COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT REPORT Accompanying the document 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
Date: 2022-05-11
Institutions: Directorate-General for Taxation and Customs Union, European Commission
Subjects: basis of tax assessment, corporation tax, interest, tax avoidance, tax harmonisation, tax law, tax relief, taxable income

EN 

  EN 

   EUROPEAN COMMISSION  Brussels, 11.5.2022  SWD(2022) 145 final/2  COMMISSION STAFF WORKING DOCUMENT  IMPACT ASSESSMENT REPORT  Accompanying the document 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 {COM(2022) 216 final} - {SEC(2022) 204 final} - {SWD(2022) 144 final} - {SWD(2022) 146 final}  
 
 
Table of contents 

1. 

2. 

INTRODUCTION: POLITICAL AND LEGAL CONTEXT ............................................................... 4 

PROBLEM DEFINITION .................................................................................................................... 6 

2.1. What are the problems? ........................................................................................ 7 
2.2. What are the problem drivers? ........................................................................... 14 
2.3. How will the problem evolve? ........................................................................... 16 
2.4. DEBRA in context of the Commission’s Strategic Foresight report ................. 17 

3.  WHY SHOULD THE EU ACT? .........................................................................................................18 

3.1. Legal basis .......................................................................................................... 18 
3.2. Subsidiarity ......................................................................................................... 19 

4.  OBJECTIVES: WHAT IS TO BE ACHIEVED? ................................................................................21 

4.1. General objectives .............................................................................................. 22 
4.2. Specific objectives .............................................................................................. 24 

5.  WHAT ARE THE AVAILABLE POLICY OPTIONS? .....................................................................24 

5.1. What is the baseline from which options are assessed? ..................................... 24 
5.2. Policy Options .................................................................................................... 25 
5.3. Common elements .............................................................................................. 30 
5.4. Grandfathering of existing allowances for equity .............................................. 32 
5.5. Options discarded at an early stage .................................................................... 32 

6.  WHAT ARE THE IMPACTS OF THE POLICY OPTIONS? ............................................................32 

6.1. The modelling approach with CORTAX ........................................................... 33 
6.2. Impacts on debt bias and financing decisions of firms ...................................... 34 
6.3. Impacts on investment and growth ..................................................................... 36 
6.4. Impacts on tax revenue ....................................................................................... 38 
6.5. Impact on the burden for businesses .................................................................. 39 
6.6. Impact on the burden for tax authorities ............................................................ 40 
6.7. Relevance of the legislative initiative for SMEs ................................................ 41 
6.8. Fairness impacts ................................................................................................. 42 
6.9. Sustainable Development Goals ......................................................................... 42 

7.  HOW DO THE OPTIONS COMPARE? .............................................................................................42 

8. 

PREFERRED OPTION – THE ALLOWANCE ON NEW EQUITY WITH AN INTEREST 
LIMITATION ......................................................................................................................................47 

9.  HOW WILL ACTUAL IMPACTS BE MONITORED AND EVALUATED?...................................49 

REFERENCES ..............................................................................................................................................51 

ANNEX 1: PROCEDURAL INFORMATION .............................................................................................56 

1. 
2. 
3. 

Lead DG, Decide Planning/CWP references ................................................... 56 
Organisation and timing .................................................................................. 56 
Consultation of the RSB .................................................................................. 56 

1 

 
 
4. 

Evidence, sources and quality ......................................................................... 56 

ANNEX 2: STAKEHOLDER CONSULTATION........................................................................................58 

1. 
2. 
3. 

Summary of feedback to the Inception Impact Assessment ............................ 58 
Summary of meeting with EESC .................................................................... 59 
Summary of the open public consultation ....................................................... 59 

ANNEX 3: WHO IS AFFECTED AND HOW? ...........................................................................................67 

1. 
2. 
3. 

Practical implications of the initiative ............................................................. 67 
Summary of costs and benefits ........................................................................ 67 
Relevant Sustainable Development Goals ....................................................... 69 

ANNEX 4: ANALYTICAL METHODS ......................................................................................................71 

1. 
CORTAX: A model to simulate corporate tax policies ................................... 71 
2.  Measuring the cost of capital and effective average tax rates ......................... 73 

ANNEX 5: COMPLEMENTARY RESULTS FROM CORTAX .................................................................75 

1. 
2. 
3. 
4. 

Results on economic impacts from the uncompensated approach .................. 75 
Increased equity allowance for SMEs ............................................................. 76 
Analysis of restricted equity ............................................................................ 79 
Calibration of the preferred Option 5 .............................................................. 81 

ANNEX 6: STATISTICS ON CORPORATE INDEBTEDNESS ................................................................83 

1. 

ATAD 1 – Interest limitation rules .................................................................. 83 

ANNEX 7: OVERVIEW OF EXISTING MEASURES IN MEMBER STATES ........................................86 

1. 

2. 

Existing  measures  of  interest  allowance  for  equity  in  EU  Member 
States................................................................................................................ 86 
Transposition  of  ATAD  1  interest  limitation  rules  in  EU  Member 
States................................................................................................................ 87 

ANNEX 8: ANTI TAX AVOIDANCE RULES ...........................................................................................89 

1. 
2. 
3. 

General Anti Avoidance Rule (GAAR) .......................................................... 89 
Special Anti Avoidance Rules (SAARS) ........................................................ 89 
SAAR based on the Arm’s Length Principle (ALP) ....................................... 90 

2 

 
 
 
 
Glossary 

Term or acronym 

Meaning or definition 

CIT 

ACC 

ACE 

ANCE 

ATAD 

CMU 

COVID 

DEBRA 

EBITD 

EBITDA 

EESC 

EIB 

EIOPA 

FC  

GAAR 

GDP 

ILR 

IMF 

MNE 

NDI 

NFC 

NID 

NIR 

OPC 

OECD 

RFR 

SAAR 

SME 

Corporate income tax 

Allowance for corporate capital 

Allowance for corporate equity 

Allowance for new corporate equity 

Anti tax avoidance directive 

Capital market union 

Corona virus disease 

Debt equity bias reduction allowance 

Earnings Before Interest, Taxes, Depreciation,  

Earnings Before Interest, Taxes and Depreciation and Amortization 

European Economic and Social Committee 

European Investment Bank 

European Insurance and Occupational Pensions Authority 

Financial corporation 

General anti avoidance rule 

Gross domestic product 

Interest limitation rules 

International Monetary Fund 

Multinational Enterprise 

Non-deductibility of interest 

Non-financial corporations 

Notional interest deduction 

Notional interest rate 

Open public consultation 

Organisation for Economic Co-operation and Development 

Risk free rate 

Special anti-avoidance rule 

Small and medium sized enterprise 

3 

 
 
1. 

INTRODUCTION: POLITICAL AND LEGAL CONTEXT 

The initiative analysed in this impact assessment is embedded in a comprehensive EU tax 
agenda  and  results  directly  from  the  Communication  on  Business  Taxation  for  the  21st 
Century1. Therein, the Commission set out both a long-term vision to provide a fair and 
sustainable  business  environment  and  an  EU  tax  system,  as  well  as  a  tax  agenda  with 
targeted measures intended to promote productive investment and entrepreneurship, and 
ensure effective taxation.  

Amid those targeted measures, the Commission announced a proposal for addressing the 
debt-equity  bias  in  corporate  taxation  –  the  so-called  Debt  Equity  Bias  Reduction 
Allowance  (DEBRA).  The  initiative  is  coherent  with  the  other  actions  set  out  in  the 
Communication,  and,  in  particular,  with  the  forthcoming  “Business  in  Europe: 
Framework for Income Taxation” (or BEFIT), which will provide a single corporate tax 
rulebook  for  the  EU,  providing  for  fairer  allocation  of  taxing  rights  between  Member 
States, taking into  account  reforms  in  the international  corporate tax framework. While 
the BEFIT proposal is still in an early stage of development, the two initiatives contribute 
to the same vision of a fair and sustainable business environment in the EU. As set out in 
the Communication, targeted action on specific issues, including on the debt-equity bias 
is  envisaged  in  the  shorter  term  in  order  to  address  current  problems  in  the  EU  tax 
system. 

The initiative is part of and supports the EU’s wider policy agenda; and most notably the 
European Green Deal2, the Commission’s digital agenda, the New Industrial Strategy for 
Europe3  and  the  furthering  of  the  Capital  Markets  Union4.  The  initiative  would,  for 
example, directly contribute to the objective of the EU’s Capital Markets Union  Action 
Plan to help companies avoid over reliance on debt and improve their equity position, at 
a  time  when  the  corporate  sector  enters  the  post-COVID  recovery  period  with  higher 
deficits and debt levels, and a greater need for equity investment.  More specifically, an 
initiative at EU level to address the debt-equity bias would complement Action 4 of the 
Capital Markets Union Action Plan5, which aims to incentivise institutional investors to 
make  more  long-term  investments  and  thus  support  re-equitisation  in  the  corporate 
sector, with a view to fostering the sustainable transition. The Communication explicitly 
calls  for  the  debt  bias  in  taxation  to  be  addressed  in  order  to  remove  undue  fiscal 
incentives for debt financing, while also broadly calling for measures that support more 
stable  and  long-term  financing  to  companies  and  infrastructure  projects,  in  particular 
those contributing to the objective of smart, sustainable and inclusive growth. 

Finally,  the  initiative  replies  to  the  European  Parliament’s  expectation  that  the 
Commission  would  put  forth  a  proposal  for  a  debt-equity  bias  reduction  allowance,  in 
which  the  Parliament  urged  the  Commission  to  perform  a  thorough  impact  assessment 

1 COM(2021) 251 final 
2 COM(2019) 640 final 
3 COM(2020) 102 final 
4 COM(2020) 590 final 
5 Action 4 - Encouraging more long-term and equity financing from institutional investors | European Commission 
(europa.eu) 

4 

 
                                                           
and  incorporate  effective  anti-avoidance  provisions  to  avoid  any  allowance  on  equity 
being  used  as  a  new  tool  for  base  erosion6.  In  the  current  context  of  climate  change, 
environmental  degradation,  globalisation  and  digitalisation,  the  EU  needs  a  robust, 
efficient  and  fair  tax  framework  that  provides  direct  support  to  the  recovery  from  the 
pandemic and the green and digital transitions. But, one that also simultaneously meets 
fiscal sustainability requirements against a background in which the government debt-to-
GDP ratio in the EU has increased from 77.2 % at the end of 2019 to 90.1 % at the end of 
the  third  quarter  of  20217  and  deficits  remain  high,  with  an  overall  EU  government 
deficit  at  3.7%.8  The  tax  framework  must,  therefore,  work  to  support  and  create  an 
environment  conducive  to  fair,  sustainable  growth  and  investment,  while  taking  into 
account fiscal sustainability considerations. 

Taxation has an important role to play in supporting businesses to invest and grow. The 
ecological and digital transitions arising from the EU decision to move towards a climate 
neutral  and  digital  economy  will  require  new  technologies  and  innovation  that  imply 
large  amounts  of  investment.  In  such  a  context,  addressing  the  debt-equity  bias  would 
contribute  to  the  re-equitisation  of  businesses,  which  would  contribute  to  more  risky 
investments in vital break-through technologies. Equity financing, for example, can be a 
viable solution  for projects  with  high risk-return profile that would be too risky  for the 
banking sector to finance.  

The  ways  in  which  current  tax  systems  across  the  EU  treat  interest  costs  creates  a 
persistent  pro-debt  bias.  National  tax  laws  across  all  Member  States  accept  the 
deductibility of interest payments on debt for tax purposes, thereby reducing the tax base 
for  the  purpose  of  corporate  income  taxation.  At  the  same  time,  costs  related  to  equity 
financing  (dividends  paid)  are  non-tax  deductible  in  most  Member  States.  This 
asymmetric tax treatment of the deductibility of costs comes from the fact that the cost of 
debt  is  fixed,  has  to  be  paid  whatever  the  profit  or  loss  of  the  year,  and  is  part  of  the 
firm’s current expenses thereby reducing its revenues.  Dividends on equity are variable, 
depending  on  the  firms’  profits,  and  are  not  mandatory.  This  differentiation  induces  a 
bias in investment decisions towards debt financing since a business that finances a new 
investment with debt will reduce its tax base compared to a situation in which the same 
company financed the very same investment with an equity increase. The higher the rate 
of  corporate  income  tax  in  a  given  country,  the  stronger  the  tax  bias  towards  debt  for 
financing  new  investments.  This  tax-induced  debt  bias  is  a  long-standing  issue,  one 
which  has  even  been  highlighted  in  the  European  Semester  in  relation  to  several  EU 
Member States whose statutory corporate income tax rate is higher than the EU average. 

Of course, there are multiple factors that impact  or influence  financing decisions.  Debt 
could  be  chosen  to  increase  the  return  on  equity,  because  access  to  equity  financing  is 

6 Report on the impact of national tax reforms on the EU economy, (2021/2074(INI)) 
https://www.europarl.europa.eu/doceo/document/A-9-2021-0348_EN.html  
7 Latest available data from ESTAT, 21 January 2022: https://ec.europa.eu/eurostat/documents/2995521/14176362/2-
21012022-AP-EN.pdf/4785530c-a1dc-5d07-1e94-acb29d9986a7  
8 Latest available data from ESTAT, 21 January 2022: https://ec.europa.eu/eurostat/documents/2995521/14176365/2-
21012022-BP-EN.pdf/76140a97-e846-2eea-7bce-97c0a3260189  

5 

 
                                                           
limited, because debt financing is cheaper than equity financing (especially when interest 
rates  are  low),  to  diversify  risk,  to  reduce  tax  liabilities,  and  to  avoid  the  dilution  of 
control/voting rights of existing equity holders (owners). The argument about dilution of 
control/voting rights when new equity is taken up is especially important in the context 
of family-held companies and could explain, to some extent, national differences.  

The Commission’s objective with DEBRA is to address the specific issue of using debt 
because  of  the  tax  benefit  it  gives;  this  is  where  legislative  action  at  the  EU  level  can 
have an impact  and where it can act in complementarity to other initiatives intended to 
support diversification of funding, longer-term funding options, and incentivise equity.  

Since  the  tax  induced  debt-equity  bias  incentivises  financing  investments  with  debt,  it 
can  contribute  to  an  excessive  accumulation  of  debt  for  non-financial  corporations. 
Excessive debt levels make businesses vulnerable to unforeseen changes in the business 
environment  and  increase  their  risk  of  insolvency.  Necessary  business  restructuring 
following insolvency procedures often comes with considerable social costs in the form 
of layoffs.  Furthermore, a large number of related non-performing loans  can negatively 
affect financial stability. The total indebtedness of non-financial corporations in the EU 
amounted  to  almost  EUR 14.9  trillion  in  2020  or  111%  of  GDP9.  Against  such 
background, it is worth stressing that businesses with a solid capital structure may be less 
vulnerable to shocks, and more prone to make investments. Therefore, reducing the over-
reliance  on  debt-financing,  and  thus  supporting  a  possible  rebalancing  of  companies’ 
capital  structure,  can  on  a  macroeconomic  level  positively  affect  competitiveness  and 
growth. 

Six EU Member States (Belgium, Cyprus, Italy, Malta, Poland, and Portugal)10 and other 
neighbouring  jurisdictions  (like  Liechtenstein  or  Switzerland)  already  have  legislative 
measures in place to tackle the tax induced debt-equity bias, by providing some kind of a 
tax allowance on equity. These domestic measures are heterogeneous and differ in terms 
of their policy design. They have been introduced for different reasons weighing the pros 
and  cons  of  different  design  choices  from  a  domestic  point  of  view.  Motivations  to 
introduce  a  domestic  measure  might  have  been  to  attract  investment,  or  to  address 
specific  needs  given  the  capital  structures  of  companies  or  certain  challenges  faced. 
Those Member States that did not introduce such measures made other political choices: 
for instance, some Member States apply a very low statutory corporate income tax (CIT) 
rate, another way to mitigate the debt-equity bias.  The Commission previously included 
an  Allowance  for  Growth  and  Investment  (AGI),  as  part  of  its  2016  proposals  for  a 
Common Consolidated Corporate Tax Base11 (CCCTB). The CCCTB, in which the AGI 

9 Own calculations based on Eurostat’s financial national accounts (online data code: NASA_10_F_BS). 
Debt is the sum of debt securities, loans and financial derivatives and employee stock options. Non-
consolidated data. Only non-financial corporations are considered. 
10 An overview of existing measures of interest allowance for equity in EU Member States is given in 
Annex 7. Two neighbouring countries, Switzerland and Liechtenstein also have systems of notional interest 
deduction for equity in place. 
11 COM(2016) 685 final 

6 

 
                                                           
was  one  part  of  a  broader  reform,  did  not  reach  agreement  in  Council  and  will  be 
replaced by the forthcoming BEFIT proposal. 

As  for  the  international  context,  it  should  be  noted  that  in  the  four  main  EU  trading 
partners  (i.e.  US,  Japan,  China,  UK),  interest  payments  are  a  deductible  expense  while 
dividends  are  not.  There  is  thus  a  debt-equity  bias  present  in  these  economies  as  well. 
They all have interest limitation rules. Only a few have or are considering an allowance 
on equity. The UK is working on a UK Secondary Capital Raising Review; they plan to 
publish a report soon. However, the possibility and potential benefits of introducing such 
measure have been long discussed, including by the IMF, OECD, ECB and other private 
and  public  stakeholders.  It  is  also  worth  noting  that  it  is  generally  argued  –  by  other 
international organisations, in EU research, and academia – that equity markets are better 
developed and that equity supply is generally higher in the US, which may be the reason 
why an equity allowance is not currently under consideration in the EU’s closest trading 
partner. 

Analysis  and  tax  related  casework  demonstrates  that,  in  the  past,  tax  allowances  for 
equity  have  been  abused  for  the  purpose  of  facilitating  tax  avoidance.  The  important 
lessons  learned,  should  be  used  to  inform  further  legislation.  Past  experiences  clearly 
illustrate the need for a strong anti-tax abuse framework to accompany a tax allowance 
for  equity.  Robust  anti-tax  abuse  measures  will  ensure  that  the  initiative  is  not 
undermined  by  tax  avoidance  practices  and  will  contribute  to  a  stronger  and  fairer 
European  market  economy.  It  is  against  this  background  that  the  Commission’s 
Communication  on  Business  Taxation  in  the  21st  Century  already  established  a 
commitment  that  any  initiative  to  address  the  debt-equity  bias  would  be  coupled  with 
robust anti-abuse measures, to ensure that the rules are not used for unintended purposes. 
The  anti-abuse  measures  will  benefit  from  the  thorough  review  of  all  six  NID  regimes 
undertaken  by  the  Code  of  Conduct  Group  for  Business  Taxation,  which  led  to 
guidance12 being issued on 17 October 2019. 

An EU approach to address the debt-equity bias would allow to apply the same measures 
to  all  Member  States  in  a  coordinated  manner  and  ensure  that  equity  is  treated  in  a 
similar  way  across  the  single  market,  removing  possible  tax  related  distortions.  A 
majority of respondents to the public consultation13 are of the view that the debt-equity 
bias should not be addressed at national level, but at an EU level and that doing so would 
improve the business environment. 

2. 

PROBLEM DEFINITION 

This  section  defines  and  analyses  the  problems  and  their  drivers  and  assesses  the 
evolution of these problems in the absence of EU policy intervention. The ‘Problem tree’ 
in Figure 1 visually presents the problems, their drivers, and their consequences. 

12 WK 11093/2019 REV 1 
13 The public consultation is discussed in detail in Annex 2. 

7 

 
                                                           
2.1. What are the problems? 

Tax  systems  in  the  EU  allow  for  the  deduction  of  interest  payments  on  debt  when 
calculating the tax base for corporate income tax purposes14; while costs related to equity 
financing,  such  as  dividends,  are  mostly  non-tax  deductible.  This  asymmetry  favours 
using debt over equity for financing investments15.  

The debt-bias can create several problems. As discussed in detail below, the preferential 
tax  treatment  of  debt  can  induce  businesses  to  finance  their  investments  with  debt. 
Corporate debt levels are consequently higher than they would be without the bias. This 
increases  the  risk  of  excessive  indebtedness  in  the  corporate  sector,  which  makes 
businesses  vulnerable  to  crisis  and  increases  the  risk  of  insolvency.  Excessive 
indebtedness  increases  leverage  of  the  financial  sector  with  the  potential  to  lead  to 
financial instability.  

There  are  multiple  reasons  beyond  the  tax  induced  debt-equity  bias  why  companies 
might  prefer  debt  to  equity  financing.  Debt  could  be  chosen  to  increase  the  return  on 
equity, because  access  to equity financing is  limited, because debt  financing is  cheaper 
than equity financing (especially when interest rates are low), to diversify risk, to reduce 
tax liabilities, and to avoid the dilution of control/voting rights of existing equity holders 
(owners). These reasons for the choice of debt have been evaluated in the questionnaire 
of  the  open  public  consultation  for  DEBRA  and  stakeholders  acknowledged  the 
relevance of all these elements. NGOs and academics respondents think that debt is used 
mainly  by  companies  to  decrease  their  tax  liability  and  avoid  dilution  of  shareholders, 
whereas  business  associations  and  companies  put  as  main  reasons  the  necessity  to  find 
financing means and the opportunity of low interest rates available. 

In  addition  to  contributing  to  financial  instability,  the  debt  bias  also  reinforces  the 
disadvantage  for  young  and  innovative  businesses.  These  businesses  are  often  deemed 
risky as investments by commercial banks and other traditional credit providers. In order 
to  thrive,  these  businesses  are  therefore  often  dependent  on  equity  financing,  which  is 
scarce  in  the  European  markets,  making  it  very  hard  for  them  to  obtain  the  funds  they 
need.  Reducing  the  bias  would  have  a  positive  effect  on  the  availability  of  equity  and 
would thus promote higher levels of equity investment in the EU market. Investors will 
be  incentivised  to  invest  in  the  EU  through  a  decrease  of  the  cost  of  capital,  at  a  time 
when the digital and climate transition require more investments.  

The current situation, where only a minority of Member States addresses the debt bias, 
creates  opportunities  for  aggressive  tax  planning  and  has  the  potential  to  distort 
investment decisions in the single market. Moreover, discrepancies in how an allowance 
for  equity  is  implemented  across  the  subset  of  Member  States  where  such  a  measure 

14 As previously noted, this is the case for most but not necessarily all Member States as two EU Member 
States – Estonia and Latvia – do not allow for a (comparable) deduction of interest on debt given their 
differentiated tax systems.  
15 On the debt bias, see e.g. Fatica et al. (2013), Auerbach et al. (2010), Griffith et al. (2010), Langendijk et 
al. (2014) and Bräutigam et al. (2018). 

8 

 
                                                           
exists,  can  hamper  the  efficient  functioning  of  the  Single  Market  and  distort  firms’ 
decisions.  

These issues have been raised by several stakeholders in the context of DEBRA’s public 
consultation.  Different  business  associations  agree  that  reducing  the  debt-equity  bias  to 
encourage  equity  financing  would  have  an  overall  positive  effect  on  the  solvency  and 
financial  stability  of  businesses,  especially  in  times  of  economic  slowdown  or  crisis. 
Moreover, stakeholders from business and academic backgrounds acknowledge the need 
for  measures  to  tackle  the  debt-equity  bias  generated  by  the  different  tax  treatment  of 
these  two  types  of  financing.  Businesses  were  supportive  of  measures  to  mitigate  the 
debt-equity bias, defending the view that the bias incentivises companies to opt for debt 
instead of equity, and that high-levels of debt increase risks of bankruptcy, frequently at 
creditors’ expense.  

 Higher levels of indebtedness and their negative repercussions 

The  debt-equity  bias  is  a  long-standing  issue,  and  has  been  the  subject  of  substantial 
academic  and  policy  work.  There  is  extensive  academic  literature  establishing  the 
influence that national tax systems have on  corporate capital structure (e.g. Huizinga et 
al. 2008). The literature is condensed in two meta-studies. De Mooij (2011) and Feld and 
others (2013) which find a typical impact coefficient of the corporate income tax (CIT) 
rate on the debt-asset ratio of about 0.2716. This means that for a CIT rate of 26 percent 
(the weighted average rate in the EU), the debt-equity bias would be responsible for a 7 
percentage-point  higher  debt-to-equity  ratio  in  an  average  corporation.  The  results  also 
indicate that the response increases over time (i.e., the relationship between tax induced 
debt-bias  and  capital  structure  becomes  stronger)  and  that  the  relationship  may  not  be 
linear. The first system to address the tax debt bias was originally proposed in 1991 by 
the Capital Taxes Committee of the Institute for Fiscal Studies17. 

Under  the  current  tax  rules  of  most  Member  States,  a  company  that  finances  a  new 
investment with debt will reduce its tax base and therefore maximise its after-tax profit, 
compared  to  the  situation  where  the  company  finances  the  same  investment  with  an 
equity increase. Businesses thus tend to favour investments financed by debt. This leads 
to  higher  debt-equity  ratios  compared  to  a  situation  in  which  debt  and  equity  have  the 
same tax treatment. The debt-bias increases with the rate of corporate income taxation in 
a  given  country,  since  a  given  reduction  of  the  tax  base  becomes  more  attractive  with 
higher tax rates. The  tax induced  debt-bias also  increases with  the interest  rate, since a 
given amount of debt results in higher deductible interest payments, further reducing the 
tax base.  Of course higher interest  rates make debt  more costly  compared to  equity,  so 
that this price effect counteracts the effect on the tax-induced debt-equity bias. There is 
no  available  evidence,  which  of  the  two  effects  would  be  stronger  but  since  the  price 

16 De Mooij (2011) finds that a one percentage point higher tax rate increases the debt-asset ratio by 
between 0.17 and 0.28. Feld et al. (2013) conclude a marginal tax effect on the debt ratio of 0.27. 
17 ACE system proposal IFS, 1991; Devereux and Freeman, 1991. 

9 

 
                                                           
effect operates directly while the tax-induced debt-equity bias operates mitigated through 
the tax rate, it seems likely that the price effect might dominate.   

High  debt-equity  ratios  can  have  negative  repercussions  on  both  the  company  and 
macroeconomic levels. At the company level, higher debt-equity ratios can increase the 
vulnerability  to  unforeseen  changes  in  the  business  environment  and  the  risk  of 
insolvency.  Contrary  to  dividends,  debt  must  be  served  regardless  of  the  financial 
situation  of  a  company  and  the  business  environment.  In  this  context,  Giroud  and 
Mueller  (2017)  find  a  more  pronounced  decline  in  employment  during  the  global 
financial  crisis  in  businesses  with  higher  debt  levels  as  compared  to  those  with  lower 
debt-leverage18.  

All respondents to the public consultation acknowledge indebtedness of companies in the 
EU, including SMEs, is too high and that it makes them more vulnerable to insolvency. 
All respondents also find that an EU initiative to address the debt-equity bias would be a 
useful  tool  to  support  the  recovery  of  companies  from  the  COVID-19  crisis  and 
incentivise investment through equity in the transition to a greener digitalised economy 
without  creating  distortions  in  the  single  market.  Companies,  NGOs  and  academics 
strongly think firms should be encouraged to use more equity and less debt. 

At  the  macroeconomic  level,  higher  debt-equity  ratios  can  constitute  systemic  credit 
externalities19  (Bianchi  2011).  Sutherland  and  Hoeller  (2012)  find  that  higher  leverage 
ratios  in  the  non-financial  corporate  sector  are  associated  with  a  significantly  higher 
probability of recession. Jordà and others (2013) find that the build-up of corporate debt 
during expansion periods increase the probability  that subsequent  recessions are deeper 
and  longer  lasting.  The  link  between  higher  corporate  debt  levels  and  economic 
downturns is also shown by Bernanke et al. (1988) and IMF (2016). 

Through input-output linkages, the default of one company can spill over to others and 
amplify  aggregate  fluctuations  in  the  economy  (Acemoglu  et  al.  2012).  Furthermore,  a 
large number of non-performing loans of non-financial corporations (NFCs) can have an 
indirect  negative  effect  on  financial  stability  and  increase  the  volatility  of  the  business 
cycle (Sutherland & Hoeller 2012). Higher levels of corporate indebtedness thus increase 
the  risk  of  financial  crises  and  also  contribute  to  more  lengthy  recovery  processes.  An 
example  is  the  recovery  from  the  2008-2009  financial  crisis  (FSC  Subgroup  on  Non-
Performing  Loans  2017)20.  The  debt-bias  thus  creates  allocative  distortions,  such  as 
higher  agency  costs  or  bankruptcy  costs  that  result  in  welfare  losses  (Gordon  2010; 
Kalemli-Ozcan et al. 2014).  

18 Debt leverage is interchangeable used to refer to the share of debt of total capital or the fraction of debt 
to equity. 
19 The externality arises because agents in times of crisis and credit constraint fail to internalize the debt-
deflation effects of additional borrowing. 
20 This relationship is explained in the Report of the FSC Subgroup on Non-Performing Loans (2017), 
https://data.consilium.europa.eu/doc/document/ST-9854-2017-INIT/en/pdf. 

10 

 
 
                                                           
Figure 1: Problem Tree 

11 

 
 
 
Total  indebtedness  of  non-financial  corporations  in  the  EU  amounted  to  almost  EUR 
14.9 Trillion in 2020 or 111% of GDP, compared to EUR 11 Trillion or 100.4 % of GDP 
in 201021. 

