductible amount than the proposed DEBRA ILR, then the taxpayer will be entitled to carry forward or carry back the difference.

Some taxpayers who are not impacted by the ATAD ILR may now find that they are subject to the DEBRA ILR. For example, there is no equity escape, group escape or interest group rules under the DEBRA ILR, so taxpayers who currently avail of these reliefs, such that they are not subject to a restriction under the ATAD ILR, may now be subject to the DEBRA ILR.

On the one hand, SMEs are treated more favourably under this proposal because they avail of an increased risk premium for the purposes of the new deductible equity allowance (this increase is intended to reflect the higher risk premium and difficulties SMEs incur to obtain financing). However, unlike the ATAD ILR, there is no de minimis threshold for the DEBRA ILR, so it is possible that SMEs that are not subject to the ATAD ILR will be subject to the DEBRA ILR. Arguably, this is no accident as the aim of the proposal is to make it more attractive to provide equity rather than debt financing to such SMEs.


Various anti-avoidance provisions are set out in the proposal. For example, increases in equity that originate from: (a) intra-group loans; (b) intra-group transfers of participations or existing business activities; (c) certain cash contributions; (d) certain contributions in kind; and (e) certain liquidation transactions will be excluded from the calculation of net equity.

What entities are impacted?

DEBRA will apply to all taxpayers that are subject to corporation tax in one or more EU Member States, including permanent establishments of companies established outside the EU. However, certain financial undertakings are exempt, e.g. credit institutions, investment firms, AIFs, AIFMs, UCITS, UCITS management companies, insurance and reinsurance undertakings, pension institutions, securitisation vehicles (covered by Regulation (EU) No 2017/2402) and crypto-asset service providers. The European Commission puts forward various reasons why certain financial institutions are outside the scope of the proposal, including, that some financial undertakings are subject to regulatory equity requirements and that the economic burden of DEBRA would be unequally distributed at the expense of non-financial undertakings.

This list of financial undertakings is wider than the list of exempted financial undertakings under the ATAD ILR so some taxpayers may find that they are excluded from the DEBRA ILR but not from the ATAD ILR. Further, such taxpayers may be subject to a restriction of deductible interest under the ATAD ILR, but will not benefit from the equity allowance under DEBRA.

Impact on Ireland’s securitisation regime

  • Ireland has an effective securitisation regime that permits a qualifying Irish resident SPV (a “Section 110 Company”) to engage in an extensive range of financial and leasing transactions in a tax neutral manner.
  • The vast majority of Section 110 Companies will be securitisation vehicles so will be unaffected by DEBRA in its current form.
  • Even if a Section 110 company is not a securitisation vehicle, in many cases, a Section 110 company’s income will all be “taxable interest equivalent” for the purposes of the ATAD ILR. Therefore, similar to the analysis under the ATAD ILR, we anticipate that the “taxable interest equivalent” and “deductible interest equivalent” (including interest on Profit Participating Notes) should match so that the company should not have any exceeding borrowings costs.
  • However, it is possible that DEBRA could impact Section 110 Companies with investments in assets such as shares, commodities and non-performing loans or potentially with leasing activities, which are likely to give rise to income or gains which may not be entirely ‘taxable interest equivalent’. Unlike the ATAD ILR, there are no group debt calculation provisions and no exemption for standalone entities under DEBRA.


While the original intention with respect to this proposal was to provide relief for equity investment, the inclusion of an interest limitation provision is an unwelcome development and may place EU businesses at a competitive disadvantage to non-EU businesses by applying another layer of restriction over the existing ATAD ILR.  Many corporate groups who are currently grappling with the potential effects of the OECD Pillar One and Pillar Two proposals in addition to the EU Unshell proposal must now consider the potential effects of this proposed directive. It puts more pressure on Irish policy makers to address the fundamental basis for interest deductibility for Irish corporates. The current approach is to add EU law initiatives on top of existing concepts and restrictions – a sticking plaster approach. A fundamental reform is long overdue.

On the financial services side, while many entities will be exempt and, as discussed above, we expect that most Section 110 companies should be unaffected, there will be scenarios where the restriction applies and therefore this proposal will add another layer of tax complexity in addition to the recently introduced ATAD ILR and anti-hybrid rules in Ireland.

Effective date

It is proposed that DEBRA will apply from 1 January 2024.

As this is a proposal for a Directive, unanimity will be required from all 27 EU Member States in order for this to progress further so it remains to be seen whether substantial changes will be made to the proposal prior to agreement by all Member States.

Please do not hesitate to contact a member of the tax team to discuss.

[1] Council Directive 2013/34/EU