COVID pandemic has increased economic risks 

The COVID-19 pandemic has made it even more important to address the debt bias, as it 
is expected to exacerbate debt financing. Economic losses resulting from the COVID-19 
crisis  have  significantly  weakened  the  equity  position  of  many  businesses.  A  drastic 
reduction  in  incoming  cash  flows  has  prompted  many  European  businesses  to  raise 
additional  debt  to  meet  their  short-term  financial  obligations.  As  a  result,  the  capital 
structure of a number of businesses has become more fragile, putting some on the verge 
of insolvency. Researchers at the IMF estimate that about 2 to 3 percent of GDP will be 
needed to close the equity gap and provide firms in Europe sufficient equity, so that they 
would no longer be in difficulty (Ebeke et al. 2021). It is therefore of utmost importance 
to address the corporate debt-bias and promote the equitisation of European businesses in 
order  to  minimise  future  risks.  Such  a  measure  should  also  have  positive  effects  at  the 
macro level. 

The ECB’s financial risk assessment further strengthens such a conclusion. In November 
2020, the ECB found that “the deterioration in NFC financial health was largely driven 
by  a  drop  in  sales,  lower  actual  and  expected  profitability,  and  an  increase  in  leverage 
and  indebtedness”  (ECB  2020).  In  May  2021,  the  ECB  showed  that  the  situation  is 
especially  dire  for  already  vulnerable  businesses  with  high  debt-to-equity  ratios  since 
reliance on debt has increased among vulnerable businesses, amid higher rollover risks. 
Among  the  highest  leveraged  businesses,  the  90th  percentile  debt-to-equity  ratios  has 
increased from 220% at end-2019 to over 270% in the final quarter of 2020 (see Figure 2, 
left panel). Corporate earnings expectations for the euro area have remained below pre-
pandemic levels, while corporate funding conditions remained around the tightest levels 
seen since the pandemic started, especially for SMEs, highlighting elevated refinancing 
risks”  (ECB  2021).  According  to  IMF  a  share  of  maybe  20%  of  businesses  face  over-
indebtedness and risk insolvency. The IMF also identifies an extremely high insolvency 
risk for SMEs under its current projections, potentially resulting in a loss of 1 in 10 SME 
jobs. The major cause of insolvency risk is a lack of equity financing (Diez et al. 2021). 

21 Own calculations based on Eurostat’s financial national accounts (online data code: NASA_10_F_BS). 
Debt is the sum of debt securities, loans and financial derivatives and employee stock options. Non-
consolidated data. Only non-financial corporations are considered. 

12 

 
 
 
 
 
                                                           
Figure 2: Debt-to-equity ratios for Non-Financial Businesses and expected insolvencies. 

Notes: left panel, Q1-Q4 refers to quarter 1 to 4 of the respective year; right panel, t refers to the year the 
respective crisis started as shown in the legend, t+1 indicates the following year and so on. The legend 
indicates that for each crisis a four year interval is considered. 
Source: ECB, Financial stability review May 2021, https://www.ecb.europa.eu/pub/financial-
stability/fsr/html/ecb.fsr202105~757f727fe4.en.html 

The COVID-19 pandemic has resulted in high debt levels, not only at company but also 
at the sovereign level. Member States will need to identify means to lower current debt 
levels  and  increase  revenues  in  order  to  engender  a  sustainable  recovery  and  take 
pressure off public finances in the near-term. Measures such as the interest deduction that 
is  currently  applied  across  all  Member  States  have  an  impact  in  this  respect.  They  can 
entail potentially important losses in revenues for Member States. If we were to assume, 
for  example,  that  the  average  interest  rate  of  debt  were  3%,  and  70%  of  all  debt  is 
serviced by tax deductible interest payments, applying an EU-average corporate income 
tax  rate  of  26%  would  provide  a  very  rough  estimate  of  the  costs  of  the  existing 
deductibility of interest  of EUR 64 billion for non-financial corporations and EUR 206 
billion for financial corporations.   

Specific investment needs require more equity  

Specific investment  needs required for  the green and digital  transitions  of the economy 
and  society  provide  further  justification  for  tackling  the  debt-equity  bias.  These  twin 
transitions  constitute  a  policy  priority  for  the  EU,  one  that  will  require  many  risky 
investments,  which  in  themselves  will  require  greater  equity  investments.  The  EIB 
provides evidence that “green investments are specific in nature. They enhance welfare 
but are risky for investors.. Hence, the transition is likelier to be financed by risk-taking 

13 

 
 
and  risk-absorbing  instruments  such  as  equity.  Longer-term  investors  also  need  to  be 
attracted.”22 (EIB 2021, Chapter 6.). 

The  importance  of  equity  to  foster  the  twin  green  and  digital  transitions  has  been 
highlighted by one of the business associations that responded to the public consultation. 
According to this business association, the twin transitions will require important levels 
of investment from both the public and the private sector, which means that businesses 
will need to find more diversified sources of financing. Therefore, measures that would 
reduce the debt-equity bias will be welcome to facilitate equity financing. 

Insufficient equity financing  

The  insufficient  supply  of  equity  financing  discourages  investment  in  projects  with 
higher risks which also have prospects for higher than average future returns. As such, it 
hampers innovation and growth. The scarcity and the higher cost of equity finance affects 
all  companies,  but  is  particularly  problematic  for  young  and  innovative,  businesses, 
which due to their risk profile, often have limited access to  external debt  funding. This 
problem is aggravated by limited access to alternative sources of finance such as venture 
capital.  A  number  of  Member  States  (especially  France,  Belgian  and  Italy)  have 
introduced  tax  incentives  to  promote  venture  capital  and  business  angel  funding,  but 
these  types  of  finance  represent  only  a  small  proportion  of  the  current  total  funding 
mix23.  Consequently,  small  and  innovative  businesses,  often  perceived  by  banks  and 
financial institutions to be higher risk, might be at a particular disadvantage, despite their 
importance  in  generating  future  growth24.  This  problem  also  extends  to  businesses  in 
need of scale-up-financing (e.g. Aernoudt 2017). 

The  European  Investment  Bank  (EIB)  shows  that  the  availability  of  sufficient  equity 
financing  has  further  diminished  during  the  COVID-19  crisis.  Especially  young  and 
small enterprises as well as SMEs face an adverse environment. The slump in demand is 
more  pronounced  in  sectors  with  many  smaller  firms,  which  have  less  flexible  cost 
structures and more restricted access to finance. “Survey indicators suggest that various 
sources  of  finance  specific  to  young  enterprises  and  SMEs  –  such  as  private  equity, 
venture  capital  and  business  angels  –  may  dry  up.  This  should  cause  concern  as  these 
sources of finance were already not sufficiently developed in Europe prior to the crisis” 
(EIB 2021). 

At the same time the impact of insufficient equity financing has become direr because of 
the heightened specific investment needs related to the digital and green transition. This 
could  limit  the  opportunities  especially  for  SMEs  to  engage  in  profitable  investments, 

22 See Chapter 6 of the EIB Investment report 2020/2021 where ample evidence is presented that market 
and equity based investments are more successful in greening the economy than  
23 See for example PWC (2017), Effectiveness of tax incentives for venture capital and business angels to 
foster the investment of SMEs and start-ups. 
24 Problems of equity financing are further discussed in a recent study on equity investments in Europe 
(European Commission 2021),   https://op.europa.eu/en/publication-detail/-/publication/4a355d87-669a-
11eb-aeb5-01aa75ed71a1/ 

14 

 
                                                           
due  to  their  limited  access  to  financing.  This  initiative  could  thus  also  support  the 
recovery of SMEs and help them adapt to the new business environment. 

The  view  that  equity  financing  is  insufficient  in  the  EU  is  shared  by  some  of  the 
stakeholders that responded to the public consultation. According to  a national business 
association, apart from a favourable tax treatment of debt over equity, capital markets are 
very  hard  to  reach  for  SMEs,  “as  external  private  equity  seems  to  be  constrained  to 
specific types of entrepreneurship.” Another business association highlights the fact that 
because  European  businesses  are  still  widely  financed  by  bank  loans,  these  are  more 
vulnerable to shocks than American businesses which tend to have more access to other 
sources of financing.  

Of  course,  this  situation  is  not  due  to  the  debt  bias  alone;  but  this  initiative  would 
contribute  to  the  objective  of  the  EU’s  Capital  Markets  Union.  In  particular,  and  as 
previously  highlighted,  it  would  complement  Action  4  of  the  Capital  Markets  Union 
Action Plan – which aims to incentivise institutional investors to make more long-term 
investments  and  thus  support  re-equitisation  in  the  corporate  sector  –  by  addressing 
undue fiscal incentives for debt financing stemming from the differentiated tax treatment 
of debt and equity costs. On top of this broad policy objective of incentivising equity and 
diversifying financing, specific provisions of the initiative would align with other broader 
tax policy objectives – such as the fight against tax avoidance and evasion. 

Limited number of measures to mitigate the debt-equity bias through an allowance 
on equity  

Currently, only six Member States (Belgium, Cyprus, Italy, Malta, Poland and Portugal) 
have some form of tax allowance for equity in place in order to mitigate the debt-equity 
bias  (see  Table  A7.1  in  Annex  7  for  an  overview).  Table  1  below  indicates  the  actual 
debt-equity  bias  in  those  countries.  The  table  reports  effective  average  tax  rates  for 
retained  earnings,  new  equity  and  debt,  based  on  a  notional  interest  rate  on  equity  and 
retained earnings as applied in the respective Member States. The model used by ZEW to 
calculate  these  effective  rates  assumes  a  nominal  interest  rate  of  7.1%.  If  the  notional 
interest rate were equal to the nominal interest rate of 7.1%, only Cyprus would still have 
a  small  debt  bias  due  to  the  construction  of  its  measure.  The  appropriate  choice  of  the 
notional interest rate can eliminate the debt bias (see ZEW 2020 and Annex 5). 

Table  1:  Effective  average  tax  rates  and  debt-equity  bias  with  actual  notional  interest 
rate. 

Notional 
interest rate 
Retained 
Earnings 
New Equity 
Debt 
Mean 
Debt Bias* 

Belgium 
0% 

Cyprus 
5.536% 

Italy 
1.3% 

Malta 
6.43% 

Poland 
1.5% 

Portugal 
7.0% 

7 

7 
4.7 
6.2 
2.3 

5.6 

5.6 
4.9 
5.4 
0.7 

6.6 

6.6 
4.8 
6 
1.8 

15 

4.8 

4.8 
4.4 
4.6 
0.4 

5.8 

5.8 
4.7 
5.4 
1.1 

4.4 

4.4 
4.3 
4.3 
0.1 

 
 
Source: ZEW (2020) 

Although all these measures provide for a tax allowance on equity, they differ in policy 
design (e.g., interest rate of the allowance, calculation of the basis for the allowance, type 
and  severity  of  anti-tax  avoidance  measures).  Such  differences  can  have  negative 
consequences  for the single market.  Firstly,  the interaction between  different  measures, 
combined  with  the  absence  of  equivalent  measures  in  other  Member  States,  can  lead 
businesses to base their investment financing decisions on the availability (or not) and the 
generosity of rules that allow deductions for equity costs. This creates distortions and a 
misallocation  of  investments  in  the  single  market.  Secondly,  these  measures,  when 
applied  at  the  national  level  only,  without  a  harmonised  anti-tax  avoidance  framework, 
can  create  loopholes  that  can  be  exploited  for  aggressive  tax  planning  purposes  and 
increase  harmful  tax  competition  among  Member  States,  leading  to  tax  avoidance  and 
evasion.  Finally,  different  country-specific  approaches  to  mitigate  the  debt-equity  bias 
increase compliance costs for businesses active across borders. 

The  need  for  measures  to  tackle  the  debt-equity  bias,  was  recognized  by  some  of  the 
stakeholders during the public consultation. One business association expressed the belief 
that promoting equity financing is essential to promoting strong and sustainable business 
growth. This view was shared by another stakeholder which specifically stated that: “Tax 
measures  that  aim  at  facilitating  equity  financing  will  be  welcome,  provided  they  are 
coherent with the overarching economic policies.” Business associations, companies and 
academics  respondents  clearly  agree  that  such  an  initiative  will  reduce  tax  competition 
between  Member  States.  Importantly,  all  respondents  think  that  an  EU  initiative  would 
be beneficial for enterprises operating across countries in the single market. 

2.2. What are the problem drivers? 

The debt-equity bias and its determinants 

How  large  is  the  debt-equity  bias?  One  approach  to  measure  the  debt-equity  bias  is  to 
compare  the  cost  of  capital  for  equity-financed  investments  with  that  of  debt-financed 
investments.  Figure  3  shows  the  debt  bias  in  corporate  taxation,  measured  as  the 
difference in cost of capital between new equity and debt-financed investment. One can 
see  that  the  Member  States  which  have  implemented  an  allowance  for  equity  (i.e., 
Belgium, Cyprus, Italy, Malta, Poland and Portugal) have no or a very low debt-equity 
bias25. Hence, the introduction of a specific measure on equity can lead to a reduction of 
even the elimination of the bias. 

25 Note that the cost-of-capital calculations are theoretical calculations based on the tax code. A zero debt-
equity bias in MT, PT, IT, PL and BE thus follow by assumption and do not derive from an empirical 
measurement. 

16 

 
                                                           
Figure 3: Debt-equity bias in corporate financing 2010 and 202026 

Source: Annual Report on Taxation (European Commission 2021)  
Notes:  (1)  The  cost  of  capital  measures  the  required  minimum  pre-tax  return  of  a  real  investment  (the  ‘marginal  investment’)  to 
achieve  a  5%  after  tax  real  return.  (2)  To  reflect  the  allowance  for  corporate  equity  in  Belgium,  Cyprus,  Italy,  Malta,  Poland  and 
Portugal, the assumption is that the rates of these allowances equal the market interest rate in the model. For Belgium, the debt-equity 
bias could be non-zero due to the notional interest rate being relatively low, while the eligible equity only covers the average annual 
increase over the previous 5 years. For Cyprus, the bias is small, since the allowance does not apply to investments in financial assets. 

One can also see that countries with high statutory CIT rates tend to have a higher debt-
equity  bias.  Ceteris  paribus,  the  advantage  of  tax  deductibility  of  interest  payments 
increases with the statutory tax rate. The higher the rate of the corporate income tax in a 
given country, the stronger is the bias towards debt for the financing of new investments. 
In the last decade, while the debt-equity bias has increased or remained stable for some 
countries, it has decreased for others. The decrease is probably driven by the downward 
trend of CIT rates in the EU and the consistent decline in interest rates. However, this is a 
reversible trend such that specific measures might be needed to avoid a possible increase 
in the debt bias due to changes in macroeconomic variables. 

The prevailing interest rate also affects the debt-equity bias. A higher interest rate results 
in higher interest payments that significantly reduce the taxable base of businesses. This 
means  less  tax  is  due.  The  tax-induced  bias  for  debt  is  thus  stronger.  However, 
everything  else  being  equal,  one  would  expect  that  higher  interest  rates  reduce  the 
demand for debt with a possible negative impact on investment. In a similar vein, rising 
interest rates increase the burden for a company to service a given debt level. The ECB 
points  out  that  “higher  (risk-free)  rates  would  increase  debt  servicing  costs  from 
historical lows and could raise medium-term risks in countries with elevated debt levels” 

26 BE appears in the figure as the sole country without a debt equity bias in 2010 because it was the only 
EU member state with an allowance for equity in place at the time. The 5 others have been introduced after 
2010. 

17 

 
 
 
                                                           
(ECB,  2021).  Increasing  interest  rates  thus  increase  the  business  risk  associated  with 
indebtedness and aggravate the problem of high debt levels.  

The debt-equity bias can also be addressed through the tax-treatment of corporate debt. 
Many  countries  have  implemented  interest  limitation  rules  or  thin  capitalization  rules. 
Such rules limit the amount of interest that can actually be deducted. It has been shown 
that  these  rules  increase  the  cost  of  debt  and  thus  indeed  reduce  the  debt-equity  bias27. 
Common  interest  limitation  rules  in  the EU have been introduced by the  first  Anti-Tax 
Avoidance Directive (ATAD 1)28 with the primary objective of countering tax avoidance 
and aggressive tax planning. As indicated, these rules do to some extent also contribute 
to mitigating the debt-equity bias and related over-indebtedness.  

The EU’s interest limitation rule is laid down in Article 4 of ATAD 1 and prescribes that 
the total annual borrowing costs can be fully deductible for tax purposes to the extent that 
they do not exceed taxable interest and other economically equivalent taxable revenues. 
The deductibility of any excess borrowing costs (without distinction of whether the costs 
derive from domestic or cross-border transactions) is limited to the higher of: 

  A Safe Harbour of EUR 3 million, or 
  30% of EBITDA (Earnings before interest, tax, depreciation and amortisation) 

These  are  de-minimis  provisions  and  Member  States  have  implemented  these  rules 
differently.  Some  Member  States  have  gone  further,  for  example,  by  applying  a  lower 
Safe  Harbour,  a  lower  percentage  limit  than  foreseen  in  the  ATAD  provision,  or 
introducing  the  limit  based  on  earnings  before  interest,  tax  and  depreciation  (EBITD) 
instead of EBITDA.  An  overview of the specific  interest  limitation rules applied  in  the 
EU is provided in Table A7.2 in Annex 7. 

2.3. How will the problem evolve? 

Most  problems  that  are  directly  or  indirectly  related  to  the  debt-equity  bias  will  not 
change as long as the debt-equity bias persists and no specific measures to address it are 
introduced. The bias emanates from the different tax treatment of debt versus equity and 
there are no external drivers that, if addressed, would permanently solve or mitigate the 
issue. In other words, if no action is taken in the field of taxation, the debt bias and the 
associated negative repercussions will persist.  

As detailed above, low CIT rates and low interest rates could reduce the bias. However, 
such measures depend on the macroeconomic situation more generally and might change. 
For example, an increase in inflation might lead to an increase in interest rates.  

27 See European Commission (2016b) and IMF (2016) on the effectiveness of interest limitation rules and 
thin capitalization rules for mitigation of the debt-equity bias. 
28 COUNCIL DIRECTIVE (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance 
practices that directly affect the functioning of the internal market 

18 

 
                                                           
Member States  could  also individually implement  actions that reduce the debt  bias and 
the ‘price’ of equity. So far, only a few Member States have used such measures, while 
the issue has been a long-lasting one.   Accordingly,  one may  expect  that it would  take 
time for additional Member States to take action while some may continue to choose to 
take no action at all. Moreover, actions taken at national level can result in a patchwork 
of  different  rules,  increasing  regulatory  complexity  across  the  EU  for  businesses  and 
creating opportunities for tax planning and tax avoidance and evasion.   

Several  EU  policies  that  aim  to  provide  incentives  and  access  to  financing,  notably  to 
meet  the investment  needs related to  the  recovery  and the  digital  and  green transitions, 
could  contribute  to  reducing  the  cost  of  equity.  The  EU’s  Recovery  and  Resilience 
Facility  (RRF)  provides  emergency  financing  for  the  recovery,  containing  minimum 
thresholds for investments and reforms geared towards the green and digital transitions. 
The RRF, however, is very much a country-led process in terms of the design and choice 
of policies, so it would not necessarily address the issue of cross-country differences. The 
Action Plan for the Capital Market Union29 has also announced several policy measures 
aimed at improving the access to equity financing, such as encouraging more long-term 
and  equity  financing  from  institutional  investors  and  increasing  the  visibility  of 
businesses to cross-border investors. However, such measures do not directly address the 
tax-system  induced  treatment  that  incentivises  or  favours  the  use  of  debt  over  equity, 
which  means  the  debt-equity  bias  will  nonetheless  persist.  This  is  precisely  why,  as 
previously  mentioned,  both  the  Capital  Markets  Union  Action  Plan  itself  and  the 
Commission’s  Communication  on  Taxation  for  the  21st  Century  seek  action  to 
specifically alleviate the tax associated burden in cross-border investment.  

2.4. DEBRA in context of the Commission’s Strategic Foresight report 

An  initiative  to  address  the  debt-equity  bias  is  expected  to  foster  an  increase  of  equity 
investments in the EU and mitigate tax-related incentives that help sustain high leverage 
and  overreliance  on  debt.  Consequently,  the  DEBRA  initiative  could  be  expected  to 
contribute  positively  to  three  of  the  ten  areas  identified  in  the  EU’s  2021  Strategic 
Foresight Report (“SFR”)30. On the area of “Digital hyper connectivity and technological 
transformations”  the  SFR  states  that  the  EU  lags  behind  its  main  competitors  in  the 
availability of “private investment into research”. By reducing the treatment differences 
between debt and equity, DEBRA may create incentives to increase private investments 
in the EU. 

The same applies to the area of environmental and energy innovation. According to the 
SFR,  the  EU  will  need  EUR  470  billion  in  investment  to  reach  its  2030  climate  and 
environmental  objectives;  and  new  technologies  will  be  key  to  ensuring  that  energy 
decarbonisation  objectives  are  reached.  These  investments  will  require  a  massive 
mobilization of private capital. Addressing the debt-equity bias and introducing a means 

29 COM(2020) 590 final 
30 https://ec.europa.eu/info/strategy/strategic-planning/strategic-foresight/2021-strategic-foresight-
report_en 

19 

 
                                                           
of  incentivising  equity  would  facilitate  an  increase  in  private  investment  in  green 
innovative technology and thus help the EU reach its 2030 climate objectives. 

Lastly,  the  initiative  is  also  in  line  with  the  EU’s  objectives  of  creating  resilient  and 
stable  economies  that  are  prepared  for  future  shocks.  According  to  the  SFR,  solid 
economic fundamentals,  productivity, investments and reforms will determine the EU’s 
future  economic  performance,  linked  with  positive  financing  conditions  for  the  public 
and  private  sector.  High-levels  of  debt  increase  risks  of  bankruptcy  and  of  a  systemic 
crisis.  By  reducing  incentives  to  debt  financing  and  promoting  equity  investments, 
DEBRA  would  lower  debt  levels  of  EU  companies  and  contribute  to  a  more  robust 
economy. 

3.  WHY SHOULD THE EU ACT? 

The  debt-equity  bias  is  a  long-standing  issue  that  has  gained  much  attention  globally 
from  business  and  academic  research.  With  this  initiative,  the  EU,  one  of  the  world’s 
major  economic  actors  and  one  of  the  largest  capital  markets  globally,  would  act  to 
remedy the bias in a coordinated and harmonised way, with a strong homogenous anti-
tax  abuse  framework  applicable  across  the  EU,  mitigating  mismatches  and  loopholes. 
Only an EU-wide measure can mitigate the problem across the EU for all EU businesses, 
while not leaving room for harmful tax practices.  

3.1. Legal basis 

The legal base for this initiative is Article 115 TFEU on the approximation of laws of the 
Member  States,  which  directly  affect  the  establishment  or  functioning  of  the  internal 
market.  The  identified  problems,  their  underlying  causes  and  reasons  for  coordinated 
action  are  common  to  all  Member  States.  The  article  provides  for  the  adoption  of 
legislation through directives, following the special legislative procedure, which requires 
a  unanimous  vote  by  Member  States  in  Council.  The  European  Parliament  and  the 
Economic and Social Committee have to be consulted but do not hold decision-making 
power. Directives are addressed to Member States and solely bind them as to the result to 
be achieved while leaving the means (for doing so) to national transposition measures.  

The current initiative  complements  the new framework  for business  taxation in  the EU 
that  the  Commission  is  committed  to  present  by  2023.  The  “Business  in  Europe: 
Framework  for  Income  Taxation”  (or  BEFIT)  will  provide  a  single  corporate  tax 
rulebook  for  the  EU,  providing  for  fairer  allocation  of  taxing  rights  between  Member 
States. BEFIT will replace the 2016 CCCTB proposals, which also included a proposal 
for an Allowance for Growth and Investment31. 

Concerning  the  anti-tax  abuse  framework  that  will  need  to  accompany  the  rules  on  the 
deductibility  of  equity  costs,  the  Code  of  Conduct  Group  on  Business  Taxation  has 

31 COM(2016) 685 final 

20 

 
                                                           
issued guidance on notional interest deduction regimes32 and this blueprint will guide the 
work on the anti-tax avoidance rules that will be integrated in the legal proposal.  

3.2. Subsidiarity 

According  to  the  subsidiarity  principle  laid  down  in  Article  5(3)  TFEU,  action  at  EU 
level should be taken only when the aims envisaged  cannot be achieved sufficiently by 
Member  States  acting  alone  and  in  addition,  by  reason  of  the  scale  or  effects  of  the 
proposed action, can be better achieved by the EU. 

3.2.1. 

 Subsidiarity: Necessity of EU action 

There are a number of reasons why EU level action, rather than national action, is needed 
to mitigate the tax debt-equity bias.  

First, the problem described in Chapter 2 is widespread across the EU and common to all 
Member States. Most Member States’ corporate tax systems allow a company to deduct 
for tax purposes interests that arise from debt financing while the costs related to equity 
financing  (notably,  payments  of  dividends)  are  not  tax  deductible.  It  must  be  note  that 
interest deductions are already subject to some kind of limitations according to existing 
EU rules (ATAD1). 

Second,  six  Member  States  have  already  unilaterally  addressed  the  debt-equity  bias  at 
national  level  through  the  introduction  of  a  tax  allowance  on  equity.  However,  these 
measures  differ  considerably  in  policy  design  (e.g.  interest  rate  of  the  allowance, 
calculation  of  the  basis  for  the  allowance,  type  and  severity  of  anti-tax  avoidance 
measures). The interaction between these disparate national frameworks, combined with 
the  absence  of  equity-side  measures  in  other  Member  States,  may  lead  to  market 
distortions  and  a  misallocation  of  investments  in  the  single  market,  as  businesses  may 
base their investment decisions on the availability (or not) and the generosity of rules that 
allow deductions for equity costs. 

In addition, the interaction of widely divergent national measures with a non-harmonised 
anti-tax  avoidance  framework  may  inadvertently  create  loopholes,  which  can  be 
exploited  for  aggressive  corporate  tax  planning  purposes.  While  these  elements  are  not 
the  only  drivers,  their  combined  effect  is  that  the  differentiation  across  the  EU27  may 
result in increasing harmful tax competition among Member States. These opportunities 
encourage  practices  of  tax  avoidance  and  evasion  in  the  EU.  Existing  EU  legislation 
cannot  address  such  distortions,  resulting  from  the  differentiated  tax  treatment  of  debt 
and equity. 

Finally, different country specific rules also imply higher compliance costs for businesses 
active  in  cross-border  operations  within  the  single  market,  as  they  are  called  on  to 
comply with various sets of different  rules.  Such compliance costs will be significantly 
reduced if a single EU-wide rule applies. 

32 WK 11093/2019 REV 1 from 17 October 2019 

21 

 
                                                           
In other words, there is a problem that is common to Member States and can only partly 
be addressed by national action. In addition, national action may even have undesirable 
implications,  by  leaving  open  a  margin  for  harmful  tax  practices.  This  conclusion  is 
supported  by  some  stakeholders,  which  state  that  an  EU-wide  initiative,  establishing  a 
common  approach,  would  reduce  tax  competition  and  fragmentation,  establishing  a 
common approach. Stakeholders further highlighted that a common approach would help 
reduce administrative burdens and facilitate access to the benefits of the measure.  

During  bilateral  contacts  with  the  Commission  services,  a  Member  State  shared  the 
outcome  of  their  study  into  a  more  equal  treatment  of  equity  and  debt.  This  study 
concludes that a more  equal  tax treatment  of equity and debt  is  desirable to  reduce the 
debt bias and strengthen the financial resilience of the business community and that it is 
preferable to achieve this objective in an international or multilateral context. This study 
also  states  that  a  European  coordinated  approach  within  the  EU  contributes  to  the 
prevention of mismatches, tax avoidance and leads to less excessive debt financing.  

3.2.2. Subsidiarity and Proportionality: Added value of EU action 

An EU level initiative will provide wider benefits for the single market compared to the 
present fragmented situation of national initiatives. 

It  would  alleviate  distortions  in  the  single  market,  which  are  potentially  caused  by 
practices  of  harmful  tax  competition  amongst  Member  States  that  are  enabled  due  to 
fragmentation. In addition to a harmonisation of rules, it would also provide a sound anti-
tax abuse framework, based on measures discussed and evaluated in the Code of Conduct 
group,  to  tackle  aggressive  tax  practices  often  linked  to  opportunities  that  arise  when 
equity  costs  are  made  deductible.  Varying  national  rules  for  notional  allowances  on 
equity can be exploited for aggressive tax planning purposes. Operating one set of rules 
across the EU will help reduce aggressive tax planning in the single market. It will limit 
the scope for mismatches between disparate rules and the loopholes that  businesses can 
take advantage of.  

A  harmonised  tax  environment  for  businesses  in  this  field  could  also  create  legal 
certainty  for  taxpayers  that  the  rules  on  the  deductibility  of  equity  costs  are  compliant 
with  EU  law.  A  single  set  of  rules  could  help  taxpayers  ascertain  that  all  national  tax 
administrations  apply  these  rules  in  a  similar  manner  and  hence  lower  the  risk  of 
disputes.  

In  the  same  vein,  a  measure  at  EU  level  would  also  simplify  the  compliance  burden. 
Given  the  cross-border  dimension  of  the  potential  tax  avoidance  schemes  linked  to  the 
deduction  of  equity-financing  costs,  diverging  anti-tax  abuse  rules,  different  definitions 
of equity and the availability of various ways for integrating such measures in the overall 
framework of tax deductions naturally increase compliance costs. For businesses active 
across  the  EU,  this  initiative  will  thus  bring  gains  in  terms  of  simplification  of 
compliance.  This  cannot  be  effectively  achieved  through  soft  law  instruments,  as  has 
been proven in practice. Following a binding legislative initiative, a company, no matter 

22 

 
in  which Member States it is  active, would operate in  the same legal  context  regarding 
the tax treatment  of equity  financing.  In addition, all affected  businesses  would benefit 
from  the  same  measure  and  face  the  same  obligations,  which  would  promote  a  level 
playing field in the single market.  

An  action  at  EU  level  will  also  be  more  effective  than  individual  fragmented  actions 
taken at Member State level and at Member States’ discretion to address the tax-induced 
debt bias. National measures can only be used by SMEs located in those Member States 
that  apply  debt  bias  mitigating  measures,  or  by  MNEs  that  can  afford  to  locate  the 
financing company of the group in such Member States. SMEs located in Member States 
that do not have any tax debt bias mitigating measure can, as such, face higher costs for 
equity  financing  as  compared  to  SMEs  in  other  Member  States.  An  EU  level  initiative 
will  provide  for  a  single  solution  to  mitigating  the  tax-induced  debt  bias  that  all 
businesses  across  Europe  can  avail  themselves  of,  regardless  of  their  size  or  Member 
State of tax residence. 

Finally,  by  reducing  in  all  Member  States  the  preferential  tax  treatment  of  debt  which 
comes  at  the  expense  of  other  financial  instruments  (in  particular  equity),  the  initiative 
will  contribute  to  making  financing  more  accessible  to  all  European  businesses,  a  key 
objective of the 2020 Communication on a Capital Markets Union (CMU) for people and 
businesses33.  By  providing  for  a  common  approach  to  mitigating  the  debt  bias,  this 
initiative will also contribute to the integration of national capital markets into a genuine 
single market, another key objective of the CMU communication. By removing the tax 
debt  bias,  which  leads  businesses  to  favour  investment  financed  by  debt,  the  initiative 
will  contribute  to  the  re-equitisation  of  European  businesses.  This  will  increase  their 
resilience  to  unforeseen  changes  in  the  business  environment  and  decrease  the  risk  of 
insolvency, thereby indirectly contributing to bringing more financial stability in the EU. 

4.  OBJECTIVES: WHAT IS TO BE ACHIEVED? 

This section defines the general and specific objectives of the initiative. The ‘Intervention 
Logic’  in  Figure  4  visually  presents  the  problems,  their  drivers,  the  specific  objectives 
and the general objective of DEBRA. 

4.1. General objectives 

The first important objective of this initiative is to establish the conditions necessary such 
that  financing  decisions  are  made  based  on  an  appropriate  risk  management  profile, 
taking  into  account  financing  needs,  without  distortions  being  created  by  differentiated 
tax  treatments.  While  it is  clear  that  a  multiplicity  of  legitimate  determinants  influence 

33 Communication From The Commission To The European Parliament, The Council, The European 
Economic And Social Committee And The Committee Of The Regions Capital Markets Union - 
Delivering One Year After The Action Plan, Com/2021/720 Final  

23 

 
                                                           
businesses’ investment  decisions, provisions of  the tax system  should not  influence the 
choice between equity and debt.34 

The  second  objective  is  to  reduce  distortions  in  the  single  market  created  by  the 
interaction between disparate national measures combined with the absence of equivalent 
measures in other Member States. 

The third important objective of this initiative is to mitigate the risk that businesses take 
advantage  of  the  interaction  among  tax  systems  with  and  without  debt-equity  bias 
mitigating  measures  and  with  non-harmonised  anti-tax  abuse  frameworks  for  tax 
avoidance and tax evasion practices. 

A fourth objective is  to  increase the stability of the financial system such that action is 
taken that will support growth and investment   

4.2. Specific objectives 

This initiative supports the creation of a harmonised tax environment that places debt and 
capital  financing on  an equal  footing  across the  EU. This  will  encourage investment  in 
equity, help reduce distortions in the single market and facilitate cross-border activity.  

This  initiative  aims  to contribute to  the re-equitisation  of EU-based  businesses, thereby 
supporting wider EU policies such as the European Green Deal, the Commission’s digital 
agenda  and  the  New  Industrial  Strategy  for  Europe.  It  aims  to  boost  competitiveness, 
growth and ultimately employment in the EU. Following the COVID-19 health crisis and 
in the framework of the transition to a green and digitalised economy, substantial equity 
financed  investments  are  of  central  importance  for  a  fast  and  sound  recovery.  The 
ecological and digital transitions that the EU and its Member States are undertaking will 
require  new  technologies  and  innovation  that  imply  large  investment.  Break-through 
technologies  will  likely  require,  like  all  risky  investments,  greater  equity  financing. 
Moreover,  businesses  with  a  solid  capital  structure  are  less  vulnerable  to  shocks  and 
more prone to make investments and to take risks.  

By addressing the asymmetric tax treatment between equity- and debt-related costs, the 
initiative  will  help  reduce  the  accumulation  of  debt  for  non-financial  corporations, 
thereby decreasing insolvency risks. It will contribute to building a fully functioning and 
integrated market for capital, allowing the EU’s economy to  grow in a sustainable way 
and  be  more  competitive  as  set  out  in  the  2020  Communication  on  Capital  Markets 
Union. 

In addition, this initiative is expected to further remove distortions in the single market, 
as it will be combined with a comprehensive set of anti-tax abuse provisions to prevent 
businesses from circumventing the measure.  

34 It is alternatively argued that in a situation with comparatively low levels of equity in the corporate 
capital structure, the tax system should not be biased against equity. 

24 

 
                                                           
Figure 4. Intervention logic  

25 

 
 
 
5.  WHAT ARE THE AVAILABLE POLICY OPTIONS? 

5.1. What is the baseline from which options are assessed? 

The baseline scenario is established on the premise that, in the absence of intervention at 
the EU level, the tax induced debt-equity bias will persist in most Member States and the 
minority of Member States that have been frontrunners in adopting measures to mitigate 
the  debt-equity  bias  at  national  level  will  continue  to  apply  non  harmonised  tax-
allowances  on  equity  financing.  Businesses’  investment  decisions  will  thus  continue  to 
be  distorted  by  the  availability  (or  not)  and  the  generosity  of  rules  that  allow  notional 
deductions  for  the  cost  of  equity  capital.  In  a  baseline  scenario,  the  distortions  and 
misallocations  of  investment  in  the  single  market  as  outlined  earlier  in  this  assessment 
will persist alongside the other factors that impact or influence financing decisions, such 
as avoiding the dilution of control/voting rights of existing equity owners, limited access 
to equity financing, or debt financing being cheaper than equity financing.  

In  the  absence  of  an  EU-wide  initiative  to  tackle  the  tax  induced  debt-equity  bias,  it  is 
likely that compliance costs and the fragmentation of the legal framework in place will 
persist  or  could  even  increase.  As  detailed  in  Chapters  2  and  3,  maintaining  diverse 
national measures against the tax induced debt-equity bias across the Union is likely to 
compromise the effectiveness and efficiency of these rules even at national level. Given 
the  close  integration  of  European  economies  and  the  fact  that  corporate  groups  usually 
operate  across  several  Member  States,  compliance  costs  for  groups  faced  with  several 
different  national  measures  to  mitigate  the  bias  are  higher  compared  to  a  situation  in 
which  an  EU-wide  measure  were  to  be  in  place.  Concerning  SMEs  specifically,  these 
specific types of businesses can benefit from national measures only if they are located in 
one of the Member States that have debt bias mitigating measures in place. SMEs located 
in  Member  States  that  do  not  have  any  tax  debt-bias  mitigating  measure  face  a  higher 
cost for their equity financing in comparison to other SMEs in the EU. This can act as a 
barrier  for  such  SMEs,  preventing  them  from  scaling  up  or  making  riskier  investments 
that  would  support  their  growth  and  stability,  reducing  the  competitiveness  of  the 
European economy as a whole35.  

At this  stage, the EU Code of Conduct  for business  taxation is the sole instrument that 
provides for a harmonised framework against abuse of Member States’ notional interest 
deduction schemes. In 2019, the Code of Conduct issued “Guidance on the assessment of 
NID Regimes”36. This Guidance mentions a number of limitations to the scope and anti-
tax abuse measures that should be in place in order to prevent tax planning and address 
abusive  situations  when  applying  notional  interest  deduction  regimes.  However,  the 
Code,  as  a  soft  law  instrument,  which  relies  on  a  political  commitment  by  Member 

35 On the general financing problems for companies when scaling up see e.g. Aernoudt (2017). 
36 WK 11093/2019 REV 1, Brussels 17 October 2019 

26 

 
 
                                                           
States,  does  not  provide  for  a  fully  harmonised  anti-tax  abuse  framework  for  national 
measures.  The Code’s conclusions  have not  led to  a similar approach to  addressing the 
debt-equity  bias  in  those  Member  States  who  have  implemented  measures  at  national 
level.   

A  binding  measure  at  EU  level  would  tackle  the  specific  issues  at  stake  in  a  more 
efficient and effective manner than the current mix of purely national measures and soft 
law.  This  is  even  more  important  in  the  current  context  of  ecological  and  digital 
transitions, which will require major equity investments to finance the new technologies 
and  innovation  needed.  This  legislative  action  at  the  EU  level  aims  at  addressing  the 
specific point of the tax debt equity bias; it will act in complementarity to other initiatives 
intended  to  support  diversification  of  funding,  longer-term  funding  options,  and 
incentivise equity. 

5.2. Policy Options 

The following policy options would be applied to all businesses in the EU.  

5.2.1.  Allowance for a notional interest on all corporate equity (Allowance for 

corporate equity (ACE) - Option 1) 

Option  1  provides  for  a  legislative  initiative  that  would  envisage  an  allowance  on  the 
stock of corporate  equity. Equity  is defined37 as  the sum  of  paid-up  capital,  the share 
premium accounts, revaluation reserve and reserves38 and profit or loss brought forward. 
The  value  of  the  allowance  is  determined  by  multiplying  the  allowance  base  with  the 
notional interest rate. 

The allowance base of a taxpayer in a given tax year is defined by the difference between 
the stock of equity at the end of the tax year minus the tax value of its participation in the 
capital  of  associated  enterprises  and  the  value  of  its  own  shares.  Participations  and  the 
value of own shares are excluded from the allowance base in order to prevent cascading 
of  the  allowance  through  participations  (for  details  see  section  5.3.2  on  associated 
enterprises below). 

Since  the  allowance  is  granted  on  the  stock  of  corporate  equity,  the  duration  of  the 
allowance is implicitly unlimited. As long as the value of equity in a company is higher 
than the value of its participations, the company can request the allowance.39 

37 In the sense of Annex III to Directive 2013/34/EU of the European Parliament and of the Council on the 
annual financial statements, consolidated financial statements and related reports of certain types of 
undertakings. 
38 Reserves include: 1. Legal reserve, in so far as national law requires such a reserve; 2. Reserve for own 
shares, in so far as national law requires such a reserve, without prejudice to point (b) of Article 24 (1) of 
Directive 2012/30/EU; 3. Reserves provided for by the articles of association; 4. Other reserves, including 
the fair value reserve 
39 A sub-option with a restricted equity definition has also been analysed for this option. Please refer to 
Annex 5.3 for discussion and results. 

27 

 
                                                           
5.2.2.  Allowance  for  a  notional  interest  on  new  corporate  equity  (Allowance 

for new corporate equity (ANCE) - Option 2) 

Option  2  provides  for  a  legislative  initiative  that  would  envisage  a  notional  interest 
allowance  on  new  equity.  Equity  is  defined40  like  in  option  1  as  the  sum  of  paid-up 
capital, the share premium accounts, revaluation reserve and reserves41 and profit or loss 
brought forward. The value of the allowance is determined by multiplying the allowance 
base with the notional interest rate.. 

This  option  entails  an  incremental  allowance,  meaning  that  it  is  granted  on  the 
difference in the level of net equity at the end of the tax year compared to the level of net 
equity  at  the  end  of  the  previous  tax  year  multiplied  by  the  notional  interest  rate.  Net 
equity  is  defined  as  the  difference  between  the  equity  of  a  taxpayer  as  defined  in  the 
previous  paragraph  and  the  tax  value  of  its  participation  in  the  capital  of  associated 
enterprises  and its own shares. Participations and the value of own shares  are excluded 
from  the  allowance  base  in  order  to  prevent  cascading  of  the  allowance  through 
participations  (for  details  see  5.3.2.  on  associated  businesses  below).  In  case  of  a  net 
equity decrease, an amount equal to the allowance equity base decrease multiplied by the 
notional interest rate would become taxable. 

This allowance is granted for ten years in order to emulate the average maturity of debt 
and limit the fiscal cost. 

In  case  the  allowance  base  is  negative  in  a  given  tax  year,  an  amount  equal  to  the 
decrease in the allowance base multiplied by the notional interest rate becomes taxable. 
This  is  important  to  prevent  that  the  same  equity  is  repeatedly  re-introduced  into  a 
company to obtain repeated allowances. In addition, this option should be coupled with 
specific  anti-tax  abuse  rules  to  ensure  that  new  capital  can  only  benefit  once  from  the 
deductibility no re-categorisation of old equity as new equity. 

Since only increases in equity will qualify for an allowance, this option will create much 
stronger incentives for businesses to take up new equity compared to Option 1.42 

5.2.3.  Allowance  for  a  notional  interest  on  corporate  capital:  equity+debt 

(Allowance for corporate capital (ACC) - Option 3) 

Option  3  provides  for  a  legislative  initiative  that  would  envisage  a  new  allowance  for 
notional interest on corporate capital (i.e., equity, as per also Options 1 & 2) and debt, 

40 In the sense of Annex III to Directive 2013/34/EU of the European Parliament and of the Council on the 
annual financial statements, consolidated financial statements and related reports of certain types of 
undertakings. 
41 Reserves include: 1. Legal reserve, in so far as national law requires such a reserve; 2. Reserve for own 
shares, in so far as national law requires such a reserve, without prejudice to point (b) of Article 24 (1) of 
Directive 2012/30/EU; 3. Reserves provided for by the articles of association; 4. Other reserves, including 
the fair value reserve 
42 A sub-option with a restricted equity definition has also been analysed for this option. Please refer to 
Annex 5.3 for discussion and results. 

28 

 
                                                           
while  deductibility  of  actual  interest  payments  is  disallowed.  The  value  of  the 
allowance is determined by multiplying the allowance base with the notional interest rate. 

The allowance base in this case is defined as the total amount of debt and equity (debt + 
paid-up capital + share premium account + reserves + profit or loss brought forward). In 
this option, the notional interest rate for equity and debt is identical by construction. The 
cost of equity and the cost of debt are thus perfectly equated. 

This options is being evaluated for its ability to perfectly eliminate the debt-equity bias. 
The  fiscal  implications  of  the  measure  will  depend  on  the  level  of the  notional  interest 
rate chosen. Businesses will receive a notional allowance for equity and debt alike. They 
would  thus  generally  profit  from  the  measure  since  it  would  reduce  effective  tax  rates. 
Only  for  companies  with  very  high  interest  payments  or  if  the  notional  interest  rate  is 
very low, could the loss of deducibility of interest payments outweigh the positive effect 
of  obtaining  an  allowance  for  equity.  Since  the  allowance  is  based  on  the  full  stock  of 
capital, the duration is implicitly unlimited.  

5.2.4.  Non-deductibility of interest payments (NDI - Option 4) 

Policy Option 4 provides for a legislative initiative that would completely disallow the 
deductibility of interest expenses. This fully aligns the tax treatment of debt and equity 
costs by making both non-deductible.  

Debt already existing by the time the measure is announced would be grandfathered for 
its full maturity  in  order to  mitigate immediate impacts on businesses.  Long term  debt, 
which will be signed after approval of the measure but before implementation, would be 
grandfathered  for  a  duration  of  ten  years.  This  limited  grandfathering  would  limit  the 
incentive to roll-over existing debt just for the sake of being grandfathered. Under option 
4 as under all other options, the adoption of the DEBRA directive would be accompanied 
by the abolition of existing national schemes providing an allowance on equity. 

5.2.5.  Combination of equity and debt related measures (Option 5) 

Option  5  provides  for  a  legislative  initiative  that  would  combine  an  allowance  for 
notional interest on new corporate equity (same as proposed under Option 2) with a 
partial limitation of tax deductibility. The combination of an equity allowance with a 
partial interest limitation rule would tackle the debt-equity bias simultaneously from the 
debt and equity side. At the same time, the limitation of interest deductibility would help 
finance the allowance for equity. As per Options 1, 2 and 3, equity is defined as the sum 
of  paid-up  capital,  the  share  premium  accounts,  revaluation  reserve  and  reserves43  and 
profit or loss brought forward. The allowance would also be incremental – i.e., granted 
on  a  base  equal  to  the  difference  in  the  level  of  net  equity  at  the  end  of  the  tax  year 

43 Reserves include: 1. Legal reserve, in so far as national law requires such a reserve; 2. Reserve for own 
shares, in so far as national law requires such a reserve, without prejudice to point (b) of Article 24 (1) of 
Directive 2012/30/EU; 3. Reserves provided for by the articles of association; 4. Other reserves, including 
the fair value reserve 

29 

 
                                                           
compared  to  the  level  of  net  equity  at  the  end  of  the  previous  tax  year  (new  corporate 
equity).  In  the  same  vein,  and  as  per  Option  2,  net  equity  is  defined  as  the  difference 
between the equity of a taxpayer (paid-up capital + share premium account + reserves + 
profit  or  loss  brought  forward)  and  the  tax  value  of  its  participation  in  the  capital  of 
associated enterprises and its own shares. The allowance could be granted for 10 years in 
order to emulate the average maturity of debt.  

The partial limitation of tax deductibility of interest expenses could be implemented by 
simply reducing interest deductibility by a given proportion of x% for all companies. The 
parameter x would need to be further defined. Such a proportional interest limitation in 
the  context  of  DEBRA  would  also  need  to  define  the  interaction  with  existing  interest 
limitation rules (ILRs), specifically the ILR contained in the  EU’s Anti  Tax Avoidance 
Directive  1  (ATAD  1).  The  ATAD  1  ILR  states  that  net  interest  expenses  can  only  be 
deducted up to a value of 30% of the company’s EBITDA with a safe haven of EUR 3 
million (as minimum requirement)44.   

It  could  be  decided  to  keep  ATAD  1  and  DEBRA  ILRs  mutually  exclusive,  with  the 
more stringent ILR being applied. This would imply that companies affected by ATAD 1 
ILR,  would  fall  under  ATAD  1  ILR  while  all  other  companies  would  fall  under  the 
proportional DEBRA ILR. At first sight such an approach seems even-handed, since each 
company would be  captured under the more stringent  ILR. The ATAD  1  ILR however 
allows  in  several  Member  States  the  carry  forward  of  non-deductible  excess  interest 
expenses so that eventually all interest expenses can potentially be deducted, albeit at a 
later point in time. In contrast, the DEBRA ILR would not allow for any carry forward of 
non-deductible interest expenses. Companies being captured under ATAD 1 would thus 
be  treated  preferentially  compared  to  all  other  companies  for  which  the  DEBRA  ILR 
would apply. As a consequence the interaction between DEBRA ILR and ATAD 1 ILR 
might thus be preferably designed in a sequential way. Under such sequential treatment, 
all  companies  would  first  apply  the  proportional  DEBRA  ILR.  In  a  second  step  the 
ATAD 1 ILR would be applied. Relevant net interest expenses to be capped at 30% of 
EBITDA or the safe harbour of EUR 3 million would only bel those net interest expenses 
which have not been already limited by the DEBRA ILR. (In the case where the DEBRA 
ILR is 20% so that 80% of net interest expenses are deductible and the company has net 
interest  expense  of  EUR  500000,  EUR  100000  of  net  interest  expenses  would  not  be 
deductible  under  DEBRA  ILR.  The  remaining  EUR  400000  would  now  be  applied  to 
ATAD 1  ILR. Since there is  a safe harbour of EUR 3 million  or at  least 1 million,  the 
company would not further fall under ATAD 1 ILR).  

Table 2 provides an overview over the five different policy options. 

44 See Annex 7.2 on the specific implementation of ATAD 1 ILR across Member States.  

30 

 
 
 
                                                           
Table 2. Overview of policy options 
Policy 
options 

Approach 

Allowance base and equity 
definition 

Option 1  Notional interest 

deduction; no 
specific action 
on the debt side.  

Option 2  Notional interest 

deduction; ; no 
specific action 
on the debt side.  

Option 3  Notional interest 

deduction;  
Current 
deduction on 
debt related 
interest is 
disallowed. But 
debt is included 
in the base for 
the notional 
allowance. 

Option 4  No deduction of 

interest 
payments. 
Measure focuses 
on the debt side 
only. 
Option 5  Notional interest 

deduction for 
equity plus 
partial limitation 
of interest 
deductibility  

All equity, net of participations and 
value of own shares;  
Equity definition comprises paid-up 
capital, the share premium accounts, 
revaluation reserve and reserves and 
profit or loss brought forward.  
New equity, i.e. year on year increase 
in equity, net of year on year increase 
in participations and own stocks; 
Equity definition comprises paid-up 
capital, the share premium accounts, 
revaluation reserve and reserves and 
profit or loss brought forward.   
All corporate capital, i.e. equity 
(paid-up capital, the share premium 
accounts, revaluation reserve and 
reserves and profit or loss brought 
forward) and debt, net of 
participations and value of own shares.  

Other design 
elements 

Notional interest 
rate, definition of 
associated 
enterprises, anti-
abuse framework 

Notional interest 
rate, definition of 
associated 
enterprises, anti-
abuse framework 

Notional interest 
rate, definition of 
associated 
enterprises, anti-
abuse framework 

Deduction of interests paid on debt is 
fully disallowed.  
No allowance of any kind is granted. 

n.a. 

New equity (as under Option 2), i.e. 
year on year increase in equity, net of 
year on year increase in participations 
and own stocks; 
Equity definition (as under Option 2) 
comprises paid-up capital, the share 
premium accounts, revaluation reserve 
and reserves and profit or loss brought 
forward. 
Introduce limitation of interest paid on 
debt (e.g. proportional limitation rule). 

Notional interest 
rate, definition of 
associated 
enterprises, anti-
abuse framework, 
interest limitation 
rule 

31 

 
 
 
 
 
 
 
5.3. Common elements  

This section discusses the notional interest rate, associated enterprises and the anti-abuse 
framework.  These  are  elements  common  to  all  policy  options  that  allow  a  notional 
interest deduction (options 1, 2, 3, 5). 

5.3.1. The notional interest rate 

The choice of the notional interest rate (NIR) is an important parameter, relevant for all 
options granting an allowance for equity (i.e. options 1, 2, 3, 5). The notional interest rate 
is one of the determinants of the value of the allowance and thus affects the cost of equity 
as well as the reduction of taxable income.   

In the construction of a notional interest rate, there is a trade-off between simplicity and 
exactness.  Three  approaches  can  be  envisaged:  (1)  One  single  NIR  could  be  applied 
across the EU. (2) There could be a currency specific NIR for each currency in the EU, or 
(3)  there  could  be  a  specific  NIR  for  each  Member  State.  One  unique  notional  interest 
rate  for  the  EU  would  be  simple  to  apply  and  would  provide  for  a  high  degree  of 
harmonisation  across  Member  States.  A  single  EU-wide  rate  however  would  disregard 
differences  in  financing  conditions,  amongst  others  currency  risks,  between  Member 
States leading to  possible distortions  which could  result in  (dis)advantages for Member 
States  not  in  the  Euro-area.  The  opposite  case  of  a  unique  EU-wide  NIR  would  be  a 
country  specific  NIR  which  would  reflect  the  specific  average  financing  conditions  in 
each Member State. Such an approach however creates complexity due to a large number 
of NIRs.  The risk-free rate strongly depends on the currency, because of characteristics 
like  inflation  and  central  bank  policy.  A  currency  specific  notional  interest  rate  is  the 
intermediate approach between the two extremes, accounting for currency risks and some 
country specificities while limiting the number of different NIRs.  

In  general,  the  notional  interest  rate  (NIR)  could  be  determined  with  reference  to  an 
interest rate for risk-free investments (risk free interest rate, RFR) adding a risk premium 
(x) to take into account the fact that private borrowers usually face higher interest rates 
than risk free borrowers.  

NIR = RFR + x   

(RFR is the risk free interest rate, x the risk premium) 

The reference to the risk free rate will capture changing market conditions.  

The  European  Insurance  and  Occupation  Pensions  Authority  (EIOPA)  regularly 
publishes  risk  free  interest  rate  schedules  for  a  wide  range  of  maturities.  A  transparent 
and peer-reviewed methodology45 for determining the risk free rates has been determined 
and  serves  as  basis  for  implementation  of  EU  legislation  (Solvency  II).  The  applied 
method results in risk free rates for each currency. Such an approach would thus have the 
additional benefit of assuring consistency across EU legislation. 

45 See https://www.eiopa.europa.eu/sites/default/files/risk_free_interest_rate/12092019-
technical_documentation.pdf 

32 

 
 
                                                           
The currency specific EIOPA 10-year risk-free-rate46 published in December could thus 
be used as the reference risk-free rate for the following tax year.  

The risk premium could be determined in different ways.  

a)  A  fixed  risk  premium,  following  the  example  of  existing  measures  for  an  equity 

allowance. 

b)  A risk premium conditioned on available market rates. The credit risk premium is the 
compensation  that  investors  ask  for  investing  into  risky  debt  instruments.  It  can  be 
assessed  as  a  spread  between  yields  on  risky  debt  instruments  and  risk  free  bonds. 
The risk premium would be determined as difference between the market rate and the 
risk-free rate:  x = MR – RFR where MR is the yield on risky debt instruments. The 
notional interest rate would be determined as follows: 

      NIR = RFR + x  

  NIR = RFR + MR – RFR 

  NIR = MR 

Accordingly, a market index reflecting the overall corporate market could be directly 
used to obtain the yields of risky debt instruments and thus to determine the notional 
interest rate. Different relevant indexes would have to be considered. 

A  fixed  risk  premium  provides  simplicity,  clarity  and  predictability.  In  contrast, 
conditioning  the  risk  premium  to  market  rates  might  result  in  “dramatic  variation  over 
time”  and  “co-movement  with  macroeconomic  indicators,  even  after  controlling  for 
expecting  default  losses”  (Berndt  et  al.,  2018).  The  use  of  market  indices  as  reference 
rate would further have the issue that most available market indices are proprietary and 
not  freely  available47.  They  are  created  and  could  be  modified  or  discontinued  by 
financial service institutions, which themselves could benefit from DEBRA.  In order to 
assure tax certainty for taxpayers and to mitigate the volatility of the reference rate, the 
notional interest rate should be linked to a value of the reference rate in the past. 

Given  the  above-mentioned  considerations  and  issues,  it  is  proposed  to  determine  the 
Notional  Interest  rate  (NIR)  of  the  allowance  under  DEBRA  by  taking  the  currency 
specific EIOPA risk free rate as the reference and adding a fixed risk premium. Based on 
European Commission empirical analysis, taking into account credit and equity costs, the 
rsik premium could take alternative values between 0% and 6%. Higher values of the risk 
premium  generally  imply  a  stronger  reduction  of  equity  costs  for  companies  but  also 
higher fiscal costs for Member States. There is generally no analytical solution to balance 
this trade-off so that the decision for the appropriate risk premium needs to be based on a 
value judgment taking into account the broader context. 

46 See https://www.eiopa.europa.eu/tools-and-data/risk-free-interest-rate-term-structures_en. 
47 See e.g. Gilchrist and Mojon (2018), https://publications.banque-france.fr/en/economic-and-financial-
publications-working-papers/credit-risk-euro-area 

33 

 
                                                           
5.3.2 Associated enterprises 

Cascading an allowance on equity through participations is a well-known way of abusing 
equity  allowance  measures.  In  this  type  of  scheme,  a  first  amount  of  genuine  equity 
injection  is  transferred  to  other  related  businesses  through  participations,  in  order  to 
easily multiply the allowance deduction. The number of cascades is virtually unlimited. 
To prevent cascading the allowance through participations, the participation in associated 
enterprises will be deducted from the allowance base in the options where this is relevant 
(options 1, 2, 3, 5). Associated enterprises are defined using a 25% control threshold as 
under the DAC 6 definition48. 

5.3.3. Anti-Tax Abuse Framework 

The measure will encompass an anti-tax abuse framework. A set of Specific Anti Abuse 
Rules  (SAARs)  –  inspired  from  the  Guidance  on  notional  interest  deduction  regimes 
adopted  in  2019  by  the  Code  of  Conduct  (Business  Taxation)  –  will  address  the  well-
known avoidance schemes using this type of measure (e.g. cascading within a group by 
means  of  loans,  acquisition  of  businesses  held  by  associated  enterprises,  etc.).  A  set  of 
potential anti avoidance rules are presented in Annex 8. 

5.3.4. Interest limitation rules included in ATAD 1 

Under options 1, 2 and 3, the current ATAD rules would stay in place. Under Option 4, 
the  deductibility  of  interest  payments  would  be  completely  disallowed;  the  interest 
limitation rule of ATAD 1 would thus become obsolete. Option 5 combines an allowance 
for  equity  with  a  partial  restriction  of  interest  deductibility.  ATAD  1  rules  would  still 
remain  in  place.  The  measure  however  has  to  define  the  interaction  between  ATAD  1 
ILR  and  DEBRA  ILR.  The  rules  could  be  applied  mutually  exclusive  or  sequentially. 
Under exclusive treatment, the more stringent rule would apply, while under sequential 
treatment  the  proportional  DEBRA  ILR  would  first  be  applied  to  all  companies,  with 
ATAD 1 ILR then being applied to the remaining net interest expenses.  

5.3.5. Exclusion of the financial sector 

The measure will apply to all sectors except Financial Corporations. The reason for this 
is  that  an  equity  allowance  and  an  interest  limitation  have  very  different  impacts  on 
Financial  Companies  (FCs)  and  Non-Financial  Companies  (NFCs).  FCs  usually  have 
more  interest  received  than  interest  paid.  Therefore,  the  interest  limitation  would  not 
apply  for  them  since  the  basis  (interest  paid-interest  received)  would  be  negative.  This 
means that NFCs would finance the allowance on equity of the FCs. Moreover, FCs are 
subject  to  regulation  on  their  capitalisation,  which  means  that  the  issue  of  under 
capitalisation is addressed in another way. 

The possibility of limiting the allowance to companies active in certain sectors was 
explored within the Commission. One option would have been to base the choice on 

48 Council Directive (EU) 2018/822 of 25 May 2018 

34 

 
                                                           
sectors on the EU’s Taxonomy Regulation, as this has already engendered much debate 
and is based on a prevailing agreement with Member States. The outcome of this 
reflexion was that firstly, the DEBRA would have become extremely complex if not 
impossible to implement in practice. Companies would have to be individually checked 
(against the taxonomy) in order to be granted the allowance, introducing a potentially 
enormous burden on tax administrations. The changing nature of what could potentially 
constitute ‘eligible sectors’ at any given time could have also meant discrepancies in the 
treatment of companies in the same sector over time. Second, the objective of the 
DEBRA is to address the debt-equity bias in the EU, and not only in certain sectors. This 
possibility was therefore discarded and not considered as a viable design element of a 
possible allowance on equity. 

5.4. Increased allowance for SMEs 

SMEs  often  face  a  higher  burden  to  obtain  financing.  Especially  young  and  innovative 
companies need equity financing due to their specific risk structure. The measure could 
thus grant a higher notional interest rate for SMEs to meet SMEs higher financing costs 
and equity demand. Such a rate top-up can be applied in all cases outlined under policy 
options 1, 2, 3 and the allowance element of Option 5. The measures proposed in these 
policy options would apply in exactly the same way to all businesses, irrespective of their 
size  or  sector;  it  is  only  the  notional  interest  rate  applied  as  part  of  the  allowance  that 
would be higher for SMEs. SMEs would be defined as per Article 3 of the Accounting 
Directive49. In addition it would be required that for a company to be considered a SME, 
it must not be part of a group of businesses which, at consolidated level, exceeds at least 
two of the three limits50 under the Accounting Directive. 

The  application  of  an  increased  notional  interest  rate  for  SMEs  would  have  to  be 
implemented in all Member States. There should be no discretion on the part of Member 
States as to whether to apply a higher rate for SMEs or what rate to apply as the top-up 
for  SMEs  in  order  to  avoid  selectivity  concerns  as  regards  EU  State  Aids  rules  and  to 
ensure a level playing field for SMEs in the EU regardless of their place of residence. 

5.5. Treatment of loss-making companies and option for benefit carry-forward 

Loss  making  companies  do  not  pay  corporate  income  taxes.  They  can  thus  not  profit 
from an allowance on equity. Similarly, the reduction of interest deduction as proposed in 
option 4 and 5 would not hurt a loss-making company, since there is not taxable income 
from which to deduct. In order to assure that companies can profit from the full ten years 
of equity allowance, it could be considered to grant a carry-forward for the allowance so 
that companies can carry forward the unused allowance through loss-making years. Such 
a  benefit  carry  forward  could  be  applied  for  a  specific  number  of  tax  years  or  ad 
infinitum.   

49 Directive 2013/34/EU of the European Parliament and of the Council of 26 June 2013. 
50 Average number of employees in the fiscal year of 250; net turnover of EUR 40 million; balance sheet 
total of EUR 20 million. 

35 

 
                                                           
In case of losses, the loss of year t will appear in retained earnings of year t+1 which will 
negatively affect the base of the allowance leading to a taxable allowance. However, this 
allowance  will  only  actually  be  taxed  when  the  company  is  making  profits  again  and 
after all the losses brought forward from previous exercises have been offset by profits. 

A provision could be included in the legal draft stating that the taxable allowance shall 
not apply if the taxpayer provides sufficient evidence that the negative allowance base is 
due to losses and does not come from the distribution of profits used to benefit a second 
time from the deduction of the allowance on equity without a genuine increase of equity. 

5.6. Grandfathering of existing allowances for equity 

There  are  currently  six  Member  States  that  have  an  allowance  for  equity  in  place.  In 
order  to  mitigate  the  negative  effects  on  businesses  of  a  sudden  change  in  the  equity 
allowance  regime  in  place  in  these  countries,  the  DEBRA  would  allow  for  a 
grandfathering  for  those  companies  that  have  already  benefitted  from  an  equity 
allowance  under  the  regimes  in  place  at  the  time  that  the  EU  Directive’s  comes  into 
force. 

5.7. Options discarded at an early stage 

This impact assessment considers all possible means of addressing the debt-equity bias, 
and  various  designs  in  some  cases,  among  the  policy  options  for  consideration  and 
analysis.  

The only option that was discarded ex-ante is the option of a soft-law approach. Previous 
experience with recommendations in the direct taxation field have demonstrated that such 
soft law does not lead to a harmonised approach being taken across Member States  

Given the sensitivities around the field of taxation, a general recommendation to address 
the debt-equity bias would most likely not ensure a common set of anti-abuse rules, nor a 
homogeneous  treatment  of  the  key  building  blocks  of  such  an  initiative  (base  of  the 
allowance,  notional  interest  rate,  number  of  years  the  allowance  is  granted,  possible 
carves-out). Even if all Member States were incentivised to take action, a differentiated 
approach  on  critical  design  elements  would 
to  even  more 
fragmentation of the single market.  

instead  contribute 

The  Code  of  Conduct  Group  (“the  Code”)  already  considered  and  assessed  notional 
interest deduction regimes and published Guidance on the issue in 2019. This guidance 
provides  views  on  a  preferred  approach  in  relation  to  a  number  of  critical  questions 
regarding  the  anti-abuse  framework  and  presents  a  non-exhaustive  list  of  elements  and 
characteristics which indicate that a Notional Interest Deduction Regime may be harmful 
when assessed against the criteria of the Code of Conduct.   

Despite  the  existence  of  these  assessments  and  Guidance  issued  at  EU  level,  the  six 
national  measures  currently  in  force  across  the  EU  differ  significantly  and  segment  the 
common  market.  In  particular,  the  Guidance  did  not  lead  to  a  general  adoption  by 

36 

 
Member  States  of  a  harmonised  anti-abuse  framework  for  NIDs.  The  Code  guidance 
focusses on ways to avoid that notional interest deduction (NID) regimes are abused and 
prescribes  that  NID  regimes  should  have  certain  limitations  in  scope  and  be  properly 
constrained  by  appropriate  anti-abuse  measures  to  make  them  less  vulnerable  to 
aggressive tax planning. The objective of fighting tax avoidance is generally shared and 
well  supported  by  Member  States;  but  even  on  such  non-controversial  and  limited 
aspects  of  design,  the  guidance  of  the  Code  did  not  manage  to  lead  to  a  holistic  or 
common approach by Member States. 

This lack of action following on soft-law guidance, or the divergence in approach where 
action was taken, is precisely why the Commission has not considered another soft law 
measure among the current policy options. Such approach was considered but discarded 
in view of the fact that it did not provide sufficient impetus for a harmonised approach to 
address the challenge at hand. 

It  was,  therefore,  considered  more  appropriate  to  take  a  more  stable  and  harmonised 
approach to the tax debt equity bias at EU level. 

6.  WHAT ARE THE IMPACTS OF THE POLICY OPTIONS? 

This  section  examines  the  different  options  to  address  the  debt-equity  bias  in  terms  of 
effectiveness and efficiency. As discussed in Section 5, the available options are: 

•  An allowance for all corporate equity (ACE) (Option 1), 
•  An allowance for new corporate equity (ANCE) (Option 2),  
•  An allowance for corporate capital (ACC) (Option 3), 
•  Non-deductibility of interest payments (NDI) (Option 4), 
•  An  allowance  for  new  equity  coupled  with  a  reduction  of  interest  deductibility 

(Option 5)  

Several methods are used to analyse the impacts of the different policy options, namely 
desk  research,  stakeholder  feedback  through  a  public  consultation  and  individual 
meetings, discussions with Member State, own calculations, and the use of the CORTAX 
computable  general  equilibrium  (CGE)  model,  provided  by  the  JRC,  to  assess 
macroeconomic impacts. The options are not expected to have environmental impacts. 

6.1. Data limitations and methodological short-comings 

The observable quantity, which should be impacted by the debt-equity bias, is the debt-
equity  ratio.  In  most  EU  Member  States  the  debt-equity  ratio  was  exceptionally  high 
around  the  time  of  the  great  recession  (ca.  2007-2010)  and  has  gone  down  since.  This 
might, to some extent, be driven by a reduction of CIT rates, lower interest rates, newly 
introduced thin capitalisation rules (debt-equity ratio rules and interest limitation rules), 
and other regulations aimed at increasing equity of companies after the financial crisis.  

It is very difficult to exactly assess or identify how important the debt-equity bias is for 
debt-equity  ratios,  compared  to  other  factors  (international  investment  climate,  stock 

37 

 
market  performance,  business  cycle,  interest  rates,  inflation  etc.).  These  elements  of 
finance  and  economy  are  intertwined.  The  studies  discussed  in  Chapter  2  have 
established  an  empirical  link  between  tax  rates  and  levels  of  debt-leverage,  this  is 
however not enough to determine the importance of the debt-equity bias. 

The analysis of DEBRA is supported by the CORTAX general equilibrium model run by 
the Joint Research Centre (JRC). In addition, two sources of data have been used to try to 
understand  further  empirical  aspects  of  DEBRA:  national  financial  account  data  and 
ORBIS company-level data.  

CORTAX is a highly stylized general equilibrium model which will be further discussed 
in  the  next  section.  Economic  modelling  approaches  like  CORTAX  mostly  rely  on 
standard  assumptions  of  neoclassical  economics  with  perfect  markets  and  complete 
information. As a consequence there will always be a market clearing price for debt and 
equity which implies that no agents will be restricted in their choices. In reality we know 
that there are companies which are restricted in  their financing  choices  because  neither 
equity nor debt can be accessed. 

While such assumptions are unproblematic when comparing different policy options and 
understanding their impact on the economy, they become relevant when exact predictions 
about  specific  policy  choices  are  required.  In  other  words,  CORTAX  is  very  useful  to 
compare  different  policy  options.  It  is  however  problematic  to  rely  too  heavily  on  the 
point estimates of CORTAX. In order to identify and overcome potential short-comings 
of the modelling approach and to complement the analysis, two alternative data sources 
are used: macro-data from national financial accounts and company level data from the 
ORBIS  data-set.  There  are  a  number  of  problems  also  related  to  these  data,  which 
prevent a complete analysis of all policy design aspects of the policy options.  

National financial accounts (NFAs) are an element of national accounting. NFAs contain 
aggregate  information  on  equity,  interest  paid  and  interest  received  per  sector  of  the 
economy. For the analysis of DEBRA there are however a few challenges. The category 
of equity in NFAs contains a few elements that would likely not qualify as equity under 
DERBA.  In  addition,  equity  is  reported  as  the  market  value  of  traded  and  non-traded 
shares.  The  market  value  of  shares  might  differ  considerably  from  the  book  value  of 
equity,  which  is  the  relevant  base  for  the  equity  allowance.  For  interest  payments,  the 
aggregation  means  that  relevant  interest  payments  might  be  averaged  out,  whereas  the 
interest limitation of option 4 or 5 would be applied to net interest payments, i.e. interest 
paid minus interest received. In the dataset, gross interest payments are about four times 
larger than net-interest payments.  

ORBIS  provides  company  level  data.  A  major  problem  of  ORBIS  is,  sample  bias  and 
incompleteness. ORBIS can consequently not be used to  calculate absolute values (like 
the equity allowance costs in billion EUR) since only a fraction of companies is covered 
and the coverage differs across Member States. However, ORBIS can be used to analyse 
ratios,  such  as  what  share  of  benefits  of  an  equity  allowance  on  the  company  level  are 

38 

 
balanced  out  by  a  loss  in  interest  deductibility.  Another  data-limitation  with  ORBIS  is 
that it does not have information about interest received but only about interest paid.  

While CORTAX accounts for the behavioural adaptation of agents to  changing relative 
prices, all estimates derived from ORBIS or national financial accounts are static, i.e. no 
growth effects can be considered.  

6.2. The modelling approach with CORTAX 

CORTAX  is  a  highly  stylized  computable  general  equilibrium  model,  designed  to 
evaluate  the  effects  of  corporate  tax  reforms  in  the  27  EU  Member  States.  The  model 
assumes optimal behaviour of all agents and each country is assumed to have the same 
structure  in  terms  of  consumption,  savings,  production  and  public  finances  (though  the 
data are country-specific). Countries are linked via international trade in goods markets, 
intermediate  goods  markets  and  investment  by  multinationals.  The  model  also  includes 
the  EU’s  main  trading  partners.  Results  are  provided  at  the  country  level  reporting 
changes in tax rates, tax revenues, investment, employment, wages and GDP. CORTAX 
is a single sector model excluding the possibility of sectorial analysis. There is no time in 
the  model  and  changes  have  to  be  interpreted  as  change  between  the  old  equilibrium 
pathway and the new equilibrium pathway. 

The estimations  with  CORTAX are performed  with  two different  approaches.  The  first 
approach is a compensated approach where changes in the effective tax rates due to the 
policy  are  compensated  with  commensurate  changes  in  statutory  corporate  income  tax 
rates  so  as  to  assure  revenue  neutrality.  The  second  approach  is  an  uncompensated 
approach where statutory tax rates remain unchanged. On top of the structural effects of 
the  measure  driving  the  results  in  the  compensated  approach,  the  uncompensated 
approach thus also accounts for budgetary implications.    

While  policy  option  4  has  no  parameters,  all  other  policy  options  could  assume 
alternative parameter values for the risk premium (and thus the notional interest rate) and 
in  the  case  of  option  5  for  the  level  of  interest  limitation.  In  order  to  compare  the 
structural  characteristics  of  the  policy  options  it  is  assume  that  the  policy  options 
entailing  an  allowance for  equity would have  a  notional  interest  rate (NIR) of 2.2% on 
average,  applied  for  all  types  of  businesses.  When  considering  policy  options  with  an 
SME  top-up,  the  NIR  is  2.5%  on  average.  These  values  are  derived  from  the  ECB’s 
Survey  on  the  access  to  finance  of  enterprises  (SAFE).  Separate  analysis  have  been 
conducted for member state specific NIRs and an EU wide NIR. The intermittent case of 
currency  specific  NIRs  provides  results  strictly  in  between  those  two  extreme  cases. 
Ceteris paribus the Member State specific NIRs indicate on average lower impacts than a 
currency specific or EU-wide NIRs. In order to simplify the presentation and to provide a 
conservative  lower-bound  estimate  for  effects,  the  analysis  of  Chapter  6  is  based  on 
Member State specific NIRs. Annex 5.1. provides further details.  

The  risk  free  rate  at  the  time  of  analysis  was  about  0.2%,  implying  an  assumed  risk 
premium  for  the  analysis  of  2%.  The  complexity  of  the  analysis  (with  at  least  eight 

39 

 
different calibrations required for each option51) makes it impossible to fully explore the 
parameter  space  for  alternative  values  of  the  risk  premium  or  NIR.  To  understand  the 
structural implications of the different options it is important to compare options with the 
same NIR. For the comparison of options any viable NIR could be used since the relative 
performance  of  the  options  would  not  change  when  the  NIR  (or  risk  premium)  is 
changed52. 

Option  5  proposes  an  allowance  for  equity  as  in  Option  2  in  combination  with  a 
proportional  limitation  of  interest  deduction  by  25%  in  order  to  mitigate  budgetary 
impacts. The level of interest limitation (25%) is chosen so as to assure fiscal neutrality 
of  option  5  on  average  in  the  dynamic  modelling  context  of  CORTAX.  ATAD  1  also 
includes an interest limitation rule (ILR) which provides a minimal provision to limit the 
deductibility of net interest expenses to 30% of EBITDA with a safe harbour of EUR 3 
million53.  While  there  are  issues  of  data  availability,  which  make  it  very  difficult  to 
perform  a  detailed  analysis  of  ILRs,  some  preliminary  analysis  suggest  that  very  few 
companies  are  captured  under  the  ATAD  1  ILR.  Since  the  companies  currently  falling 
under  ATAD  1  are  already  restricted  in  their  deductibility,  these  companies  would  not 
provide  new  resources  to  compensate  for  the  equity  allowance,  when  falling  under  the 
proportional  ILR  of  option  5  instead.  Further  details  on  the  estimates  are  provided  in 
Annex  6.  CORTAX  does  not  explicitly  model  ATAD  1  ILRs.  Given  the  very  limited 
impact  on  the  revenue  generating  potential  of  a  proportional  ILR  under  option  5,  it  is 
however argued that this omission does not bias overall estimates.    

Loss-making  companies  are  not  paying  taxes  and  are  thus  not  affected  by  any  of  the 
options. CORTAX accounts for loss-making companies and includes the country-specific 
share of loss-making companies in its calibration. 

For  the  purpose  of  this  impact  assessment,  average  EU  values  of  the  estimates  will  be 
reported. CORTAX however is  calibrated at  the  country level  and estimates impacts  at 
the country level. There is considerable heterogeneity across Member States in terms of 
debt-equity  ratios  and  financing  conditions.  For  the  compensated  approach  the  model 
arrived  at  corner  solutions  for  some  policy  options  when  including  an  SME  top-up 
(Scenario  2)  in  some  countries.  In  that  situation  the  model  could  not  provide  results, 
because  there  was  no  valid  change  in  the  CIT  rate  which  could  compensate  for  the 
budgetary impact, i.e. the CIT rate required to compensate the tax revenue losses would 
have  been  larger  than  100%.  The  comparison  of  policy  options  for  Scenario  2  is  thus 
incomplete.  It  will  however  become  clear  in  the  following  that  CORTAX  provides  a 
consistent  ranking  of  policy  options  across  approaches  and  scenarios.  The  level  of  the 
point  estimates  changes  contingent  on  the  approach  (compensated/uncompensated)  and 
scenario (Scenario 1/Scenario 2), the resulting  ranking of policy options  however stays 

51 Calibrations for no-SME top-up / SME top-up, single EU NIR / MS specific NIR and compensated / 
uncompensated approach would be required resulting 2*2*2=8 calibrations.   
52 Note that option 4, which fully disallows interest deductibility does not depend on the NIR.    
53 The interest limitation rules currently in place in each Member State are summarized in Table A7.2 in 
Annex 7. Some empirical analysis is presented in Annex 6.1. 

40 

 
                                                           
the  same.  As  would  be  expected,  the  macroeconomic  impacts  on  investment, 
employment, wages and growth, reported by the model are smallest for the compensated 
approach without an SME top-up and highest for the uncompensated approach with a rate 
top-up  for  SMEs.  The  CORTAX  model  is  further  discussed  in  Annex  4.  Annex  5 
provides complementary results. 

6.3. Impacts on debt bias and financing decisions of firms 

A  multiplicity  of  factors  influence  a  company’s  capital  structure.  Firm  level  factors 
named in the literature are, e.g. the degree of specialization, the extent of R&D activity, 
firm  size,  firm  profitability,  firm  growth,  tax  shield  and  earning  volatility  (e.g.  Titman 
and  Wessels  (1988)  and  Marodi  and  Paulet  (2019)).  Time  and  firm  effects  seem  to 
explain the largest share of heterogeneity while sector and country effects play a smaller 
role (Kayo and Kimura 2011). Specific reasons for the choice of debt could be the desire 
to  increase  the  return  on  equity,  because  access  to  equity  financing  is  limited,  because 
debt financing is cheaper than equity financing (especially when interest rates are low), 
to diversify risk, to reduce tax liabilities, and to avoid the dilution of control/voting rights 
of existing equity holders (owners). However, such reasons do not diminish or negate the 
fact  that  a  differentiated  tax  treatment  of  equity  and  debt  exists,  and  that  this  has  an 
impact on companies’ financing choices. This tax-induced debt-equity bias is the focus of 
the  present  measure.  This  implies  that  other  reason  for  companies  to  choose  debt  over 
equity will remain unaffected after the measure is implemented, some degree of debt bias 
might  thus  exist  also  ex-post.  The  relative  importance  of  the  different  factors  is  not 
understood54.   

It  is  important  to  note  that  the  tax  debt-equity  bias  only  operates  through  taxes  on 
income. Loss-making companies have negative income and are thus not taxed. There is 
accordingly  no  tax  bias  present  for  loss-making  companies.  Especially  start-ups  and 
young and innovative companies tend to be loss-making. Due to their risk structure they 
need to rely on equity financing. As long as such companies are loss making, they cannot 
profit form the equity allowance, since no taxes are paid. Without the possibility to carry 
forward the allowance, the company  could  lose the equity allowance if it remains loss-
making  for  the  full  duration  the  allowance  is  granted.  If  instead  the  allowance  can  be 
carried forward, the company will always be entitled for the equity allowance for the full 
duration of the allowance.     

To  analyse  the  economic  impacts  of  the  debt-equity  bias,  the  cost  of  capital  concept  is 
used as an indicator to express the financing costs of a company for different sources of 
financing (the cost of capital concept is explained in detail in Annex 4). As long as the 
cost of capital for debt is lower than for equity, also due to differential tax treatment, a 

54 As discussed in Chapter 2, academic research has established a causal link between the CIT rate and 
changes in observed debt-equity ratios. Since however does not provide an indication how important the 
tax induced debt-equity bias is compared to other factors which might drive companies towards debt.   

41 

 
                                                           
debt  bias persists.  Only  in  the ideal  case where the  deductibility of debt  is  equal  to  the 
deductibility of equity would the tax system be neutral with regard to financing decision. 

A  study  by  ZEW  (2016a)  analyses  the  impact  of  various  tax  reforms  on  the  cost  of 
capital to address the debt-equity bias55. The reforms simulate revenue neutrality to avoid 
that  results  are  driven  by  changes  in  the  overall  tax  burden.  It  further  shows  that  both 
Option 1 (ACE) and Option 3 (ACC) mitigate the debt bias and strongly reduce the tax-
induced  distortions  of  financing  decisions  by  largely  equalising  the  cost  of  capital  of 
debt-financed and equity-financed investments. Option 4 also equalises the tax treatment 
of  debt  and  equity,  with  the  consequence  however  that  the  cost  of  capital  for  debt  and 
thus the effective tax rate for businesses increases. The increase in effective tax rates has 
in most situations a detrimental effect on investment activity. Option 2, an allowance for 
new equity is not analysed in this study. There are, however, the real world examples of 
Belgium,  Cyprus,  Italy,  Poland  and  Portugal,  which  have  implemented  an  ANCE-style 
measure as laid out in Option 2 and which have been recently analysed with the cost of 
capital  approach  (ZEW  2020)56.  The  cost  of  capital  calculations  for  given  notional 
interest rates have been depicted in Table 1 in Section 2. It becomes obvious that in most 
ANCE systems based on standard definitions of equity, the debt-equity bias gets smaller 
as  the  notional  interest  rate  approaches  the  nominal  interest  rate  prevalent  in  the 
economy. The study further shows that if those two rates are equal, the debt-equity bias 
could  be  fully  eliminated.  The  approach  to  the  notional  interest  rate  suggested  in  this 
impact assessment (Section 5) would mitigate the existing debt-equity bias to ensure that 
the tax system provides for a neutralisation of businesses’ financing options.  

The introduction of a notional allowance for equity in Belgium in 2006, and in  Italy in 
2011,  offer  the  possibility  to  assess  empirically  the  effect  of  such  allowances  on 
businesses’ debt leverage, since sufficient time has passed to collect, analyse and publish 
related data. The first Belgian systems, which resembled the ACE (Option 1) was based 
on  the  stock  of  equity  and  an  anti-avoidance  framework,  although  the  way  certain  tax 
planning  opportunities  were  addressed  was  considered  incomplete  (e.g.  Zangari,  2014). 
Since  2018,  only  incremental  changes  in  equity  are  the  basis  for  a  notional  interest 
deduction  in  Belgium  and  the  anti-abuse  framework  has  been  reinforced.  The  Italian 
system was based on incremental equity from the beginning and has a relatively complete 
anti-avoidance  framework.  It  thus  resembles  more  closely  Option  2  analysed  in  this 
impact assessment, i.e. an allowance for new corporate equity (ANCE).  

For Belgium, a number of studies find a reduction in debt leverage (i.e., the use of debt) 
of non-financial Belgian firms after the introduction of the ACE57. Schepens (2015) finds 

55 The concept of cost of capital is explained in Annex 4. 
56 The respective cases are discussed in ZEW (2020) Section B.8, B.9, B.11, B.12 and B.14. Malta also has 
introduce an allowance on equity, which however resembles more an ACE than and ANCE. An overview 
over existing tax allowances for equity is provided in Annex 6. Note that the equity definition in existing 
measures also includes profits and losses, contrary to Option 1 and 2. 
57 See for example Princen (2012), aus dem Moore (2014), Panier et al. (2015), Hebous and Ruf (2017) and 
De Mooji et al. (2018). 

42 

 
                                                           
similar effects for the financial sector. For Italy, Panteghini et al. (2012) find evidence of 
a significant decrease in the leverage of firms  following the introduction of the ANCE. 
This is confirmed by Branzoli and Caiumi (2020) which show that the reduction of debt 
leverage  from  an  incremental  ACE  would  be  more  pronounced  for  older  and  smaller 
businesses. In addition, the impact of the ANCE  would higher for more vulnerable and 
risky  firms.  Together  these  results  confirm  that  an  incremental  ACE  would  be  an 
effective  policy  tool  to  reduce  the  debt  leverage  ratios  of  European  enterprises.  As  no 
country has  yet  applied  any of the other options (options  3, 4, 5), there is  no empirical 
evidence on their effects available.  

The  simulations  with  CORTAX,  based  on  an  average  notional  interest  of  2.2%  and 
discussed  in  more  detail  below,  indicate  that  all  options  would  indeed  reduce  the  debt 
leverage  of  firms.  Table  3  reports  the  estimated  changes  in  the  share  of  debt-financed 
assets in the EU. The debt share in the model before implementing a policy is 46.4%.  All 
policy options result in a notable reduction in the debt share. The estimated reduction is 
2.3  to  3.2  percentage  points  in  the  case  of  the  ACE  (Option  1),  0.8  to  1.6  percentage 
points in the case of the ANCE (Option 2), 2.8 to 3.5 percentage points in the case of the 
ACC (Option 3) and up to 5.5 percentage points for  Option 4. With Option 5, the debt 
share would be reduced by 3.03 to 3.27 percentage points.  

Table 3. Change in EU average debt share (in percentage points) 
compensated 
-2.29 
-0.83 
-2.76 
-5.50 
-3.03 

ACE based on standard equity  
Option 1 
ANCE based on standard equity  
Option 2 
ACC 
Option 3 
NDI 
Option 4 
ANCE  + partial NDI 
Option 5 
Source: Joint Research Centre of the European Commission (2021).  
Note: Estimates are based on the assumption of equal treatment of all businesses (no SME top-up). 

uncompensated 
-3.23 
-1.55 
-3.48 
-5.49 
-3.27 

The  potential  of  options  1,  2  and  5  to  mitigate  the  debt-equity  bias,  is  driven  by  the 
choice of the notional interest rate. To fully mitigate the debt-equity bias, the NIR would 
need to equate cost of equity with the cost of debt. Since the cost of debt differs across 
companies, the NIR chosen will always be an approximation. For the choice of the NIR, 
other  constraints,  like  e.g.  fiscal  considerations  also  play  a  role.  This  relates  to  the 
discussion on the appropriate choice of the risk premium above. Option 3 will equate the 
tax  treatment  of  debt  and  equity  by  definition.  The  notional  interest  rate  will  however 
determine the extent to which the measure would actually limit the use of debt.    

Another important policy variable for the potential of an equity allowance to mitigate the 
debt-equity bias is the duration the allowance is granted. For Option 1 and 3, the duration 
is per definition unlimited, since the allowance is granted for all equity or all capital. For 
Option  2  and  5  however  the  duration  could  be  limited.  Generally,  a  longer  duration 
would increase the extent the debt-equity bias is mitigated.  

43 

 
 
 
6.4. Impacts on investment and growth 

In  order  to  separate  the  structural  impact  of  the  policy  options  from  their  budgetary 
impact,  policy  options  need  to  be  analysed  under  the  assumption  of  budget  neutrality. 
The model achieves CIT revenue neutrality by adapting CIT rates. It is important to keep 
in  mind that DEBRA does not  touch upon the question of CIT rates. The compensated 
approach, where CIT rates are appropriately adapted, just serves for analytical purposes.  

The macroeconomic impacts of the five potential policy options for Scenario 1 (where all 
businesses are treated equally),  are summarised in Table  4 below. Compensated results 
are  presented,  which  ensure  corporate  income  tax  revenue  neutrality  of  the  respective 
policy option by adjusting the CIT rate accordingly.58 The first variable CIT rate reports 
the  average  change  to  the  CIT  rates  that  has  been  implemented  to  achieve  revenue 
neutrality.  The  cost  of  capital  captures  the  change  in  percentage  points  of  total  cost  of 
capital, i.e. cost of capital for debt and cost of capital for equity.  Investment reports the 
change  in  total  capital  stock  as  a  percent  of  GDP.  The  share  of  debt-financed  assets  is 
reported in levels ex-post, i.e. after the implementation of the measure. Ex-ante the debt-
share is reported as 46.4%. Wages report the percentage change of the average wage rate. 
Employment reports the percentage change of total employment. GDP finally reports the 
impact on GDP.  

The  results  for  Scenario  1  indicate  that  an  ACC  (Option  3)  has  the  most  positive 
macroeconomic effects with investment increasing by 5.1% of GDP and GDP increasing 
by 1.8%. The ACE (Option 1) would result in investment increases of 4.9% of GDP and 
GDP growth of 1.7%. For the ANCE (Option 2), an investment increase of 1.4% of GDP 
and a rise in GDP of 0.47% are estimated. The combined approach of equity allowance 
and  limited  interest  deduction,  proposed  as  Option  5,  would  increase  investments  by 
0.26% of GDP and GDP by 0.018%. Policy option 4, of fully disallowing deductibility of 
interest  payments,  would  instead  reduce  investments  by  1.9%  of  GDP  and  result  in  a 
contraction of the economy by 0.79% of GDP.  

Table 4: Economy-wide impacts of budget-neutral debt bias reforms; Scenario 1 – equal 
treatment of all businesses; GDP-weighted EU-27 average 

(1) 
ACE  

(2) 
ANCE  

(3)  
ACC 

(4)  
NDI 

(5) 
ANCE 
+ partial 
NDI 

CIT rate (change in percentage points) 

6.013 

3.093 

5.728 

-7.168 

0.551 

Cost of capital (change in percentage 
points) 

-0.349 

-0.114 

-0.4 

0.127 

-0.042 

Investment (change in % of GDP) 

4.881 

1.4 

5.065 

-1.92 

0.261 

58 Note that tax revenue neutrality is an ex-ante characteristic. This means that CIT rates are adapted so that 
the tax revenue loss would be fully compensated, if no behavioural adaptation of economic agents would 
take place. Since both the policy option implemented and the CIT rate change induce behavioural changes, 
it is impossible to assure ex-post revenue neutrality. 

44 

 
 
 
 
 
 
                                                           
Share of debt-financed total assets (level, 
ex-post) 

44.12 

45.58 

43.65 

40.91 

43.39 

Wages (change in %) 

1.727 

0.465 

1.764 

-0.476 

0.153 

Employment (change in %) 

0.379 

0.07 

0.43 

-0.338 

-0.11 

GDP (change in %) 

1.727 

0.474 

1.795 

-0.789 

0.018 

Source: Joint Research Centre of the European Commission (2021). 

Ranking  the  policy  options  from  the  most  positive  to  most  negative  impacts  on 
investment and GDP, we obtain: (3) > (1) > (2) > (5) > (4). A similar ranking can also be 
observed  for  employment,  wages  or  the  cost  of  capital.  For  Option  3,  the  increase  in 
employment and wages  would be highest, with the largest reduction in costs of capital. 
On the other extreme, Option 4 would lead to the strongest decline in employment and 
wages, and increase the cost of capital59.  

If the assumption of budget neutrality is discarded and instead uncompensated results are 
analysed,  the  same  ranking  of  policy  options  can  be  observed,  albeit  at  a  higher  level. 
The  allowance  for  corporate  capital  (Option  3)  would  result  in  GDP  growth  of  2.4% 
while non-deductibility of interest (Option 4) would result in economic contraction of -
3.3%. The full set of results for this case is presented in Table A5.1 in Annex 5. 

Under  Scenario  2  with  a  risk-permium  top-up  for  SMEs,  the  risk  premium  for  SMEs 
would be 50% higher than for other businesses. As can be inferred from Table 5 below, 
the rate top-up for SMEs has additional growth  effects on investment, employment and 
GDP.  Since  under  Option  4  there  are  no  allowances,  a  rate  a  top-up  for  SMEs  is  not 
relevant  for  this  option.  The  way  the  SME  rate  top-up  shifts  estimates  up,  can  be 
observed  in  the  uncompensated  results  from  comparison  of  Tables  A5.1  and  A5.3  in 
Annex 5.  

CORTAX could not provide solutions for a SME top-up under the two “extreme” options 
for  an  allowance  for  equity,  Option  1  for  all  corporate  equity  and  Option  3  for  all 
corporate capital60. The ranking among options however remains valid: (2) > (5) > (4). 

Table 5: Economy-wide impacts of budget-neutral debt bias reforms; Scenario 2 – higher 
notional interest rate for SMEs; GDP-weighted EU-27 average 

(1) 
ACE  

(2) 
ANCE  

(3)  
ACC 

(4)  
NDI 

(5) 
ANCE 
+ partial 
NDI 

CIT rate (change in percentage points) 

Cost of capital (change in percentage 
points) 

Investment (change in % of GDP) 

n.a. 

n.a. 

n.a. 

3.426 

-0.107 

1.546 

n.a. 

n.a. 

n.a. 

-7.168 

0.874 

0.127 

-0.033 

-1.92 

0.361 

59 Results for a restricted equity definition are presented in Annex 5.2. 
60 Compensated results could not be computed since the CIT rate increase required to compensate for CIT 
revenue losses would result in a CIT rate larger than 100% for several countries, which of course is not 
possible. 

45 

 
 
 
 
 
 
                                                           
Share of debt-financed total assets (level, 
ex-post) 

Wages (change in %) 

Employment (change in %) 

GDP (change in %) 

n.a. 

n.a. 

n.a. 

n.a. 

45.48 

0.521 

0.069 

0.52 

n.a. 

n.a. 

n.a. 

n.a. 

40.91 

43.26 

-0.476 

0.193 

-0.338 

-0.113 

-0.789 

0.048 

Source: Joint Research Centre of the European Commission (2021). 

If the assumption of CIT revenue neutrality is lifted, the application of a single notional 
interest  rate  across  the  EU  together  with  a  rate  top-up  for  SMEs  results  in  a  further 
upward-shift of the results. In such a situation, Option 5 would no longer exhibit negative 
employment effects but would indeed result in higher employment and higher wages. It 
is  specific  to  Option  5  that  the  overall  economic  impact  is  determined  by  the  correct 
calibration between the allowance for equity and the reduction in interest deductibility61.  

While a top-up for SMEs seems justified on the grounds that SMEs face higher burdens 
to acquire new equity and higher financing costs, it could be argued that such a rate top-
up  might  result  in  disincentives  for  companies  to  grow  beyond  a  certain  size.  The 
moment a company has  grown sufficiently to not qualify as a SME any more, it would 
lose the rate-top up and thus part of the notional allowance on equity. This argument is 
more important for policy options which grant a permanent allowance (options 1 and 3). 
Since the notional allowance for Option 2 and Option 5 could be limited in its duration, it 
seems  that  the  advantage  of  growth  like  economies  of  scale  and  economies  of  scope 
together  with  increasing  market  shares  would  outweigh  any  disincentive  created  by  a 
reduction in  the notional allowance.  The disincentive would be small  in  any  case since 
the proposed top-up is limited (0.5 percentage points).  

The  negative  impact  of  full  non-deductibility  of  interest  (Option  4)  on  investment  and 
growth is further confirmed by the IMF (2016) and also by the analysis of effective tax 
rates conducted by ZEW (2016a). 

The experience of some Member States with notional interest deductions for equity have 
provided  the  opportunity  for  an  empirical  analysis  of  the  impacts  of  these  policies. 
Regarding investment in the context of the Belgian ACE (first version similar to Option 
1a), Moore (2014b) finds "highly significant and robust estimates that correspond to an 
increase  in  investment  activity  by  small  and  medium-sized  firms  of  about  3  percent  in 
response  to  the  ACE  reform".  Hebous  and  Ruf  (2017)  find  no  effect  on  production 
investment  from  multinational  affiliates,  which  are  the  focus  of  their  study.  Zangari 
(2014)  concludes  that  while  the  Belgian  ACE  has  possibly  benefitted  investment  by 
SMEs,  multinationals  seem  to  have  used  the  ACE  mostly  as  a  tax-planning  device.  He 
stresses the weaknesses of the anti-avoidance framework of the Belgian ACE as opposed 
to the Italian system, where no similar effect has been reported. The fact that the Belgian 
ACE was initially granted on the already existing stock of a company's equity implied a 

61 Uncompensated results, which do not implement revenue neutrality, are presented in Annex 5, Tables 
A5.1 to A5.4. 

46 

 
                                                           
windfall  gain  for  businesses,  without  any  impact  on  investment  decisions  or  their 
financing  source.  For  Italy,  Zeli  (2018)  finds  a  positive  impact  of  the  Italian  measure 
(similar to Option 2) on investments. 

The  magnitude  of  economic  impacts  of  options  1,  2,  3  and  5  depend  on  the  notional 
interest (NIR), (or risk premium) chosen. Higher levels of NIR (risk premium) will result 
in lower effective tax rates for companies and thus induce more investment and growth. 
The same applies to the duration of the allowance for option 2 and 5. A longer allowance 
would  increase  the  positive  economic  impacts.  For  options  1,  2,  3,  and  5  it  can  be 
generalized that a higher allowance would result in more positive economic impacts and 
in more negative impacts on the fiscal position of governments. 

For  Option  5,  the  economic  impacts  also  depend  on  the  extent  that  interest  deductions 
would  be  restricted.  A  more  pronounced  restriction  of  interest  deductibility  would 
increase  effective  tax  rates  for  corporations  and  would  thus  dampen  investments  and 
growth.  The  CORTAX  modelling  results  suggest  that  a  proper  calibration  between  the 
allowance and the reduction in interest deduction for Option 5 (i.e. a notional interest rate 
of 2.2% combined with a reduction of interest deductibility by 25%)  can achieve a solid 
economic impact at comparatively low fiscal costs. 

6.5. Impacts on tax revenue 

An empirical assessment of revenue impacts for options 3, 4 and 5 are not available since 
they have not been implemented so far. Regarding the revenue impact of measures like 
the  Belgium  one  before  its  revision  (similar  to  the  ACE,  Option  1),  De  Mooij  (2012) 
finds a potential decrease in the tax base and tax collection for advanced economies of on 
average about 15%, i.e. 0.49% of GDP respectively. For Italy (similar to ANCE, Option 
2), Zangari (2014) finds modest revenue losses of 1.3% of actual CIT revenues for 2011. 
This is due to contextual factors and the short time since the introduction of the measure. 
In  the  long  run,  Zangari  sees  much  higher  revenue  losses  possible.  Since  the  Italian 
system calculates new equity based on a fixed reference year, over time the measure will 
resemble  more  an  allowance  on  the  stock  of  equity.  De  Mooij  and  Devereux  (2011) 
simulated  a  hypothetical  reduction  of  CIT  revenues  of  up  to  50%.  Disallowing  the 
deduction of interest payments as considered under Option 4 (NDI) would likely have a 
positive impact on tax revenues. The option has never been implemented, so no empirical 
data is available. There are in any case two countervailing effects. On the one hand the 
reduction in investment and the contraction of the economy would reduce CIT revenues 
and  other  tax  revenues.  On  the  other  hand,  expenses  for  interest  payments  could  no 
longer be deducted from the corporate income tax base, increasing the tax base and thus 
tax  revenues.  Given  that  the  value  of  non-financial  corporate  debt  in  the  EU  almost 
equals the value of GDP, it seems likely that overall CIT revenues would increase.  

The CORTAX model also allows for an assessment of revenue impacts of the debt bias 
mitigating  reforms.  Since  DEBRA  does  not  propose  any  changes  to  CIT  rates,  the  tax 
revenue impact will be analysed using the unconsolidated approach, where CIT rates are 
kept constant. Table 6 reports estimated revenue impacts on CIT revenues and total tax 

47 

 
revenues.  It  becomes  obvious  that  Option  3,  which  had  the  most  positive  economic 
impact,  comes  with  the  highest  fiscal  costs.  In  a  situation  with  no  SME  top-up,  CIT 
revenues are reduced by 1.16% of GDP, total tax revenues decrease by 0.13% of GDP. 
The  revenue  losses  would  be  even  more  pronounced  with  an  SME  rate  top-up.  The 
decrease  in  CIT  revenues  is  partly  offset  by  an  increase  in  other  tax  revenues  (mainly 
value added taxes and personal income taxes). For 2021, Eurostat reports GDP for EU-27 
of EUR 14,448 billion (i.e. EUR 14.4 trillion). Expressed in 2021 values, CIT revenues 
would  thus  be  reduced  by  EUR  167.6  billion  while  overall  tax  revenues  would  be 
reduced by EUR 18.8 billion. 

Table 6: Revenue impacts of debt bias reforms with and without SME top up – 
uncompensated approach – GDP-weighted EU-27 average 

Scenario 

(1) Without SME top-up 

(2) With SME top-up 

(1) 
ACE  

(2) 
ANCE  

(3)  
ACC 

(4)  
NDI 

CIT revenue 

-1.128 

-0.472 

-1.16 

Total tax revenue 

-0.116 

-0.038 

-0.129 

CIT revenue 

-1.237 

-0.515 

Total tax revenue 

-0.128 

-0.04 

-1.237 

-0.128 

1.701 

0.348 

1.701 

0.348 

(5) 
ANCE 
+ partial 
NDI 

-0.001 

0.076 

-0.044 

0.075 

Source: Joint Research Centre of the European Commission (2021). 
Note: All simulations are changes expressed in % of GDP compared to the baseline scenario.  

Full disallowance of interest deduction (Option 4) leads to increases of CIT revenues by 
1.7% of GDP and an increase in total tax revenues by 0.35% of GDP62. Since no equity 
allowance is granted, the rate top-up for SMEs does not affect Option 4. 

In  the  case  without  (with)  an  SME  rate  top-up,  the  combination  of  allowance  and 
restricted  interest  deduction  under  Option  5  results  in  CIT  revenue  losses  of  -.001%  (-
0.044%) of GDP and an increase of all tax revenues of up to 0.076% (0.075%) of GDP. 
Expressed in 2021 terms, this would amount to CIT losses of EUR 0.14 (6.4) billion and 
overall tax revenue increases of EUR 11 (10.8) billion. Overall tax revenues increase due 
to GDP growth and resulting additional tax revenues in other taxes63. The comparatively 
low  budgetary  impact  of  this  measure  results  from  the  combination  of  two  measures 
which together balance the debt-equity bias simultaneously from the debt and equity side, 
thus also balancing budgetary impacts. 

62 Assuming 2021 values this would amount to a CIT revenue increase of EUR 245.6 billion and overall 
tax revenue increase of EUR 50.6 billion. 
63 In the CORTAX model growth materialises mechanically from the reduction of the cost of capital. In a 
world with many exogenous risks to growth, a static perspective might help to draw up a more cautious 
picture. This is further discussed in Chapter 8 and Annex 6. 

48 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                                           
Regarding  alternative  parameter  values,  a  higher  NIR  (higher  risk  premium)  would 
generally  result  in  more  positive  economic  impacts,  while  the  budgetary  costs  for 
Member  States  would  generally  be  higher.  A  higher  NIR  (risk  premium)  will  be  more 
costly for options 1, 2, 3 and 5. An allowance granted for a longer duration in options 2 
and  5  would  also  increase  the  fiscal  impact.  A  more  biting  restriction  of  interest 
deduction in Option 5 would reduce the fiscal burden.  

6.6. Impact on the administrative burden for businesses 

The total compliance costs for businesses result from one-off implementation costs and 
recurrent administrative costs. Options 1, 2, 3 and 5 would introduce a tax allowance for 
equity  financing.  The  measure  is  not  mandatory  and  businesses  will  make  use  of  this 
opportunity  if they have an  equity increase for a given financial period and if their tax 
savings  are larger than  related compliance costs. From an  administrative point of view, 
the  tax  allowance  for  equity  will  be  automatically  calculated  by  the  software  used  for 
filing  the  Corporate  Income  Tax  (CIT)  declaration64.  Such  software  is  usually  made 
available  free  of  charge  by  the  national  tax  authorities  that  also  bear  the  cost  for  its 
update. Hence, there are no one-off costs for businesses. 

Recurrent compliance costs for the proposed measure are determined by the amount and 
format  of  information  that  needs  to  be  computed  and  transmitted  to  tax  authorities. 
Businesses  that  want  to  use  the  tax  allowance  shall  indicate  the  equity  amount  in  the 
relevant  section  in  their  Corporate  Income  Tax  declaration.  Furthermore,  they  are  also 
expected  to  provide  additional  information  to  the  tax  authorities  to  comply  with  the 
specific anti-abuse measures. Based on the experience from the six Member States with a 
tax allowance for equity in place, required information is limited. Information that needs 
to  be  provided  is  the  amount  of  equity  and  how  it  is  made  available  (transfer,  cash,  in 
kind….),  intra-group  participations,  intra-group  loans.  Most  of  this  information  is 
generally  already  included  in  company  balance  sheets  which  are  transmitted  to  tax 
authorities. Each Member State will request such information in the best way according 
to  their  national  tax  system.  This  could  be,  for  example,  an  additional  section  in  the 
annual  tax  declaration  or  a  separate  form  to  be  annexed  to  their  CIT  declaration. 
Unfortunately,  quantitative  estimations  of  these  costs  are  not  available.  However,  they 
are expected to be negligible or very low because the number of information items to be 
transmitted is limited and the points needed are all already collected for other purposes. 
Moreover,  although  not  quantifiable,  multinational  companies  will  benefit  from  cost 
savings stemming from the harmonisation of the existing fragmented national measures 
on a tax allowance for equity.  

64 According to the 2021 study “Tax compliance cost for SMEs” commissioned by EASME, less than 5% 
of SMEs file the Corporate Income Tax declaration not electronically (it can be assumed that the 
percentage is close to zero for large enterprises). Link to 2021 version added once the study is officially 
published. 

49 

 
                                                           
In the case of policy option 4, the deductibility of interest payments would be disallowed. 
This  would  considerably  reduce  the  administrative  burden  for  businesses  since  interest 
limitation  rules  would  become  obsolete  and  all  related  compliance  work  would  be 
eliminated/unnecessary. 

In  absolute  terms  compliance  costs  are  similar  for  all  companies.  In  relative  terms 
smaller  companies  have  higher  compliance  costs  since  tax  administration  exhibits 
economies of scale. A higher NIR (or risk premium) for SMEs would partly compensate 
them for relatively higher compliance costs. 

6.7. Impact on the administrative burden for tax authorities 

Independent of the actual policy option chosen, implementation of the proposed measure 
would  entail  an  update  of  the  relevant  software  used  for  filling  CIT  declarations.  It 
should  be  noted  that  the  software  for  the  tax  declaration  is  nevertheless  updated  every 
year  and  the  additional  burden  stemming  from  the  proposal  could  be  considered 
negligible. The two main sources of increased administration costs might result from the 
training  for  tax  inspectors  and  necessary  enforcement  efforts,  i.e.  the  tax  audit  of 
companies that will apply for the specific allowance for equity.  

The potential introduction of an interest limitation rule as outlined under Option 5 is not 
expected to have an impact on enforcement costs since such rule is already in place under 
the  ATAD  165.  Even  if  the  interest  limitation  rule  were  implemented  through  another 
legal instrument, the principle is already well known to tax administrations.  

The application of the anti-abuse framework66 may generate additional enforcement costs 
in  Options  1,  2,  3  and  5  compared  to  a  no-action  scenario  and  the  non-deductibility  of 
interest (Option 4), the application of ACE (Options 1), ANCE (Option 2) ACC (Option 
3)  and  Option  5  could  increase  the  burden  of  tax  administrations  for  enforcement.  But 
these extra costs are difficult to quantify. This is because the administrative burden will 
depend  on  the  anti-abuse  framework  that  will  be  retained  in  the  proposal  and  on  the 
frequency  of  controls  decided  by  each  Member  State.  Generally  speaking,  the  specific 
anti-abuse  measures  will  entail  a  learning  process  before  application  while  the  general 
rule will follow the same principles as the General anti-abuse rules already in place for 
other  tax  measures.  The  additional  efforts  that  will  be  required  for  auditing  companies 
will  depend  on  the  nature  of  the  specific  anti-abuse  measures  implemented.  However, 
these extra audit costs must be put in perspective vis-a-vis the fairness objectives, as the 
consequences  of  not  implementing  this  measures  could  lead  to  tax  revenue  losses  that 
largely exceed these extra audit costs. 

65 As provided for by the Anti Tax Avoidance Directive 1 
66 The anti-tax abuse framework for DEBRA will propose a set of Specific Anti Abuse Rules –to  address 
specific abuse and a General Anti Abuse Rule that  ensure a second line of defence against  new schemes 
that might appear in the future (see also section 5.3.3) 

50 

 
                                                           
 
According  to  the  experience  from  the  countries  that  currently  have  an  allowance  for 
equity,  a  very  broad  estimation  for  the  additional  enforcement  cost  depends  on  the 
complexity  of  the  corporate  structure  and  can  go  from  EUR  27.5  (i.e.,  one  hour)  for  a 
SME  (or  company  with  simple  corporate  structure)  to  EUR  110  (i.e.,  four  hours)  for  a 
multinational enterprise with subsidiaries across the EU. However, tax audits would not 
likely be performed every year and the exact costs will depend on the organisation of the 
national  administrations  (DEBRA  audit  performed  at  central  level  vs.  by  local  tax 
auditors) and resources of each Member States’ tax authority.  

6.8. Fairness impacts 

The design of the  measure to  address the  debt-equity  bias is crucial for the impacts  on 
fairness. Past experience with notional interest deduction regimes has shown that failure 
to address the tax planning opportunities when designing such measure could create the 
risk of international groups exploiting the measure for aggressive tax planning purposes. 

Policy  measures  that  provide  allowances  for  equity  have  been  criticised  because  of  the 
tax  planning  opportunities67  they  can  theoretically  open  up  in  the  form  of cascading  of 
the deductions on the same initial capital if no proper anti-avoidance rules are in place. 
To  avoid  such  cascading,  there  is  a  need  to  make  sure  that  the  same  euro  of  capital 
invested  in  the  group  receives  tax  deductibility  only  once68.  This  is  achieved  by 
embedding an anti-avoidance framework into the proposal. Such provisions will ensure 
that  the  funds  injected  in  a  group  benefit  from  deductibility  only  once.  As  such,  the 
system would remove those loopholes used for aggressive tax planning. 

Specific rules to make the system robust to tax planning will include a general anti-abuse 
rule (GAAR) and specific anti-abuse rules that will exclude, amongst others, items that 
do not represent business needs or genuine investment, as well as participations and own 
shares.  

6.9. Sustainable Development Goals 

By  mitigating  the  debt-equity  bias,  DEBRA  is  expected  to  promote  equity  investment 
and  thus  innovation  –  particularly  in  the  green  and  digital  fields.  It  is  also  expected  to 
reduce reliance on debt, which leads to greater leverage and can have negative economic 
or  financial  consequences,  consequently  reducing  the  risk  of  systemic  crises  and 
fostering economic growth. These positive effects are in line with the targets set out by 
the United Nations’ Sustainable Development Goals (SDG). More specifically, DEBRA 
may  contribute  directly  to  SDG  8  –  “Promote  sustained,  inclusive  and  sustainable 
economic growth, full and productive employment and decent work for all”; and SDG 9 
– “Build resilient infrastructure, promote inclusive and sustainable industrialization and 

67 For the Belgian ACE, Hebous and Ruf (2015) find indications for the use of such tax planning strategies. 
68 Zangari (2014) discusses the Belgian and Italian ACE systems and the role of anti-avoidance provisions 
targeting intra-group transactions. 

51 

 
                                                           
foster innovation”. Further detail  on how DEBRA may contribute to  these goals  is  laid 
down in Annex 3. 

7.  HOW DO THE OPTIONS COMPARE? 

All  policy  options  would  increase  the  neutrality  of  the  tax  system  with  respect  to 
financing  decisions  when  compared  to  the  status  quo,  and  in  that  respect  meet  the 
primary  objective  of  the  policy  initiative.  That  said,  the  objective  is  met  to  varying 
degrees by each of the five policy options considered. Options 3 (ACC), 4 (NDI) and 5 
(ANCE+  partial  NDI)  are  most  successful  in  reducing  the  debt  share  in  the  economy, 
while options 1 (ACE) and 2 (ANCE) reduce the use of debt to a lesser extent since the 
notional  interest  rate  does  not  fully  equalise  the  cost  of  equity  with  the  cost  of  debt. 
Option 3 equalises the tax treatment of equity and debt since both are deducted using the 
same  notional  interest  rate.  Option  4  goes  farthest  in  neutralising  the  impact  of  tax 
systems  on  financing  decisions  by  eliminating  the  very  tax  treatment  that  currently 
introduces the debt-equity bias. However, there are strong reasons why this policy option 
still fares worst among those under consideration, as evidenced in the remainder of this 
chapter below. Policy option 5 tackles the debt-equity bias simultaneously from the debt 
and equity side and, in so doing, achieves to almost completely eliminate the debt-equity 
bias, as evidenced by a steep decline in the debt share in the economy. 

The  fairness  of  the  tax  system  is  to  some  extent  improved  by  all  policy  options.  The 
policy options involving the introduction of a notional allowance for equity (options 1, 2, 
3, 5) improve the fairness of the tax system in several ways:  firstly, a harmonisation of 
the allowance for equity rules across Member States would level the playing field among 
competitors in the single market. Secondly, a top-up for SMEs (included in all options, 
except option 4 which totally suppresses the deductibility of interests) would ensure that 
SMEs can also access more easily the equity market. Thirdly, a unified  measure would 
reduce the opportunities for using equity allowances for aggressive tax planning purposes 
and avoiding taxation. Tax avoidance is further mitigated by the introduction of a solid 
anti-abuse framework. The anti-abuse framework is part of these four policy options, so 
that on the equity side no single option is more conducive than the others to achieving tax 
fairness. The disallowance of the deductibility of interest on debt as outlined in Option 4 
would  eliminate  unequal  tax  treatment  of  debt  and  equity  across  the  internal  market. 
However, investors have based their investment decisions in the past on the tax effect of 
the debt bias. From a tax certainty perspective, the question would therefore arise as to 
how to treat existing debt. It could be envisaged to grandfather existing debt, excluding 
its  possible  refinancing.  The  full  disallowance  of  interest  deduction,  however,  would 
introduce a problem of double economic taxation since interest earnings are taxed. This 
would in practice imply that the financial sector is excluded from the measure. In terms 
of tax fairness, Option 5 stands out compared to all the other options. In addition to the 
arguments  related  to  the  notional  interest  allowance  already  discussed,  Option  5  would 
further  limit  the  deductibility  of  interest  payments  and,  in  so  doing,  also  reduce 
opportunities for profit shifting using intra-group loans, which would add to the fairness 
of  the  tax  system.  As  for  the  other  options,  a  top-up  for  SMEs  in  option  5  would 

52 

 
compensate for the higher risk born by investors in SMEs and facilitate access to equity 
financing. 

In  view  of  tax  fairness  considerations,  it  should  be  noted  that  the  Code  of  Conduct 
guidance  on  Notional  Interest  Deduction  regimes69  clearly  recommends  to  use  an 
incremental NID (as in options 2 and 5) instead of a stock-based one (as in option 1) to 
reduce  potential  abuse  of  the  regime.  An  allowance  on  new  equity  has  also  been 
identified as the most suitable option to tackle the debt-equity bias by a majority of the 
respondents to the public consultation. The application of a top-up for SMEs would have 
to  be  implemented  in  all  Member  States  and  at  the  same  rate  in  all  Member  States  to 
avoid  selectivity concerns as regards EU  State Aids  rules  and to  ensure a level  playing 
field for SMEs in the EU regardless of their place of residence. 

The distortions in the single market would be substantially reduced by any EU wide-
rule compared to a situation in which only a subset of Member States operate unilateral 
measures  for  reducing  the  debt-equity  bias.  Cross-border  investment  decisions  are 
influenced by the co-existence of different national systems of tax allowances for equity 
financing as well as by the fact that the majority of Member States do not accommodate 
debt-bias alleviating measures. Policy options 1, 2, 3 and 5 would thus be equally suited 
to achieve this objective. As for the disallowance of the deductibility of interest on debt 
under  option  4,  the  option  would  harmonise  an  EU  wide  approach  to  mitigate  the 
influence  of  tax  systems  on  financing  decisions.  Any  potential  benefit  of  EU-wide 
harmonisation  would,  however,  need  to  be  weighed  against  the  potential  risk  of 
introducing  major  distortions  for  the  EU  when  compared  to  its  international  partners. 
Fully  disregarding  the  tax  deductibility  of  interests  paid  on  debt  is  associated  with  the 
non-taxation  of  interest  received  and  could  result  in  major  distortions  between  the  EU 
and the rest of the world. Unilateral implementation of such a measure by the EU could 
require  new  international  agreements  on  the  taxation  of  interest  payments  in  order  to 
prevent double taxation or non-taxation of interest incomes. In particular, it would force 
Member  States  to  renegotiate  their  Double  Tax  Treaties  in  order  to  make  them 
compatible with the new tax treatment of interests paid and received in the EU. It would 
create  mismatches  between  the  tax  treatment  of  interest  paid  and  received  between  the 
EU and the rest of the world and, in so-doing, would de facto open up new loopholes for 
tax planning opportunities. It could also have negative effects in terms of the EU single 
market’s  business  competitiveness  vis-a-vis  other  jurisdictions  where  this  deductibility 
remains in place. 

As  demonstrated  in  the  impact  analysis  in  Chapter  6,  the  policy  options  will  have 
differentiated impact on investment and growth. If there were fewer distortions in the 
single market, resources would be allocated in a more appropriate and efficient manner, 
which  would  improve  economic  efficiency.  At  the  same  time,  an  allowance  on  equity 
generally reduces  effective tax rates and would have positive incentive effects.  Against 
such  considerations,  the  first  three  policy  options  would  be  expected  to  have  a  direct 

69 WK 11093/2019 REV 1 of 17 October 2019, Draft Guidance on notional interest deduction regimes 

53 

 
                                                           
positive effect, with the ACC (Option 3) assessed to have the largest economic impact, 
followed  by  the  ACE  (Option  1)  and  ANCE  (Option  2).  However,  as  options  1  and  3 
would provide for an allowance for all equity, they would also create a deadweight loss 
effect, allowing for tax deduction without necessary new investments. An allowance for 
new equity (as outlined in options 2 and 5), on the other hand, would provide economic 
benefits while avoiding deadweight loss effects. Policy option 4 would increase effective 
marginal  tax  rates  for  businesses,  and  thus  be  expected  to  lead  to  a  reduction  in 
investment and a contraction of the economy. The benefit of an EU-wide approach under 
Option  4  would  be  further  diminished  by  introducing  international  distortions:  whereas 
the  EU  would  no  longer  allow  for  a  debt  interest  deduction,  such  measures  would 
continue  to  exist  in  other  major  international  jurisdictions,  creating  a  potential 
disincentive  to  invest  in  the  EU.  Policy  option  5  would  be  expected  to  have  a  slightly 
positive  impact  on  investment,  while  also  being  effective  in  reducing  the  debt  share. 
However, as it would limit interest deductions to some extent compared to the status quo, 
option  5  would  also  counteract  investment  incentives,  such  that  it  has  a  lesser  positive 
effect compared to option 2. Option 5 will be coherent with other EU rules such as the 
Anti-Tax  Avoidance  Directive  with  its  interest  limitation  rule  and  Growth  and 
Employments goals, achieving growth while preserving the fiscal balance of the Member 
States. 

Investment  and  growth  are  closely  linked  with  the  competitiveness  of  the  EU,  with 
competitiveness being both a prerequisite for investment and growth as well as a result of 
it.  The  structural  effect  of  closing  the  debt-equity  bias  will  generally  have  a  positive 
effect  on  EU  competitiveness.  The  specific  effect  of  each  option  is  driven  by  each 
option’s impact on effective taxation. The stock based allowances under options 1 and 3 
provide large reductions in the tax base and thus considerably reduce effective taxation. 
This has positive effects on the EU’s competitiveness globally. The ANCE under option 
2 has a more limited effect. Given that option 5 combines the allowance for equity with 
partial limitation of interest deduction, the two measures balance out such that effective 
taxation largely remains unchanged and the effect on competitiveness is overall neutral. 
A  full  disallowance  of  interest  deduction,  as  proposed  under  option  4,  would 
considerably  increase  effective  taxation  of  businesses  to  the  detriment  of  EU 
competitiveness in the global economy.  

On the back of the COVID-19 crisis, all policy options under consideration have also to 
be  weighed  against  their  possible  budgetary  impact  and  thus  effects  on  fiscal 
sustainability,  which  represents  a  direct  link  to  their  macroeconomic  impact.  On 
average, it is true for all options that more positive economic impacts come with higher 
budgetary  costs,  and/or  overall  lower  tax  revenues.  In  a  post-crisis  period  with  already 
high  existing  debt  levels,  and  needs  for  fiscal  consolidation  to  come  in  the  future,  tax 
policy  measures  that  risk  to  substantially  or  even  partially  reduce  revenues  or  increase 
budgetary costs for Member States must be carefully considered. 

A stock-based notional interest deduction like the ACE under Option 1 or the ACC under 
Option  3  would  result  in  substantial  fiscal  costs.  The  allowance  base  is  much  larger 

54 

 
compared to incremental allowances proposed under Options 2 and 5. In addition, stock 
based allowances are by design of unlimited duration70, while the duration of incremental 
allowances  can  be  limited,  which  by  default  limits  the  costs  related  to  introducing  and 
maintaining  the  measure.  An  incremental  notional  interest  deduction  like  the  one 
provided for under options 2 and 5 is not associated with the windfall effect of a regime 
based on the stock of equity, since it only allows deductibility of an increase in equity. In 
this respect, Option 3 appears to be less efficient than option 2 and 5. 

Policy option 4 – which would fully disallow the deductibility of interest on debt – would 
perhaps fare best in this respect, as removing the deductibility of interest on debt would 
increase tax revenues (which are otherwise currently foregone) and have overall positive 
budgetary implications for Member States. On the whole,  however,  this option raises a 
number  of  vital  issues  that  outweigh  this  potential  benefit.  Fully  disallowing  the  tax 
deduction on debt interest is efficient in eliminating the debt bias, but increases effective 
tax rates for businesses and has negative effects  on growth  and employment,  driven by 
depressed investment. As a consequence, this option would substantially hinder the post-
crisis  recovery.  The  IMF  has  confirmed  the  negative  investment  impacts  of  full  non-
deductibility of interest expenses (IMF 2016). Moreover, a unilateral implementation of 
such  a  measure  at  the  EU  level  could  create  substantial  distortions  with  the  rest  of  the 
world since new international agreements on the taxation of interest payments would be 
required  in  order  to  prevent  double  taxation  of  interest  incomes.71  This  option  is 
considered by a large majority of respondents to the public consultation as being the least 
suitable  option,  3  respondents  out  of  67  considered  this  option  as  the  most  suitable. 
Considered  against  the  objective  to  preserve  growth  and  employment,  the  option  4 
appears to be the less effective. 

By  combining  an  allowance  for  new  equity  with  a  limitation  of  the  existing  interest 
deduction, Option 5 would prevent the negative impact on Member States’ budgets and 
might even result in moderate tax revenue increases. This option would address the debt-
equity bias while at the same time potentially provide for new tax revenues and thus help 
balance the overall budgetary impact. It would have a positive impact on investments and 
GDP.  If  the  allowance  for  equity  is  sufficiently  generous,  positive  employment  effects 
could also be observed72. Option 5 appears to be effective in mitigating  the debt equity 
bias,  maintaining  the  fiscal  capacity  of  the  Member  States  and  preserving  growth  and 
employment.  This  triple  effectiveness  is  only  achieved  by  this  option,  while  options  3 
and  4  score  high  on  mitigating  the  debt-equity  bias  but  low  on  maintaining  the  fiscal 
capacity of Member States and preserving growth and employment. Similarly, options 1 
and 2 do poorly on maintaining the fiscal capacity of member States. 

Coherence  of  EU  action  would  be  best  ensured  by  option  5  which  contributes  to 
reinforcing  equity-financing,  particularly  needed  with  the  green  and  digital  transition, 

70 The allowance ends when equity is equal to zero, that is when the company is liquidated or the 
accumulated losses equal capital + reserves. 
71 IMF (2016), Tax policy, leverage and macroeconomic stability.  
72 See Table A5.4 in Annex 5. 

55 

 
                                                           
while enhancing EU growth and reinforcing EU tool kit against tax avoidance. Option 5 
appears clearly the most efficient, decreasing the debt level while, increasing growth and 
employment  and  preserving  the  fiscal  capacity  of  Member  States.  In  terms  of 
effectiveness,  the decrease of the debt-equity bias  has to  be balanced by  preserving the 
competitiveness  of  the  EU  market,  which  option  4  does  not  achieve,  and  the  fiscal 
capacity  of  Member  States,  which  options  1,  2  and  3  are  threatening.  So  taking  into 
account  the  three  constrains  of  decreasing  the  debt-equity  bias,  improving  growth  and 
employment in the EU and preserving the fiscal capacity of the Member States, option 5 
is the most effective. 

All  policy  options  would  ease  the  administrative  burden  of  businesses  engaging  in 
cross-border  activities  due  to  the  harmonisation  of  equity  allowances  across  Member 
States. The additional data to provide to benefit from the allowance in option 1, 2 and 5 is 
limited  to  new  equity,  which  is  easily  available  at  company  level.  Option  4  would 
propose  a  full  disallowance  on  interest  deductions,  making  all  interest  limitation  rules 
redundant. Option 4 would thus reduce the compliance burden for businesses more than 
the  other  options.  The  disallowance  of  interest  payments  under  said  option  would  also 
reduce  the  administrative  burden  for  tax  administrations  since  interest  limitation  rules 
become redundant and aggressive tax planning strategies based on profit shifting through 
intra group loans are made impossible in the EU. All other policy options would slightly 
add to the administrative burden of tax administrations. The additional burden however 
would be limited to one off set up costs and additional efforts when auditing tax payers. 

Table 7 above summarises the discussion of this chapter. 

Table 7: Assessment of impacts of debt-bias options 

(1) 
ACE  

(2) 
ANCE  

(3)  
ACC 

(4)  
NDI 

(5) 
ANCE 
+partial 
NDI 

Making the tax system neutral 
for financing decision 

Enhancing the fairness of the tax 
system 
- 

Reduce cross-border tax 
planning opportunities 
-  More level playing field for 
domestic and multinational 
businesses in the single 
market 

Reducing distortions in the single 
market 
Stimulating growth and 
investment in the EU 
- 

Impact on investment and 
growth  

- 

- 

- 

- 

Fiscal sustainability 

Competitiveness of the EU 
economy  
Reduce the administrative 
burden for businesses 
Reduce the administrative 
burden for tax 

+ 

+ 

+ 

+ 

++ 

-- 

++ 

+ 

- 

+++ 

+++ 

++ 

+ 

+ 

+ 

++ 

- 

++ 

+ 

- 

++ 

++ 

0 

+ 

--- 

+++ 

--- 

++ 

+ 

+ 

+ 

++ 

++ 

0 

+ 

- 

+ 

+ 

+ 

+ 

++ 

- 

+ 

+ 

- 

56 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
administrations 

Source: European Commission 
Note: The evaluation is based on a scale of five steps from very negative (- - -) to very positive (+++). "0" indicates no 
change (i.e. neutrality). A reduction in administrative burden generally results in lower related costs, ‘+’ thus 
indicates cost savings while ‘-‘ indicates cost increases. 

8.  PREFERRED  OPTION  –  THE  ALLOWANCE  ON  NEW  EQUITY  WITH  AN  INTEREST 

LIMITATION 

This impact assessment has analysed five policy options. The option that appears to meet 
all objectives and offer the best balance between fiscal costs and economic outcomes  is 
option 5 (as outlined in section 5.2.5). This entails introducing a deductibility of equity 
costs in the form of an allowance for a notional interest on new equity (as in option 2) 
combined with a limitation of the deductibility of interest.  

Option  5  is  successful  in  addressing  the  debt-equity  bias  (the  main  objective  of  the 
measure), while balancing the budgetary impacts (a second objective) and addressing the 
fairness aspects of the tax system. It is expected to have a positive impact on investment 
and  GDP,  and  moderate  impacts  on  employment,  depending  on  the  final  calibration  of 
the equity allowance and reduction of interest deductibility. 

Under Option 5, the allowance is granted on new equity over a duration of 10 years. A 
limit  to  the  duration  of  the  allowance  prevents  that  the  measure  transforms,  over  time, 
into  a  stock-based  allowance  and  will  thus  be  less  costly  for  Member  States’  public 
finances.  Moreover,  the  10  year  period  has  been  chosen  to  approximate  the  average 
maturity of debt. The allowance is computed based on the difference between net equity 
(defined  as  the  difference  between  the  equity  of  a  taxpayer  [paid-up  capital  +  share 
premium  account  +  reserves  +  profit  or  loss  brought  forward]  and  the  tax  value  of  its 
participation in the capital of associated enterprises and own shares) at the end of the tax 
year and net equity at the end of the previous tax year, multiplied by the relevant notional 
interest  rate.  In case of  a net  equity  decrease,  an amount equal  to  the allowance equity 
base decrease multiplied by the notional interest rate would become taxable. This ensures 
that the equity is not reduced after the 10 year allowance period but then re-increased the 
year after strictly to benefit from a new 10-year period of deduction without any genuine 
equity increase. 

The notional interest rate (NIR) is defined as the risk free rate (RFR) plus a fixed top up: 
NIR = RFR + x   

(RFR is the risk free interest rate and x the risk premium) 

A  currency  specific  notional  interest  rate  is  chosen  since  the  risk-free  interest  rate 
strongly  depends  on  the  currency,  because  of  characteristics  like  inflation  and  central 
bank policy. Accordingly, the RFR relevant for a given tax year will be the 10-year risk-
free-rate published in December of the previous tax year by the European Insurance and 
Occupation Pensions Authority (EIOPA) for the relevant currency. The preferred option 
applies a risk premium of 1% for larger companies and 1.5% for SMEs. 

57 

 
 
Loss-making companies  are not  paying taxes. They  can thus  not profit  from  the equity 
allowance.  The  legal  proposal  will  encompass  the  possibility  to  carry  forward  the 
allowance  that  cannot  be  used  in  loss  making  years  so  that  ultimately  every  company 
which  has  increased  its  equity  can  profit  from  the  related  equity  allowance  for  the  full 
duration of 10 years. 

The allowance for equity  is combined with  a reduction of the tax deductibility of debt-
related  interest  payments.  This  will  be  achieved  by  limiting  the  interest  deduction 
proportionally for all companies by  a fixed percentage of net interest expenses (interest 
paid minus interest received) through a dedicated article in the DEBRA Directive. 

In order to properly balance the equity allowance, a reduction of interest deductibility by 
15% is chosen73. The preferred option thus applies a risk premium of 1% for large firms, 
a risk premium of 1.5% for SMEs and an interest limitation of 15% for all firms. These 
parameters have been determined following a comprehensive analysis of the impacts on 
the initiative’s complementary and conflicting objectives. The selected parameter values 
simultaneously mitigate the debt-equity bias on both the equity and debt side and account 
for the uncertainty underlying the quantitative predictions.  

The  economic  analysis  in  Chapter  6  compared  the  policy  options  with  alternative 
parameter  values.  It  was  assumed  that  the  notional  interest  rate  would  be  2.2%  for  all 
different types of allowances (options 1, 2, 3, 5). This resulted from a RFR at the time of 
about 0.2% and a risk premium of 2%74. The interest limitation for option 5 was set to 
25% of net interest expenses, in order to balance the fiscal costs of the equity allowance. 
In  CORTAX,  additional  investments  and  growth  mechanically  lead  to  overall  tax 
revenue  increases.  Further  analysis,  based  on  national  financial  account  data  and 
supplemented  by  ORBIS  data,  has  revealed  that  in  a  static  context,  these  policy 
parameters might result in a substantial financing gap. 

In order to further consider this potential fiscal gap, let’s call the original calibration with 
2.2% NIR (2% risk premium), SME-top-up and 25%  ILR  alternative 5a. The preferred 
option with a risk premium of 1%, an SME top-up and only 15% ILR should instead be 
nominated as alternative 5b. A detailed comparison of alternative 5b with alternative 5a 
(2.2%/2.7% NIR and 25% ILR) is provided in Annex 6.2.75  

Table  8  reports  the  financing  gap  in  billion  EUR  that  could  result  for  given  policy 
alternatives  and  scenarios  in  a  static  approach.  The  brackets  report  the  share  of  fiscal 
costs of the equity allowance which would be compensated by higher tax revenues due to 
the  interest  limitation  rule  in  the  specific  context.  These  values  rest  on  a  number  of 
assumptions  and  bear  considerable  uncertainty  (see  Annex  6.2  for  details).  They 

73 As was the case in the economic analysis of Chapter 6, the level of interest limitation is again chosen so 
as to equilibrate the fiscal impact in an dynamic context as modelled by CORTAX. 
74 As mentioned earlier, the application of the same notional interest rate is more important to compare 
options than the actual level of the notional interest rate. 
75 Alternative 5b is not included in the analysis of Section 6 since it is paramount to compare the different 
policy options with identical parameter values. 

58 

 
                                                           
demonstrate that the relative share of revenue losses covered is similar for both options. 
However,  in  absolute  terms  the  potential  financing  gap  of  alternative  5a  is  more  than 
twice as large as for alternative 5b. 

Table 8: Financing gap in billion EUR (share of equity costs covered in %) 

Alternative 5a 
Alternative 5b 

Pessimistic 
43.6 (4.3%) 
21.6 (5.1%) 

Optimistic 
23.1 (19.0%) 
11 (22.8%) 

This potential financing gap in the static approach highlights the importance of economic 
growth  for  the  CORTAX  results.  If  in  an  uncertain  environment  effective  tax  rate 
reductions and lower costs of equity do not mechanically translate into more investments 
due  to  exogenous  reasons  like  a  war,  drought  or  other  major  disruptions,  CORTAX 
results might be too optimistic about the revenue impacts of alternatives 5a and 5b.  

While it is inherently difficult to disentangle the effect of the equity allowance from the 
effect  of  the  interest  limitation  rule,  different  model  runs  of  CORTAX  can  be  used  to 
develop some preliminary understanding of the issue.  It seems that the notional interest 
rate  has  a  stronger  effect  on  the  reduction  of  the  debt  shares  compared  to  the  interest 
limitation rule. This is another argument for the rate top-up for SMEs. Secondly, there is 
a complementarity between the NIR and the  ILR, i.e. a change in  one variable is  more 
impactful with a higher level of the other variable. This is further discussed in Annex 6.3. 

A grandfathering of existing equity allowance regimes would also be allowed for those 
Member States where such regimes exist in order to mitigate the possible negative impact 
on businesses that have availed themselves of these regimes to date.  

The  measure  will  apply  to  all  sectors76  except  financial  corporations  for  the  reasons 
explained in chapter 5. The reason for this is that an equity allowance combined with an 
interest  limitation  have  very  different  impacts  on  financial  companies  (FCs)  and  non-
financial companies (NFCs). FCs usually have more interest received than interest paid. 
Therefore, the interest limitation would not apply for them since the basis (interest paid-
interest received) would be negative. This means that NFCs would finance the allowance 
on  equity  of  the  FCs.  Moreover,  FCs  are  subject  to  regulation  on  their  capitalisation, 
which means that the issue of under capitalisation is addressed in another way. 

It  will  encompass  a  strong  anti-tax  abuse  framework  to  address  possible  abuses  and 
harmful tax practices. A set of Specific Anti Abuse Rules (SAARs) – inspired from the 
Guidance  on  notional  interest  deduction  regimes  adopted  in  2019  by  the  Code  of 
Conduct  will address  the well-known existing schemes (e.g.,  cascading  within a group, 
acquisition of businesses held by associated enterprises…) while the General Anti Abuse 
Rule (GAAR) included in the ATAD 1 will ensure a second line of defence against new 
schemes that might appear in the future. 

76 Financial corporations are excluded from the scope of DEBRA. 

59 

 
 
 
                                                           
9.  HOW WILL ACTUAL IMPACTS BE MONITORED AND EVALUATED? 

Progress  towards  achieving  the  objectives  of  the  initiative  will  be  monitored  and 
evaluated. This is particularly important, first, in order to verify that key design features, 
such  as  the  choice  of  the  allowance  base,  the  notional  interest  rate  and  the  interest 
limitation  rule  remain  appropriate  to  pursue  the  objective  of  mitigating  the  debt-equity 
bias in the EU. Second, in the case of DEBRA, the effective application of the anti-tax 
abuse framework  across  all Member States is  a key element of  the measure in  order to 
prevent  loopholes  that  leave  room  for  harmful  tax  practices.  Monitoring  will  be  an 
incentive  for  Member  States  to  actively  implement  and  properly  enforce  the  anti-tax 
abuse  framework  that  will  come  with  the  measure.  In  this  context,  monitoring  should 
cover: 

1.  Reporting by Member States on the evolution of the debt/equity ratio at national 

level. 

2.  Reporting  by  Member  States  on  the  annual  budget  cost  connected  to  equity 
allowance under DEBRA as well as on tax revenues from such beneficiaries. 
3.  Reporting  by  Member  States  on  the  total  sum  of  net  interest  expenses  that  are 
relevant  for  the  interest  limitation.  In  addition  annual  revenues  connected  to 
interest limitation under DEBRA should be reported. 

4.  Reporting of data by Member States on the implementation of the anti-tax abuse 

framework, both at administrative and Court levels. 

5.  Public  reporting  by  the  Commission  on  its  assessment  of  the  effect  of  the 
implementation of the measure on the debt-equity bias across the EU and on the 
efficiency  of  application  of  the  anti-tax  abuse  framework  Member  States  by 
Member States. 

The data to be collected from Member States will depend on the content of the adopted 
measure, but should include the following: 

1.  Number of taxpayers that have benefited from the allowance on equity in the tax 
year  as  compared  to  the  total  number  of  taxpayers  in  scope  of  this  directive  in 
accordance with Article 2.  

2.  Number  of  small  and  medium  enterprises  (SMEs)  that  have  benefitted  from  the 
allowance in the tax year as compared to total number of SMEs registered in the 
Member State 

3.  Total  amount  allocated  to  the  allowance  as  compared  to  the  national  gross 

domestic product. 

4.   Total  amount  of  exceeding  borrowing  costs  (i.e.  interest  paid  minus  interest 

received) summed over all companies.  

5.  Total amount of non-deductible exceeding borrowing costs.  
6.  Number  of  taxpayers  to  which  measures  from  the  anti-tax  abuse  framework  of 
DEBRA were applied and a description of tax consequences and sanctions linked 
to this. 

7.  Data on the evolution of the debt/equity ratio in the meaning of Annex III, letters 

a) and c) of Directive 2013/34/EU. 

60 

 
The Commission will review the situation in the Member States regularly and publish a 
report.  The  monitoring  framework  will  be  subject  to  further  adjustments  in  accordance 
with the final legal and implementation requirements and timeline.   

Five years after the implementation of the allowance, the Commission plans to evaluate 
the results  of this  policy initiative on tackling  debt/equity bias and  effectively  applying 
the anti-tax  abuse framework  as well as the overall impact  on tax revenues,  businesses 
and the internal market. In this context, data will be collected from both the business and 
Member  States.  In  this  context  the  Commission  should  consider  whether  the  design  of 
key  elements  of  the  initiative,  including  in  particular  the  notional  interest  rate  and  the 
calculation of the allowance base, remain pertinent to achieve the objectives pursued. 

61 

 
 
 
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66 

 
ANNEX 1: PROCEDURAL INFORMATION 

1.  Lead DG, Decide Planning/CWP references 

The  lead  Directorate  General  is  the  Directorate  General  for  Taxation  and  the  Customs 
Union (DG TAXUD).  

This initiative is supported by the following political agreements:  

-  Agenda  Planning:  Debt  Equity  Bias  Reduction  Allowance 
(PLAN/2021/10435)  

(DEBRA) 

- Inception Impact Assessment: Debt Equity Bias Reduction Allowance (DEBRA) (Ref.  
Ares(2021)3879996)  

- The initiative was announced in the Communication on Business Taxation for the 21st 
Century, COM(2021) 251 final. 

2.  Organisation and timing 

The work for this initiative was launched in April 2021. An Inter-Service Steering Group 
was  established  and  chaired  by  the  Secretariat  General.  The  following  Directorates 
General  were  invited  to  the  Inter-Service  Steering  Group  (ISSG):  BUDG,  CNECT, 
COMM,  COMP,  ECFIN,  EEAS,  ESTAT,  FISMA,  GROW,  INPTA,  JRC,  JUST,  SJ, 
OLAF, TRADE.  

The  Inter-Service  Steering  Group  met  four  times  to  discuss  the  file.  Meetings  of  the 
steering  group  took  place  on,  2  June  2021,  12  July  2021,  30  September  2021,  11 
November  2021  and  3  February  2022.  In  addition  to  the  meetings  of  the  Inter-Service 
Steering  Group,  DG  TAXUD  met  regularly  and  repeatedly  in  bilateral  meetings  with 
representatives of the following Directorates General to discuss the analysis in the impact 
assessment, the design of options, and legal issues: COMP,  FISMA, GROW, JRC. 

3.  Consultation of the RSB 

The  Impact  Assessment  report  was  scrutinized  by  the  Regulatory  Scrutiny  Board  and 
discussed  in  the  relevant  meeting  on  16  March  2022.  In  the  opinion  dated  18/03/2022, 
the  Regulatory  Scrutiny  Board  outlined  recommendations  which  were  integrated  in  the 
impact assessment. The main changes to the document are summarized in Table A1.  

Table A1: Scrutiny by the Regulatory Scrutiny Board  

RSB comments 
(1)  The  report  does  not  sufficiently  take 
into  account  other  determinants  of  debt-
equity  choices  beyond  the  debt-equity  tax 
bias.  It  does  not  set  out  the  different 

Actions taken 
  The  report  has  been  amended 

to 
provide  a  more  comprehensive  picture 
of  the  determinants  for  choosing  debt 
or equity financing.  

67 

 
 
situations in Member States and their views 
of the problem. 

(2)  The 
report  does  not  sufficiently 
describe  the  composition  of  the  proposed 
options. 
It does not explain and analyse the choices 
on  different  option  elements,  in  particular, 
equity definitions, determining the notional 
interest rate and interest limitation rules. 

(3) It does not present in a clear, analytical 
manner  how  the  options  compare  in  terms 
of  effectiveness,  efficiency  and  coherence. 
It does not sufficiently justify the preferred 
it 
option  and  explain 
achieves the objectives. It does not contain 
the  specific  calibrations  of  the  preferred 
options. 

to  what  extent 

and 

interacts 

initiative’s 

coherence  with 

RSB requests for improvement 
(1)  The  report  should  discuss  how  this 
complements 
proposal 
existing  and  ongoing  EU  and  international 
initiatives. It should describe in more detail 
the 
the 
upcoming  Business  in  Europe:  Framework 
for Income Taxation. It should outline how 
this initiative relates to previous experience 
of  addressing  the  debt-equity  bias,  in 
particular the 2016 Proposal for a Common 
Consolidated  Corporate  Tax  Base. 
It 
should  provide  a  better  overview  of  how 
to  existing  and 
this 
ongoing initiatives from third countries. 
(2) When analysing the problem, the report 
should  give  a  broader  picture  of  the 
relevant  factors  contributing  to  the  debt-
equity  bias  and  outline  all 
relevant 
parameters 
financing 
decisions  of  a  company.  This  should  also 
be reflected in the baseline and the impact 

initiative  relates 

influencing 

the 

  The  context  of  the  different  Member 
States  and  potential  motivations  for 
adopting  an  allowance  for  equity  are 
now discussed in greater detail 

  The description of the options has been 
clarified and the arguments for specific 
choices  of  option  elements  have  been 
clarified. 

  The  available  analytical  toolset  is  now 
employed  to  provide  a  comprehensive 
analysis  of  the  design  elements  and 
clarify  implied  trade-offs.  Those  trade-
offs  ultimately  have  no  analytical 
solution  and  require  value  judgments 
(political decisions). 

  The  comparative  discussion  of 

the 
options  has  been  amended  and  their 
relative 
of 
effectiveness,  efficiency  and coherence 
has been clarified.  

impact 

terms 

in 

approximating 

  The preferred option has been justified 
in  greater detail.  It  is  further explained 
how  the  preferred  option  strikes  a 
desirable  balance  between  conflicting 
objectives. 
  Calibrations 

the 
preferred options have been included in 
the report. 
Actions taken 
  The  initiative  has  been  more  clearly 
embedded  in  the  existing  EU  and 
the 
international 
context 
relevant 
relationship  with 
third 
in 
initiative 
countries is discussed in greater detail. 

other 
the  EU  and 

and 

in 

  Also, 

experiences 

previous 
the 

of 
addressing 
bias, 
especially  in  relation  to  the  Common 
Consolidated  Corporate  Tax  Base  are 
now better reflected in the report.  

debt-equity 

  The  report  has  been  amended 

to 
provide  a  more  comprehensive  picture 
of  determinants  underlying  financing 
decisions  and  the  choice  of  specific 
sources of capital.  

  The  discussion  of  the  drivers  of  the 
debt-equity bias has been deepened and 

68 

 
in 

the 

introduced. 

analysis.  At  the  same  time,  both  in  the 
impact 
dynamic  baseline  and 
analysis,  the  report  should  outline  how 
other  macro-economic  policies  may  affect 
debt-equity financing decisions, even when 
the  proposed  measures  against  tax  debt-
equity  bias  will  be 
In 
particular,  the  report  should  explain  how 
higher interest rates may affect debt-equity 
ratios.  It  should  also  better  present  the 
rationale  behind 
the  heterogeneity  of 
Member  States’  approaches  for  addressing 
(or not addressing) the debt-equity bias. 
(3)  The  report  should  further  develop  the 
description  of 
the  options  and  better 
illustrate  what  the  available  choices  are. 
The  report  should  be  clearer  at  what  stage 
and  how  key  elements  such  as  notional 
interest rate and the interest limitation rules 
are  to  be  decided  and  implemented.  It 
should  better  discuss  the  feasibility  of  the 
options  (in  particular  the  option  on  non-
deductibility of interest payment). 
(4) The report should strengthen the impact 
analysis. It should clarify to what extent the 
investment  can  be 
effects  on  equity 
between 
determined 
in 
reduction  of  debt  versus 
equity. 
the 
macroeconomic  impacts,  in  particular  on 
tax  revenues.  It  should  also  provide  more 
context on how a reduced debt-equity bias 
would  affect  young  companies  such  as 
start-ups  and  distinguish  between  effects 
unprofitable 
versus 
on 
companies.  Furthermore, 
impact 
the 
section should clearly illustrate the ex post 
and  ex  ante  dimensions  of  the  debt-equity 
bias. 

It  should  clearly  present 

distinguishing 

profitable 

increases 

(5) The report should compare the options 
in  a  clear,  analytical  and  well-structured 
effectiveness, 
terms 
manner 
report 
efficiency  and  coherence.  The 

of 

in 

also  outlines  now  potential  influences 
developments. 
of  macro-economic 
Especially  the  ambivalent  impact  of 
rising interest rates is better analysed. 
  The  report  now  discusses  more  clearly 
the  context  of  the  different  Member 
States  and  potential  motivations  for 
adopting  or  not  an  allowance  for 
equity.  

  The  options  have  been  more  clearly 
described  and  relevant  policy  choices 
have been highlighted. 
It  has  been  clarified  in  the  report  that 
notional  interest  rate  and  the  interest 
limitation  rules  are  central  design 
elements of the preferred option. 

 

  The  discussion  of  mayor  problems 
related to specific options and thus their 
feasibility has been extended. 

  The impact analysis has been amended 
and  methodological  limitations  of  the 
analytical  tools  have  been  clarified. 
While  no  comprehensive  analysis  of 
the  differential 
impact  of  equity 
allowance  and  interest  limitation  is 
possible, there are some indications that 
changes in the notional interest rate are 
more  impactful  than  changes  in  the 
interest limitation rule. 

  The  economic  impact  on  young  and 
innovative  companies  as  well  as 
unprofitable  companies  has  been  more 
explicitly analysed. 

  Following  the  introduction  of  a  more 
comprehensive description of financing 
choices  beyond  the  tax  induced  debt-
equity bias, it has now been made clear 
that the initiative can only mitigate the 
debt  bias  induced  by  taxation  and  that 
also  with  the  measure  there  might  be 
other  reasons  why  (some)  companies 
prefer debt over equity.  

  The discussion of the options has been 
clarified  and  the  comparison  of  the 
terms  of  effectiveness, 
options 
efficiency  and  coherence  has  been 

in 

69 

 
should  better  justify  the  choice  of  the 
preferred  option,  and  strengthen  the  link 
between 
the  objectives,  options  and 
impacts.  It  should  also  better  justify  and 
explain  how  the  preferred  option  overall 
best  meets  the  all  of  the  general  and 
specific  objectives.  The  report  should 
include the full evidence base and analysis 
necessary 
specific 
calibrations  of  the  preferred  options.  It 
should  present  the  different  costs  and 
benefits  of 
the  available  calibration 
choices. 
(6)  The  report  should  better  include  and 
describe  diverging 
stakeholder  views 
throughout the main report and annexes. 

to  determine 

the 

amended.  

  The advantages of the  preferred option 
are  presented  more  clearly  and  in 
greater  detail.  It  is  further  explained 
how  the  preferred  option  strikes  a 
desirable  balance  between  conflicting 
objectives. 
  Calibrations 

the 
preferred  option  have  been  included  in 
the  report  in  addition  to  calibrations 
comparing all policy options.  

approximating 

  Stakeholder  views  and  points  of 
agreement  and  divergence  between 
stakeholder groups have been described 
in  more  detail  in  the  report  and  the 
relevant annex.  

4.  Evidence, sources and quality 

The evidence base for this impact assessment report is based on various different sources: 

•  Studies  on  the  debt-equity  bias,  including  work  by  the  IMF,  the  OECD  and  leading 
academics as referenced in the Reference List. 

• Modelling by the European Commission’s Joint Research Centre based the CORTAX 
model.  

•  Feedback  on  the  open  public  consultation,  as  summarized  in  the  synopsis  report  in 
Annex 2. 

• Exchanges with additional stakeholders through the Platform for Tax Good Governance 
and with the European Economic and Social Committee (EESC). 

• Further exchanges with additional stakeholders on an ad-hoc basis. 

• Desk research and quantitative analysis using Bureau van Dijk Orbis database, ESTAT 
Statistics,  ECB  statistics,  OECD  statistics  and  the  International  Survey  on  Revenue 
Administration  (ISORA),  powered  by  the  IMF’s  Revenue  Administration  Fiscal 
information tool (RA-FIT). 

70 

 
 
 
 
ANNEX 2: STAKEHOLDER CONSULTATION  

A broad set of activities have taken place to obtain detailed stakeholder feedback.  

- 

Inception Impact Assessment: Feedback from seven stakeholders was uploaded in 
Have-your-say from 14/06/2021 to 12/07/2021: one investment group, five business 
association (one of which from UK), one polish citizen. 

-  Public  consultation  from  1/07/2021  until  7/10/2021.  Overall,  67  responses  were 
received: 37 business associations mainly representing financial organisations of all 
sizes (including SME), 12 companies/business organisations (mostly tax accountant 
and financial organisations), 3 academic and research institutions , 8 NGOs or others 
(mostly  chamber  of  commerce,  stock  exchanges)  )  and  7  individual  citizen.  Most 
respondents came from either Belgium (14/67), Germany (14/67) or France (12/67).  
A total of 30 position papers have been uploaded. 

-  Bilateral meetings with business associations.  

-  Meeting  with  national  public  authorities/agencies,  business  associations  and  civil 
society  groups  participating  to  the  Commission  Expert  Group  “Platform  for  Tax 
Good Governance, Aggressive Tax Planning and Double Taxation”.  

-  Meeting with the European Economic and Social Committee (EESC). 

1.  Summary of feedback to the Inception Impact Assessment 

Feedback was provided by one investment group, five business association (one of which 
from UK), one polish citizen  

The  investment  group,  and  four  business  associations,  are  generally  in  favor  of  the 
introduction of an effective system intended to reduce the tax bias of indebtedness.  On 
the other hands, an UK business organization considers that the different tax treatment of 
payments  made  to  equity  investors  and  to  lenders  is  justified  by  the  fundamental 
difference  between  equity  and  debt  investments.  They  doubt  that  the  cost  for  an 
allowance  for  equity  investment  can  be  justified  by  its  likely  economic  benefits.  There 
are  already  extensive  rules  to  combat  excessive  and  tax-driven  use  of  debt,  and  no 
evidence has been provided to suggest that these are inadequate. The Danish Chamber of 
Commerce  welcomed  the  uniform  treatment  of  debt  and  equity  for  tax  purposes  but 
suggests to lower the corporation tax or abolish it altogether, as the corporation tax is the 
most  productivity-limiting  tax.  According  to  the  citizen  the  current  low  rates  of  credits 
and  loans  do  not  indicate  the  need  to  intervene  in  this  market  by  reducing  the 
indebtedness of entrepreneurs. 

The  financial  organisation  and  the  five  business  associations  (including  UK  based 
association) do not support measures that would result in either disallowing or penalising 
the  deductibility  of  interest  payments.  They  consider  that  an  intervention  in  this  sense 
“would increase the cost of capital, reduce investment and inflict lasting damage on the 
European economy, especially in the post-pandemic context”  

71 

 
The  four  business  associations  and  the  financial  organisation  support  the  approach  to 
create  an  allowance  for  equity  by  enabling  the  tax  deductibility  of  notional  interest  for 
equity. They also (cumulatively) put forward the following opinions: the preference for a 
mechanism  inspired  by  effective  systems  already  adopted,  such  as  the  one  in  force  in 
Italy (based on the "ACE" mechanism - Allowance for Corporate Equity);  the suggestion 
to include in the proposal measures for alleviating existing constraints on equity issuance 
(indeed, the choice between equity and debt is not made by companies solely because of 
tax reasons for instance, for example, equity has significant governance implications); the 
support  for  a  special  measure  for  SME    that  typically  find  it  more  difficult  than  more 
mature  companies  to  find  financing;  the  importance  to  design  effective  anti-abuse 
measures 

Finally, the financial organisation suggests a deduction of notional interest on new equity 
capital of companies since it is the only measure who would effectively encourage new 
investments in equity. 

2.  Summary of meeting with EESC 

In  preparation  of  the  opinion  an  expert  group  was  held  where  several  experts  provided 
feedback  and  comments  on  the  DEBRA  initiative.  During  the  plenary  meeting  EESC 
confirmed the view already expressed in the opinion on the Communication on Business 
Taxation for the 21st Century77. “The EESC welcomes the initiative of the Commission to 
create a Debt Equity Bias Reduction Allowance (DEBRA). Investments in new greener 
technology  are  connected  with  a  high  risk  for  the  investor.  In  such  situations,  equity 
financing  is  particularly  important  and  the  inherent  bias  against  equity  financing  built 
into the tax systems needs to be addressed.”78 

3.  Summary of the open public consultation 

While overall responses provide a mixed picture, the majority of business associations 
and corporations (which represent a majority of respondents) see an EU wide measure 
as preferable to country-specific approaches. Similarly for the view that an allowance for 
equity would support the economic recovery from the COVID-19 health crisis and help 
businesses  with  cross-border  activities  in  the  single  market.  An  allowance  on  equity  is 
markedly  preferred  to  a  disallowance  of  interest  deductions  or  an  identical  notional 
interest deduction for debt and equity alike. 

Responses from five NGOs (mostly chamber of commerce and tax accountants) are more 
heterogeneous  than  those  from  the  business  community.  An  NGO  has  provided  a 
position  paper  and  in  principle  agrees  with  the  problem  of  the  debt-equity  bias  but 
cautions on fiscal impacts. Also, it requests from the Commission to precisely calculate 
the  impact  of  an  allowance  on  equity  on  effective  tax  rates  across  EU  Member  States. 

77 COM/2021/251, https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52021DC0251 
78 ECO/558-EESC-2021, https://www.eesc.europa.eu/en/our-work/opinions-information-reports/opinions 

72 

 
                                                           
They  quote  an  audit company  with  the  claim  that  Malta’s statutory CIT rate of 35% is 
reduced to 3.5% due to the NID implemented.  

Three  responses  have  been  received  from  academic  and  research  institutions.  Research 
institutions have also  provided position papers with  a detailed analyses of the measure. 
While one provides a legal analysis and mostly agrees with the approach, another looks 
at the economic aspects. An academic has also voiced in a study meeting of the European 
Economic  and  Social  Committee  that  he  considers  an  EU  action  for  an  allowance  on 
equity as  problematic, since it does  not  account  for the interaction between the income 
taxation of corporations and individuals.     

The rational for an equity allowance 

The answers provided demonstrate that most respondents (26/67) agree that high levels 
of  debt  make  businesses  more  prone  to  insolvency,  business  associations  agree  to  that 
assertion, while corporations strongly agree. For 17 of them there are no link and only 7 
disagree. The same proportion of respondents (26/67) agree that debt levels are too high 
in  SMEs  and  large  non-financial  enterprises.  From  the  answers  provided  it  is  not  clear 
whether respondents believe that such higher levels of debt are due to the lack of other 
financing options.  

More  than  half  of  the  respondents  34/67  tend  to  agree  that  access  to  equity  is  limited, 
especially corporations which strongly agree.  

The vast majority of participants believe (42/67) that debt is used to finance investments 
because interest levels are low and therefore debt financing is cheap. Only 4/67 answers 
expressed disagreement or strong disagreement regarding this statement. 

In  general,  respondents  seem  to  agree  that  measures  should  be  taken  to  encourage 
businesses to reduce debt financing and resort more to equity financing. 

Indebtedness and financing decisions 

Most  respondents  either  agree  (business  association)  or  strongly  agree  (corporations, 
academics,  NGOs  and  citizens)  that  non-financial  businesses  are  more  vulnerable  to 
insolvency (49/67). 

More respondents disagrees or strongly disagrees 26/67 that high levels of indebtedness 
make enterprises more profitable, than the ones who agree or strongly agree with such a 
statement (7/67). However a clear pattern is hard to assess in this context, due to the fact 
that 17/67 responded that they are neutral, while 17/67 did not answer or did not know 
the answer. A similar pattern of answers is to be noted for the following questions with 
around a fourth of neutral and a fourth of no answers. 

The answers provided did not allow to assess the respondent’s position on whether high 
levels  of  debt  are  due  to  lack  of  other  financing  options.  On  the  one  hand  21/67  of 
respondents  agree  or  strongly  agree  with  such  a  statement.  On  the  other  hand  17/67 
disagree or strongly disagree that this is the case. It is also relevant to point out that 14/67 

73 

 
of respondents are neutral in this regard, and 15/67 did not answer or did not knew the 
answer to the question. 

 23/67  of  respondents  agree  or  strongly  agree  that  debt  levels  of  large  non-financial 
enterprises  are  too  high,  while  almost  none  of  the  respondents  disagree  (3  disagree,  0 
strongly  disagrees).  Most  of  the  respondents  are  either  neutral  (13/67),  don’t  know 
(12/67) or did not answered the question (16/67). 

Almost  40%  (26/67)  of  respondents  agree  or  strongly  agree  that  SMEs  have  too  much 
debt, while a very low number of respondents disagrees that debt levels of SMEs are too 
high (4 disagree, none strongly disagree. 20,9% (14/67) are neutral in this regard. Again 
around a quarter of the respondents did not respond to the question. 

A number of respondents (9/67) believe that the ideal proportion would be 25%-50%. 

28 out of 67 respondents agree or strongly agree that enterprises use finance investments 
to increase their return on equity. 11 respondents were neutral and 22 didn’t answer  

More  than  half  of  the  respondents,  especially  among  business  organisations  and 
corporations,  34/67  agree  that  their  access  to  equity  financing  is  limited  or  inexistent. 
Few  respondents  (4/67)  disagree  with  such  a  statement.  A  total  of  25/67  respondents 
were neutral, did not know the answer or did not answer. 

The vast majority of participants believe (42/67) that debt is used to finance investments 
because interest levels are low and therefore debt financing is cheap. Only 4/67 answers 
expressed disagreement or strong disagreement regarding this statement. 

The  answers  provided  with  regards  to  whether  enterprises  use  debt  to  finance 
investments to diversify risk are not conclusive. More than 50% of the answers (39/67) 
are either “don’t know” (6/67); “No answer” (18/67) or “neutral” (15/67). Regarding the 
remaining answers 16/67 respondents agree or strongly agree that debt financing is used 
to diversify risk against 12/67 respondents which disagree or strongly disagree with such 
statement.  

There  are  more  respondents,  especially  among  business  associations  and  corporations, 
who  agree  or  strongly  agree  (21/67)  that  businesses  used  debt  to  reduce  tax  liabilities 
than the one that disagree or strongly disagree (14/67). However, there is a large part of 
respondents which either did not answer (15/67), did not know the answer (3/67), or were 
neutral (14/67) with regards to this statement. 

More respondents that agree or strongly agree (24/67) that debt is used to avoid dilutions 
of  voting  rights  of  the  main  shareholders  especially  among  business  associations  and 
corporations,  than  those  who  disagree  (7/67).  Neutral  responses  are  about  half  of  the 
positive  answers  (12/67).  However  there  is  a  large  part  of  respondents  (24/67)  did  not 
provide an answer. If this results are disregarded, we reach the conclusion that more than 
50% of the respondents that provided a concrete answer, agree or strongly agree that debt 
is preferred to avoid dilution of voting rights of their main shareholders (24/43). 

74 

 
Nine respondents have presented other reasons apart from those of the questionnaire. 

Most respondents either agree or strongly agree that enterprises should be using less debt 
financing and more equity financing (41/67), among Business associations 25% strongly 
agree and 33% agree. There were further comments provided by respondents to sustain 
their answers. 

EU wide measures versus national measures 

More respondents ((26/67) disagreed or strongly disagreed that a national initiatives are 
preferable to EU initiatives because these can better targeted to the needs, among them 
66% of academics and 33% of Business associations. 15/67 agreed with such statement, 
among them 20% of Business associations and 16/67 respondents either did not know or 
did not answer. 10/67 respondents were neutral in this regard. 

An EU wide initiative is viewed as a useful tool to support economic recovery from the 
COVID-19  crisis,  and  to  foster  equity  investment  to  a  greener  digitalized  economy 
without  creating  distortions  in  the  single  market.  EU  wide  measures  were  as  also 
considered  as  being  beneficial  for  business  operating  in  the  single  market  across 
countries. Respondents also agree that national tax debt-equity bias measures are a form 
of tax competition between countries, and that EU wide measures would reduce such tax 
competition between Member States. 

Respondents are divided between those who are neutral 20/67 and those who agree that 
national legislation to tackle the tax debt-equity bias is creating barriers for enterprises to 
operate  in  the  single  market  (21/67).  A  large  part  of  respondents  did  not  provide  an 
answer or did not know (21/67). 

From  those  who  did  provide  an  answer,  there  is  clear  agreement  or  strong  agreement 
(32/67)  that  tax  debt-equity  bias  measures  are  a  form  of  tax  competition  between 
countries,  among  them  100%  of  academics,  71%  of  citizens,  58%  of  corporations  and 
28% of Business associations. Only a small number of respondents disagree (5/67) or are 
neutral in this regard (9/67). Almost a third of respondents did not provide an answer or 
did not know (21/67). 

The answers provided demonstrate that more than half of the respondents (34/67) believe 
that an EU wide initiative to tackle the debt-equity bias, would be a useful tool to foster 
economic  recovery  and  incentivize  equity  investments  in  the  twin  green  and  digital 
transitions, among them  100% of academics,  86% of citizens, 50% of corporations and 
42% of Business associations. Only a residual amount of respondents have disagreed or 
strongly  disagreed  with  such  statement  (6/67)  or  are  neutral  about  the  subject.  A 
substantial amount of respondents did not provide an answer or did not knew the answer 
(21/67). 

Respondents clearly agree that EU initiatives to reduce equity-debt bias would reduce tax 
competition between member states (27/67). Only 3 respondents disagree with such idea 

75 

 
while 9 are neutral. The amount of respondents that did not provide an answer or did not 
know the answer is substantial (28/67). 

More respondents agree or strongly agree that EU measures to tackle the debt-equity bias 
would  be  beneficial  for  businesses  (24/67),  among  them  71%  of  corporations,  66%  of 
academics,  43%  of  citizens  and  28%  of  Business  associations,  while  some  respondents 
are neutral (15/67) in this regard. A residual number disagrees or strongly disagrees. The 
amount  of  respondents  that  did  not  provide  an  answer  or  did  not  know  the  answer  is 
relevant (24/67). 

Most  respondents  strongly  disagree  that  the  debt-equity  bias  should  be  addressed  at 
national  level  (26/67). Several  respondents  have  not  expressed their position  (18/67) or 
did  not  know  the  answer  (3/67).  A  relevant  number  of  respondents  are  neutral  in  this 
regard (15/67). 

A  majority  of  respondents  that  provided  an  answer  (while  18/67  did  not  provide  an 
answer)  disagree  that  there  is  no  such  thing  as  a  debt-equity  bias,  and  that  an  EU 
initiative which tackles the tax debt-equity bias is not necessary (34/67). There were also 
10 respondents which were neutral in this regard. 

Policy options 

Note that the presentation of the policy options in the open public consultation differed 
from the presentation in this impact assessment79. According to the responses provided, 
participants  believe  that  the  best  option  to  address  the  tax  debt  bias  would  be  the 
implementation of an allowance on equity that provides for the deductibility of a notional 
interest  on  all  equity  (maintaining  the  existing  interest  deductibility).  A  second  most 
suited  option  would  be  an  allowance  that  provides  for  the  deductibility  of  a  notional 
interest on new equity.  

Most  respondents  are  against  disallowing  the  deductibility  of  any  financing  costs  as 
deductible  expense  as  a  way  of  tackling  the  debt-equity  bias.  16  Respondents  have 
provided further comments in this regard. 

The  large  majority  (48/67)  of  respondents  answered  that  Option  1  -  disallowing  any 
financing costs as a deductible expense - is the least suited option, among them 75% of 
corporations, 72% of Business associations, 71% of citizens and 66% of academics. 

Most  respondents  voted  that  Option  2  -  an  allowance  on  equity  that  provides  for  the 
deductibility  of  a  notional  interest  on  all  equity  (maintaining  the  existing  interest 
deductibility)  -  would  be  the  most  suited  option  among  them  57%  of  citizens,  50%  of 
corporations,  39%  of  Business  associations  but  0%  of  academics.  In  the  4  level  scale 
more  than  half  of  respondents  have  voted  on  1  or  2  (40/67).  Taking  into  consideration 
that 16 respondents  did not  answered the question, it is possible to conclude, that most 

79 Option 1 from the OPC is option 4 in the IA, Option 2 in the OPC is option 1 in the IA, option 3 in the 
OPC is option 2 in the IA and option 4 in the OPC is option 3 in the IA. 

76 

 
                                                           
respondents that provided an answer agree that this is indeed the best or one of the best 
options. 

Option 3 - an allowance that provides for the deductibility of a notional interest only on 
new equity (maintaining the existing interest deductibility  - is  considered a second best 
option after the allowance on equity for all equity, with most respondents (24/67) voting 
on 2 in the scale of 1 to 4. 18/67 have considered option 3 to be the best option, which 
corresponds more or less to the number of respondents that have considered Option 1 as 
the  best  option  among  them  66%  of  academics,  28%  of  Business  associations,  25%  of 
corporations  and  14%  of  citizens.  Once  again  16/67  respondents  did  not  answer  the 
question. 

On  option  4  –  an  allowance  on  corporate  financial  capital  (financial  debt+equity)  that 
would replace the tax deduction of interests - the majority of respondents have voted on 
rate 3 (29/67) or rate 4 (8/67). This means that option 3 elected as the third best option 
coming only before “Option 1 - Disallow any financing costs as deductible expense.” It 
was considered the best option by 16% of corporations, 14% of citizens, 5% of Business 
associations but 0% of academics. 

17/67 respondents did not respond to this question. See Figure A2.2. Several respondents 
have provided comments and added suggestions in this section. 

Figure A2.2. Number of respondents that elected as the most suited option 

Option 2: An allowance on equity that provides
for the deductibility of a notional interest on all
equity (maintaining the existing interest…

Option 3: An allowance that provides for the
deductibility of a notional interest on new equity
(maintaining the existing interest deductibility).

Option 4: An allowance on corporate financial
capital (financial debt+equity) that would replace
the tax deduction of interests.

Option 1: disallowing any financing costs as a
deductible expense

0

5

10

15

20

25

30

Most of the respondents (31/67) agreed that the working definition of equity in line with 
the European System of Accounts 2010 (i.e. “equity is a financial asset that is a claim on 
the residual value of a corporation, after all other claims have been met”) is useful. All of 
the 10 respondents that considered the definition as not useful have provided a suggestion 
to  improve  such  definition.  Almost  half  (26/67)  of  the  respondents  did  not  provide  an 
answer to this question.  

77 

 
 
 
 
Notional interest scope and rate  

Although the majority of respondents did not indicate how much the notional interest rate 
should be, 20 participants have provided further comments in this regard. The majority of 
respondents  agree  that  a  more  generous  rate  should  be  provided  to  SMEs  than  the  one 
provided to bigger businesses. 

A  large  number  respondents  (37/67)  did  not  provide  an  opinion  The  remaining 
respondents’  answers  point  to  a  preference  for  a  notional  interest  rate  equal  to  the  risk 
free interest rate + 3% (10/67) or higher (8/67). All other answers are disperse and do not 
allow to form a judgement. 

The majority of responses agree or strongly agree that a more generous notional interest 
rate  should  be  provided  to  SMEs  (31/67)  among  them  100%  of  citizens,  50%  of 
corporations,  36%  of  Business  associations  and  33%  of  academics.  8  respondents  did 
know the answer and a high number of participants (18/67) did not answer the question. 
However, most respondents did not provide an answer (46/67) on  much higher do you 
think the notional interest rate should be for SME compared to the notional interest rate 
applied to larger enterprises. From those that provided an answer are too disperse to show 
a clear pattern. 

Anti-abuse measures 

Respondents  agree  to  a  large  extent  that  DEBRA’s  proposal  should  include  anti-
aggressive tax planning measures. Regarding what specific measures should be taken to 
reach such an objective, there is wide agreement that a general anti-abuse rule would be 
efficient in preventing the abuse of an allowance for equity for aggressive tax purposes. 
The  exclusion  of  cascading  through  intra-group  loans  and  loans  involving  associated 
enterprises was also supported by several respondents. 

From the answers provided participants were against the exclusion of cash contribution 
in  kind. It  is  relevant  to  point out that a large percentage of respondents  did  not  give  a 
concrete answer to the questions on the specific anti-abuse provisions. 

A  large  number  of  respondents  agrees  that  the  proposal  should  include  measures  to 
prevent aggressive tax planning (33/67) among them 71% of citizens, 66% of academics, 
42%  of  Business  associations  and  33%  of  corporations,  and  only  1/67  respondent 
disagrees with  the implementation  of such measures. 20/67  respondents  did  not  answer 
or did not know the answer and a relevant number of respondents (13/67) was neutral in 
this regard. 

A large part of respondents (30/67) agrees that a general anti-abuse provision that would 
deny  notional  deduction  for  operations  carried  out  without  any  substantial  economic 
purpose or carried out with related parties and that have the main purpose of converting 
old equity into new equity with the aim of benefiting from the notional deduction would 
be  a  necessary  measure  to  prevent  aggressive  tax  planning.  Only  a  small  amount  of 
respondents  disagrees  with  such  a  measure  (6/67),  while  a  substantial  amount  of 

78 

 
participants  has  not  responded  to  the  question  (20/67)  or  does  not  know  the  answer 
(6/67). 

Most  respondents  agree,  strongly  agree  or  are  neutral  (32/67)  that  the  exclusion  of 
cascading through intra-group loans is necessary. Disagreements with such a measure are 
residual  (6/67).  It  is  important  to  note  that  a  substantial  amount  of  participants  did  not 
respond (21/67) or did not know the answer (8/67). 

A  great  part  of  respondents  disagree  or  strongly  disagree  (22/67)  that  contributions  in 
kind  and cash  should  be excluded in  order to  prevent  abuse of an allowance for equity 
against  only  (8/67)  that  agree  or  strongly  agree.  Of  the  total  amount  of  participants  a 
large share did not know the answer to this question (10/67) or did not answer (21/67). 

More respondents agree or strongly agree (19/67) with the exclusion of capital increase 
subscribed  by  the  company  or  one  of  its  subsidiaries  (own  shares),  than  the  ones  who 
disagree  14/67.  However  more  than  half  of  respondents  did  not  provide  a  concrete 
answer, therefore the results are not clear. 

More respondents  that agree or strongly  agree (17/67) that the exclusion of intra-group 
transfers would prevent aggressive tax practices, than the ones that disagree with such a 
measure (9/67). More than half of the respondents (35/67) did not answer the question or 
did  not  know  the  answer  (if  neutral  answers  are  added  41/67  did  not  present  a  clear 
answer). Therefore, the answers provided do not show a clear pattern. 

Most  respondents  did  not  have  a  clear  position  on  preventing  re-categorization  of  old 
capital as new capital through liquidations and the creation of new businesses. A total of 
43/67 were either neutral, did not know the answer or did not responded to the question. 
Among  the  remaining  respondents  13/67  agreed  or  strongly  agree  that  the  re-
categorization of old capital as new capital through liquidations and the creation of new 
businesses should be prevented, while are against (11/67) such a measure. 

The  answers  provided  do  not  reveal  a  clear  pattern  with  regards  to  the  exclusion  of 
businesses held by associated enterprises. Although more respondents agree or strongly 
agree (18/67) that businesses held by associated enterprises should be excluded, than the 
ones that disagree (10/67) with such a statement, there is a significant part of respondents 
that did not know the answer or did not answer (31/67). If the neutral (10/67) answers are 
added  to  these  figures  then  it  is  clear  that  the  majority  of  respondents  did  not  have  a 
strong position on the topic (41/67).  

55/67 respondents did not present other anti-abuse measures. 

79 

 
 
 
 
 
 
ANNEX 3: WHO IS AFFECTED AND HOW? 

1.  Practical implications of the initiative 

The  Debt  Equity  Bias  Reduction  Allowance  (DEBRA)  would  mitigate  the  tax  induced 
debt-bias.  This  would  reduce  the  role  of  taxation  in  the  decision  for  debt  and  equity 
financing  of  investments.  The  mitigation  of  the  debt  bias  should  increase  the  share  of 
equity investments.  Businesses with  relevant  equity increases are directly affected. The 
measure  also  affects  tax  administrations  in  Member  States  and  Member  States’  tax 
revenues. 

2.  Summary of costs and benefits 

Table A3.1. Overview of benefits of preferred option 

I. Overview of Benefits (total for all provisions) – Preferred Option 

Description 

Placing taxation of debt 
and equity on an equal 
footing 

Support creation of 
harmonized tax 
environment 

Compliance cost 
reductions 

Amount 

Direct benefits 

Comments 

Comparable tax advantage between 
investment through equity or debt 
that should benefit businesses and 
have broader positive financial and 
economic effects. This comparable 
advantage is achieved efficiently 
with quasi no cost to the public 
treasury thanks to a combination of 
allowance on equity and reduction of 
tax advantage of debt. 

Avoids fragmentation of the single 
market by eliminating different 
treatment under different national 
allowance for equity measures and 
stronger limitation rules across all 
Member States for debt deduction. 
Should benefit businesses operating 
in single market. It is in full 
coherence with previous measures 
already taken within the Anti-Tax 
Avoidance Directive (ATAD), such 
as the interest limitation rule and the 
General Anti-Abuse Rule (GAAR). 

Same administrative rules in all EU 
Member States compared to existing 
different compliance rules given 
several Member States currently 
have different national measures in 
place. Should benefit businesses 

++ 

++ 

++ 

80 

 
 
Help reduce the 
accumulation of debt by 
non-financial 
corporations 

Encourage equity 
investments  

Provide for a 
comprehensive anti-
abuse framework. 

Remove distortions in 
the single market 

Reduction in insolvency 
risk due to higher 
equity ratios 

Complements other 
measures to support 
equity financing 
(including for SMEs) 
and furthering capital 
markets union 

Complements other 
policy efforts to de-
leverage businesses and 
mitigate reliance on 

operating in single market. 

Higher equity ratios reduce 
insolvency risks. Stronger interest 
limitation rules would lessen 
advantages of debt interest deduction 
and make debt financing less 
attractive. Should benefit businesses 
and have overall positive financial 
and economic effects. Accumulation 
of debt is reduced while maintaining 
coherence with previous tax rules, 
not radically changing the rules and 
not affecting the legitimate 
expectations of investors. 

Positive effects on competitiveness, 
innovation, growth and employment 
in the EU. Simultaneously, equity 
investment are encouraged and use 
of debt discouraged. 

Ensure effective measures against 
aggressive tax planning are used 
throughout the EU. 

New investment through equity will 
receive comparable tax treatment as 
through debt throughout the EU. 
This option is more effective by 
playing on both equity and debt side, 
while not diminishing the 
competitiveness of the EU economy, 
which would be the case with 
disallowing completely interest 
deductibility in other options. 

Higher equity ratios reduce the debt 
burden and make businesses more 
resilient to changes in the business 
environment. 

Companies (including SMEs) will 
benefit from this measure as it will 
help incentivise their re-equitisation. 
More diverse capital structure would 
support improve broader financial 
and economic positions.  

High debt/leverage at company level 
introduces operational strains and 
heightens risks of insolvency that 
can have broader financial and 

++ 

++ 

++++ 

++++ 

Indirect benefits 

++ 

++ 

++ 

81 

 
debt financing for 
investment  

economic ramifications, which 
would be mitigated by the initiative.  

Table A3.2.  Overview of cost of preferred option 

II. Overview of costs – Preferred option 

Citizens/Consumers  

Businesses 

Administrations 

One-off 

Recurrent 

One-off 

Recurrent 

One-off 

Recurrent 

n.a. 

n.a. 

Direct costs 

Allowance 
for new 
corporate 
equity    

Indirect costs 

n.a. 

Lower tax 
revenues from 
corporate 
taxation 

Limited 
implementation 
costs 

Slight increase 
in compliance 
costs only when 
businesses 
request the 
allowance. 

Low 
implementat
ion costs for 
the 
allowance 
on equity. 

Potentially 
higher tax 
admin costs 
from 
application of 
Anti-
Avoidance 
Rules. 

n.a. 

n.a. 

n.a. 

n.a. 

n.a. 

n.a. 

Limitation 
of interest 
deduction 

Direct costs 

No additional 
reporting 
requirements so 
no additional 
one-off costs. 

Debt financing 
becomes more 
costly. 

No additional 
recurrent 
costs. 

Low 
implementat
ion cost 
since 
existing 
software 
needs 
update. 

Indirect costs 

n.a. 

n.a. 

n.a. 

n.a. 

n.a. 

n.a. 

Costs related to the ‘one in, one out’ approach 

n.a. 

n.a. 

No one-off cost 

Slight increase 
in compliance 
costs only when 
businesses 
request the 
allowance 

n.a. 

n.a. 

n.a. 

n.a. 

n.a. 

n.a 

n.a. 

n.a. 

Total   

Direct 
adjustment 
costs  

Indirect 
adjustment 
costs 

Administrative 
costs (for 
offsetting) 

3.  Relevant Sustainable Development Goals  

III. Overview of relevant Sustainable Development Goals – Preferred Option (Option 5) 
Comments 
Relevant SDG 

Expected progress towards the Goal 

82 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SDG no. 8 – Promote 
sustained, inclusive and 
sustainable economic 
growth, full and productive 
employment and decent 
work for all 

SDG no. 9 –  Build resilient 
infrastructure, promote 
inclusive and sustainable 
industrialization and foster 
innovation 

DEBRA is expected to lead to a GDP increase of 
0.26% across the EU as a whole. Investment is 
expect to increase by 0.84 percent of the EU-27 
average GDP. 

Expected to foster economic growth, 
innovation and employment creation in line 
with targets 8.1, 8.2, 8.3 among others 

By increasing equity investments across the EU, 
DEBRA is expected to indirectly promote the 
development of innovative technology 

Expected to foster investment and thus 
contribute to, for example, targets 9.2, and 
9.4 

Excessive debt levels make businesses more prone to insolvency and increase the overall 
risk of broad financial crisis. By mitigating the existing differences in the tax treatment 
between  debt  and  equity,  DEBRA  will  not  only  promote  economic  growth,  but  also 
reduce financial stability risks within the internal market. Equity financing is particularly 
relevant to meet investment needs under the twin transitions and for SMEs, which due to 
their  small  size,  low  assets  and  reduced  credit  history,  are  likely  to  struggle  to  get 
financing from traditional financial institutions.  

By  mitigating  the  differences  in  the  tax  treatment  between  debt  and  equity,  DEBRA 
creates further incentives to equity investments in bold new ideas and products, fostering 
research  and  innovation  in  the  EU.  Increasing  equity  investments  will  therefore  play  a 
major  role  in  fostering  the  development  of  new  solutions,  which  are  essential  for 
reaching  the  objectives  set  out  by  the  Commission  in  relation  to  the  twin  digital  and 
green transitions.  

Overall, DEBRA has the potential to not only reduce the risk of existing companies to go 
into  bankruptcy,  but  also  accelerate  the  creation  of  innovative  new  businesses,  and 
therefore have a positive effect on employment.  

These  positive  impacts  are  in  line  with  two  of  the  17  United  Nations  Sustainable 
Development  Goals  (“SDG”).  These  are  SDG  8  “Promote  sustained,  inclusive  and 
sustainable economic growth, full and productive employment and decent work for all” 
and  SDG  9  “Build  resilient 
inclusive  and  sustainable 
industrialization and foster innovation”. 

infrastructure,  promote 

Specifically regarding SDG 8, DEBRA is expected to, as assessed throughout this impact 
assessment, foster economic growth, innovation and employment creation. These impacts 
are  in  line  with  targets  8.1,  8.2,  8.3  among  others.  As  to  SDG  9,  by  increasing  equity 
investments in the EU, DEBRA will promote the development of innovative technology, 
which may contribute  to  target  9.2. “sustainable industrialization”, as well  as target  9.4 
specifically to “upgrade infrastructure and retrofit industries to make them sustainable”. 

83 

 
 
 
 
 
 
ANNEX 4: ANALYTICAL METHODS 

1.  CORTAX: A model to simulate corporate tax policies  

1.1. Brief Description of the Model 

The  CORTAX  model  is  a  computable  general  equilibrium  model  designed  to  evaluate 
the effects of corporate tax reforms in 27 EU countries assuming optimal behaviour of all 
agents in the economy. In the model, each country is assumed to have the same structure 
in  terms  of  consumption,  savings,  production  and  public  finances  (though  the  data  are 
country-specific).  Countries  are  linked  to  each  other  via  international  trade  in  goods 
markets,  intermediate  goods markets  and investment  by multinationals.  The model also 
includes Japan, the UK, the USA and a tax haven. 

Firms  are  divided  into  three  categories:  multinationals’  headquarters,  their  subsidiaries 
located  abroad  and  domestic  firms  that  only  produce  in  their  country  of  residence. 
Multinationals  and  domestic  firms  differ  to  the  extent  that  the  former  optimise  profits 
globally and are engaged in profit shifting activities across borders. Domestic firms pay 
their  corporate  taxes  in  their  country  of  residence  according  to  the  taxable  profits 
generated in this country only. Both domestic and multinational firms can shift profits to 
the tax haven to reduce their tax burden. In the benchmark, all firms are equal and, whilst 
on  aggregate  taxable  profits  are  positive,  there  are  random  shocks  affecting  their 
revenues that can be attributed to, for example, business cycle evolutions. These shocks 
may result in losses that can be carried forward in the model. 

A  breakdown  of  the  results  by  firm  type  is  not  commonly  done.  While  technically 
possible,  it  is  important  to  clarify  what  exactly  would  be  hoped  to  be  learnt  from  this 
additional output or what variables would be of particular interest. The calibration of the 
parameters  that  determine  the  behavioural  response  of  the  different  firm  types  would 
result in the expectation that MNEs respond slightly stronger than purely domestic firms, 
in  line  with  empirical  facts.  In  addition,  given  the  typically  lower  financing  costs  of 
MNEs compared to domestic firms, the impact of the reforms would be larger for MNEs. 

In relation to government, there is a balanced budget where consumption and public debt 
are a fixed proportion of GDP. Tax revenues and/or transfer payments  adjust to keep a 
balanced  public  budget.  The  taxes  included  in  CORTAX  are  consumption  taxes  and 
direct taxes on income from corporate and labour, dividends, capital  gains and interest. 
Government consumption and government debt as a share of GDP are kept constant after 
a reform. 

The  effects  of  reforms  can  be  expressed  as  changes  in  GDP,  household  consumption, 
business investment and fiscal revenue. The model is elaborated using data from different 
data sources including Eurostat,  the OECD, the United  Nations, the  IMF and the Orbis 
firm database. The structural description of the model and the calibration process borrow 
heavily from Bettendorf et al. (2009b). 

84 

 
 
1.2. Model Validation and Peer Review 

The CORTAX model has acquired a strong reputation among corporate tax experts. The 
model was originally produced by CPB Netherlands, and has since been used by experts 
affiliated to the Oxford University Centre for Business Taxation, the Erasmus University 
Rotterdam,  the  Tinbergen  Institute  and  CESifo.  The  model  was  previously  used  in 
European Commission’s impact  assessments of the common consolidated corporate tax 
base and is discussed in further detail in (European Commission, 2016) 

1.3. Key assumptions 

CORTAX  accounts for two types of households: old  and  young. Households  maximise 
their intra-temporal utility function subject to a budget constraint, where net savings from 
young workers (wages, current transfers and negative consumption) are equal to negative 
value of net savings from old households. The effects on welfare are calculated using the 
compensating  variation.  This  is  calculated  as  the  difference  in  transfers  received  by 
young households required to compensate the change in utility. 

Firms  maximise  their  value  subject  to  the  production  function  and  the  accumulation 
constraints on physical capital and fiscal depreciation. Total production is calculated as 
the  sum  of  production  in  all  firms  (domestic  and  multinationals)  net  of  intermediate 
inputs  in  foreign  subsidiaries.  Usually,  the  production  function  is  a  Cobb  Douglas 
combination of the fixed factor and the value added, which is a CES aggregate of labour 
and capital. The model allows the parent company to charge a transfer price for intra-firm 
deliveries that deviates from the equivalent price that would be charged if it had been an 
inter-firm  transaction  (the  ‘arms-length’  price),  which  reflects  profit  shifting  in 
multinationals. Both, multinationals and domestic firms have some access to tax havens, 
which are another mechanism by which they shift profits. The degree of profit shifting to 
tax  havens  depends  on  the  difference  between  the  statutory  rate  in  their  respective 
countries and the tax rate in the tax haven. 

CORTAX is by design a one-sector economy and does not allow to distinguish between, 
say, different NACE industries, or between financial or non-financial firms. Therefore, a 
breakdown  of  the  results  by  industry  is  not  possible.  The  purpose  of  CORTAX  is  to 
provide  a  detailed  illustration  of  the  corporate  sector  as  a  whole,  but  it  is  not  a  multi-
sector  model  in  the  classical  sense  that  considers  different  industries  and  the  linkages 
between  them.  It  can  also  not  be  parametrised  so  as  to  mirror  a  specific  industry. 
Likewise,  CORTAX  does  not  consider  different  types  of  investments,  such  as  with 
respect to the type of asset invested in. 

The  simulations  are  coded  to  ensure  that  the  government  budget  remains  balanced,  i.e. 
governments do not run deficits or surpluses. This is achieved in two ways. First, some 
simulations  are  run  under  the  assumption  that  governments  will  compensate  for  the 
change in the tax base by adjusting the corporate tax rates to maintain constant corporate 
tax revenue, prior to any behavioural response (i.e. ex-ante to the simulation). Whether or 

85 

 
not  this  ex-ante  compensation  is  introduced,  further  changes  in  the  tax  revenues  are 
balanced by the government adjusting transfers to retirees. 

1.4. Construction of the baseline and core policy simulations 

The  model  provides  a  consistent  and  connected  framework  for  firms,  household  and 
governments. The data and the current policies of each country are used to replicate the 
corporate taxation regime, and indeed the production structure and household behaviour. 
The corporate taxation regime is  necessarily stylised (for example, not  every deduction 
can be included), though the simulations confirm that at a macro-level the CIT regimes 
are replicated well. 

Debt and equity financing can be seen as imperfect substitute forms of capital use, and 
their different tax treatment introduces distortions in the way firms and investors choose 
to invest funds – the so-called debt bias. An allowance for the stock of corporate equity 
(ACE),  an  allowance  on  new  corporate  equity  (ANCE)  and  an  allowance  on  corporate 
capital (ACC) which provides an notional interest deduction on investments, regardless 
of its form (debt or equity) are analysed.  

CORTAX  parametrises  the  deductibility  of  the  cost  of  equity  and  debt  through  two  β 
parameters:  β_equity  and  β_debt.  In  a  “classical”  tax  system,  with  full  deductibility  of 
interest  payments  and  no  deductibility  of  the  cost  of  equity:  β_equity=0  and  β_debt=1. 
The baseline calibration of the model considers the existing limited deductibility of debt 
in some EU MS (e.g. Germany and Italy, where interest is not or only partially deductible 
from the local business tax base) and the existence of an allowance on equity in Belgium, 
Italy, Cyprus, and Poland. 

To simulate the effects  of the different policy options, the β_equity has  been calibrated 
for each MS and between multinational and domestic firms using data from ORBIS and 
the ECB Survey on the Access to  Finance of Enterprises (SAFE). The β_equity can be 
best seen as a product of (i) the notional allowance factor calibrated by country and type 
of enterprise and (ii) the base of the allowance. 

Next,  the  base  of  the  allowance  is  calibrated  using  data  from  ORBIS  for  the  financial 
year 2018. 

As the model does not include the implementation of the Anti-Tax Avoidance Directive 
(ATAD), it cannot directly simulate the effect of a change in such directive. Option 5 is 
simulated  by  compensating  the  increase  in  deductibility  on  equity  with  a  reduction  by 
25% of debt’s interest deductibility. 

2.  Measuring the cost of capital and effective average tax rates 

An  alternative  measure  employed  is  the  analysis  of  existing  differences  in  effective 
corporate tax rates within the EU. The aim is to detect possible tax induced distortions to 
the allocation of resources in both domestic and international investments in a theoretical 
framework which allows country comparisons. The analysis of the impact of taxation on 

86 

 
investment behaviour requires forward-looking indicators which include a large majority 
of the relevant tax provisions relevant for corporate investment. 

The  annual  report  on  effective  tax  levels  in  the  EU  carried  out  by  the  ZEW  applies  a 
forward-looking approach originally developed by Devereux and Griffith (1998a, 1998b) 
and provides a comprehensive analysis of the effects of tax legislation on investments for 
all 27 EU Member States and selected third countries. 

The  basic  approach  is  to  consider  a  hypothetical  incremental  investment  located  in  a 
specific  country  that  is  undertaken  by  a  company  resident  in  the  same  country  or  in 
another  country.  Two  tax  measures  are  computed:  the  cost  of  capital  and  the  effective 
average tax rate. The cost of capital measures the required minimum pre-tax return of a 
real investment (the 'marginal investment') to achieve the same after-tax return as a safe 
investment in the capital market. The standard assumption by the ZEW for the real return 
on  the  safe  investment  is  5%.  The  lower  the  cost  of  capital  the  more  investments  are 
undertaken. If the cost of capital is exactly equal to the return from a safe investment, the 
tax  system  does  not  distort  the  scale  of  investments.  This  approach  is  based  on  the 
presumption that firms undertake all investment projects that earns at least the required 
rate of return. 

A complementary approach is to consider discrete choices for profitable investments and 
in  particular  discrete  location  choices.  The  effective  average  tax  rate  measures  the 
relative difference between a fixed rate of pre-tax return of a profitable investment (the 
standard  assumption  by  the  model  is  20%)  and  its  after-tax  return.80  The  effective 
average tax rate is thus a measure of the attractiveness of a tax system. 

In  both  cases,  the  hypothetical  investment  takes  place  in  one  period  and  generates  a 
return in the next period. The impact of taxation is analysed by considering a number of 
features  of  the  tax  system,  including  the  statutory  tax  rate,  capital  allowances,  the 
treatment  of  interest  deduction,  the  allowance  for  corporate  equity,  the  treatment  of 
foreign  source  income,  wealth  taxes  paid  by  the  company,  as  well  as  possibly  the 
treatment  at  the  corporate  and  personal  level  of  dividends  paid  by  the  company,  and 
wealth and capital gains taxes at the personal level. 

Both the cost of capital and the effective average tax rate are computed for five different 
types of assets  (intangibles, buildings,  machinery, financial  assets, inventory) and three 
different  sources  of  financing  (retained  earnings,  new  equity,  debt).  Further,  both 
measures  are  computed  for  the  corporate  level  and  the  shareholder  level,  considering 
three different types (zero-rate, top-rate non-qualified and top-rate qualified shareholder) 
and can thereby be used to compare the relative distortions introduced by the tax system 
in  relation  to  certain  investments  or  financing  sources  both  at  the  corporate  level  and 
shareholder level. 

80 When the profitability is equal to the cost of capital, the effective average tax rate equals the effective 
marginal tax rate. 

87 

 
                                                           
In presenting averages over different forms of assets, these assets are weighted equally, 
while  unequal  weights  are  used  for  financing:  retained  earnings  55%,  new  equity  10% 
and  debt  35%  (based  on  OECD,  1991).  As  for  true  economic  depreciation  rates  it  is 
assumed: intangibles (15.35%), industrial buildings (3.1%); machinery (17.5%), financial 
assets (0%), and inventories (0%). 

In the context of the 2016 impact assessment for the CCCTB proposal, a study using the 
methodology described  above  was  produced by  the ZEW. The first  report analysed the 
impact of debt-bias reforms on the cost of capital and effective average tax rates as well 
as  the  consequences  of  a  revenue  neutral  implementation.  Four  debt-bias  reforms  were 
considered  at  the  time:  no  interest  deductibility  (Comprehensive  Business  Income  Tax, 
CBIT), Allowance for Corporate Equity (ACE), Allowance for Corporate Capital (ACC) 
and Cost of Capital Allowance (CoCA).  

In the context of the current impact assessment, the 2020 update of the ZEW study (ZEW 
2020) on effective tax rates has been used to assess evidence on the debt-equity bias and 
the effect of existing allowances in Member States. 

88 

 
 
 
 
 
ANNEX 5: COMPLEMENTARY RESULTS FROM CORTAX 

1.  Results on economic impacts from the uncompensated approach 

The  CORTAX  modelling  approach  provides  a  compensated  and  uncompensated 
approach. In the compensated approach, CIT tax rates are adapted so as to assure ex-ante 
revenue  neutrality  of  the  policy  option  in  order  to  isolate  structural  effects  from 
budgetary effects. In the uncompensated approach CIT rates are kept fix. Two scenarios 
are  estimated,  one  where  there  all  firms  are  treated  identical  and  another  one  where 
SMEs receive a higher notional interest rate (NIR) when calculating their allowance. This 
has  been  already  discussed  in  detail  in  Section  6.1.  The  policy  options  have  been 
analysed based on the application of an EU-wide NIR and a Member State specific NIRs. 
The compensated approach did not provide results with an EU-wide NIR due to technical 
problems. Specifically, the required change in CIT rates to compensate for CIT revenues 
losses due to the equity allowance would have resulted in non-feasible CIT rates of more 
than 100%. Accordingly, the results presented in Section 6.4. are those based on Member 
State  specific  NIRs.  For  the  sake  of  clarity,  the  discussion  of  country  specific  NIRs 
versus an EU-wide NIR has been avoided in Chapter 6. Comparison of results reveal that 
the  results  of  an  EU-wide  NIR  indicate  stronger  effects  than  the  results  for  a  country 
specific  NIR.  The  third  approach  of  currency  specific  NIRs  lies  between  those  two 
approaches and has not been modelled separately.  

Table  A5.1  and  A5.3  present  the  results  for  scenario  1  and  2  base  on  member  state 
specific NIRs. Table A5.2 and A5.4 present the results for an EU-wide NIR. Comparison 
of respective tables makes clear that a switch from an MS specific NIR to an EU-wide 
NIR shifts the effects of the allowance for equity up, i.e. the impact of Options 1, 2, 3 and 
5  become  more  positive.  Option  4  is  unaffected  by  the  two  different  approaches  since 
now allowance is granted. 

Table A5.1. Economy-wide impacts of debt bias reforms without budget neutrality; MS specific 
notional interest rate; Scenario 1 – equal treatment of all businesses; GDP-weighted EU-27 
average 

(1) 
ACE  

(2) 
ANCE  

(3)  
ACC 

(4)  
NDI 

(5) 
ANCE 
+ partial 
NDI 

Cost of capital (change in percentage 
points) 

-0.397 

-0.174 

-0.437 

0.49 

-0.057 

Investment (change in % of GDP) 

6.216 

2.643 

6.336 

-7.599 

0.592 

Share of debt-financed total assets (level, 
ex-post) 

Wages (change in %) 

Employment (change in %) 

GDP (change in %) 

43.18 

2.442 

0.689 

2.388 

44.86 

42.93 

40.92 

43.32 

1.064 

2.462 

-2.985 

0.309 

0.284 

1.022 

0.717 

-1.219 

-0.051 

2.431 

-3.266 

0.165 

Source: Joint Research Centre of the European Commission (2021). 
Note: Results are GDP-weighted EU-27 averages 

89 

 
 
 
Table A5.2. Economy-wide impacts of debt bias reforms without budget neutrality; EU-wide 
notional interest rate; GDP-weighted EU-27 average 

(1) 
ACE  

(2) 
ANCE  

(3)  
ACC 

(4)  
NDI 

(5) 
ANCE 
+ partial 
NDI 

Cost of capital (change in percentage 
points) 

-0.482 

-0.212 

-0.618 

0.49 

-0.096 

Investment (change in % of GDP) 

7.436 

3.127 

9.304 

-7.599 

1.077 

Share of debt-financed total assets 
(level, ex-post) 

41.39 

43.84 

43.98 

40.92 

42.25 

Wages (change in %) 

2.815 

1.223 

3.314 

-2.985 

0.471 

Employment (change in %) 

0.807 

0.325 

1.069 

-1.219 

-0.008 

GDP (change in %) 

2.767 

1.174 

3.385 

-3.266 

0.32 

Source: Joint Research Centre of the European Commission (2021). 
Note: Results are GDP-weighted EU-27 averages 

Table A5.3: Economy-wide impacts of debt bias reforms without budget neutrality; MS specific 
notional interest rate; Scenario 1 – Rate top up for SMEs; GDP-weighted EU-27 average 

(1) 
ACE  

(2) 
ANCE  

(3)  
ACC 

(4)  
NDI 

(5) 
ANCE 
+ partial 
NDI 

Cost of capital (change in percentage 
points) 

-0.397 

-0.174 

-0.397 

0.49 

-0.057 

Investment (change in % of GDP) 

6.825 

2.899 

6.825 

-7.599 

0.844 

Share of debt-financed total assets 
(level, ex-post) 

42.87 

44.7 

42.87 

40.92 

43.15 

Wages (change in %) 

2.685 

1.172 

2.685 

-2.985 

0.418 

Employment (change in %) 

0.752 

0.307 

0.752 

-1.219 

-0.028 

GDP (change in %) 

2.617 

1.119 

2.617 

-3.266 

0.262 

Source: Joint Research Centre of the European Commission (2021). 

Table A5.4. Economy-wide impacts of debt bias reforms without budget neutrality; EU- 
wide notional interest rate; Scenario 2 – Rate top up for SMEs; GDP-weighted EU-27 average 

(1) 
ACE  

(2) 
ANCE  

(3)  
ACC 

(4)  
NDI 

(5) 
ANCE 
+ partial 
NDI 

Cost of capital (change in percentage 
points) 

-0.482 

-0.212 

-0.618 

0.49 

-0.096 

Investment (change in % of GDP) 

8.181 

3.426 

12.67 

-7.599 

1.371 

Share of debt-financed total assets 
(level, ex-post) 

40.95 

43.61 

44.19 

40.92 

42 

90 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Wages (change in %) 

3.096 

1.344 

4.346 

-2.985 

0.594 

Employment (change in %) 

0.884 

0.352 

1.315 

-1.219 

0.018 

GDP (change in %) 

3.038 

1.284 

4.341 

-3.266 

0.431 

Source: Joint Research Centre of the European Commission (2021). 

2.  Analysis of restricted equity 

In  order  to  complement  the  analysis  and  better  understand  different  parameters  of  the 
policy options, an alternative equity definition has been analysed in the context of Option 
1 and 2. These alternative options will in the following be called option 1b and 2b. 

Option  1b  provides  for  a  legislative  initiative  as  well,  but  one  that  applies  a  restricted 
equity definition to the approach described for Option 1. Restricted equity is defined as 
the  sum  of  subscribed  capital  and  share  premium  accounts.  The  calculation  of  the 
allowance would be as in Option 1 but based on this restricted equity, i.e. compared to 
Option  1,  reserves  would  be  excluded.  Under  a  restricted  definition  of  equity,  only 
external capital increases would qualify for an allowance. This would limit the fiscal cost 
of the measure and focus on fresh capital only. 

Option 2b: Option 2b would apply a restricted equity definition (same as option 1b) in 
relation  to  the  approach  described  for  Option  2.  The  calculation  of  the  allowance  base 
would use restricted equity to calculate the allowance base, i.e. compared to Option 2, all 
forms of reserves would be excluded.  

The  restricted  definition  of  equity  only  takes  into  account  registered  capital  and  share 
premium  accounts.  Due  to  data  limitations,  the  structure  of  corporate  equity  across 
countries is generally not know. The firm level data base ORBIS provides information on 
registered  capital  and  total  equity  but  not  on  share  premium  accounts.  Therefore,  the 
estimations  of  policy  options  involving  a  restricted  definition  of  equity  only  consider 
registered capital and disregard share premium accounts. More detailed micro-data from 
Italy  suggests  that  restricted  equity  could  be  10%  to  30%  higher  if  share  premium 
accounts would be added. Estimations are thus lower bound results in these cases.  

Tables  A5.7  and  A5.8  provide  CORTAX  modelling  results  for  Options  1b  and  2b 
respectively.  Column  2  reports  compensated  results  with  a  special  treatment  of  SMEs 
when  Member  State  specific  notional  interest  rates  are  applied.  Column  3  adds  a  SME 
top-up  to  compensated  results  based  on  Member  State  specific  notional  interest  rates. 
Column  4  shows  uncompensated  results  without  SME  top-up  based  on  Member  State 
specific  notional  interest  rates.  Column  5  add  an  SME  top-up  to  the  uncompensated 
results  based  on  Member  State  specific  notional  interest  rates.  Column  6  and  7  finally 
show  uncompensated  results  for  an  EU  wide  notional  interest  rate  without  and  with  a 
SME top-up, respectively. 

91 

 
 
If the restricted definition of equity is applied (Option 1b and Option 2b) the changes in 
debt-shares are small or even positive. The increase in debt-shares reported for Option 2a 
results from the fact that existing notional equity allowances in six Member States would 
be substituted with an EU wide system based on a much more limited equity definition. 

The ACE with restricted equity (1b) would result in additional investments of 0.34% of 
GDP  and  GDP  growth  of  0.11%.  If  an  allowance  would  be  granted  for  new  restricted 
equity only as in Option 2b, investments and GDP would actually decrease by -0.02% of 
GDP  for  investment  and  -0.003%  for  GDP.  Given  the  very  restricted  equity  definition, 
the  measure  would  have  a  small  positive  impact  on  investment  and  growth  in  those 
Member States without any allowance for equity in place. The substitution of the existing 
allowances  for  equity  in  Belgium,  Cyprus,  Italy,  Malta,  Poland  and  Portugal  with  the 
ANCE  based  on  restricted  equity,  however  has  a  strong  contractive  effect.  Overall,  the 
negative  effect  on  the  six  Member  States  with  an  equity  allowance  in  place,  would 
overcompensate the positive effects, so that for the EU-27 a negative impact is observed. 

Table A5.7. Economy-wide impacts of ACE as in Option 1 with restricted equity 
definition  

Comp 
No-SME 
MS NIR 

Comp 
SME 
top-up 
MS NIR 

Uncomp 
No-SME 
MS-NIR 

Uncomp 
SME 
top-up 
MS-NIR 

Uncomp 
No-SME 
EU-NIR 

Uncomp 
SME 
EU-NIR 

Change in CIT rate (change in 
percentage points) 

Cost of capital (change in 
percentage points) 

Investment (change in % of 
GDP) 
Share of debt-financed total 
assets (level, ex-post) 

0.884 

0.988 

0 

0 

0 

0 

-0.028 

-0.025 

-0.048 

-0.048 

-0.061 

-0.061 

0.336 

0.379 

0.732 

0.82 

0.879 

0.978 

46.35 

46.33 

46.24 

46.19 

46.14 

46.09 

Wages (change in %) 

0.112 

0.129 

0.303 

0.341 

0.349 

0.391 

Employment (change in %) 

0.017 

0.017 

0.079 

0.086 

0.089 

0.097 

GDP (change in %) 

0.112 

0.126 

0.288 

0.322 

0.33 

0.367 

Source: Joint Research Centre of the European Commission (2021). 
Note: Results are GDP-weighted EU-27 averages 

Table A5.8. Economy-wide impacts of ANCE as in Option 2 with restricted equity 
definition  

Comp 
No-SME 
MS NIR 

Comp 
SME 
top-up 
MS NIR 

Uncomp 
No-SME 
MS-NIR 

Uncomp 
SME 
top-up 
MS-NIR 

Uncomp 
No-SME 
EU-NIR 

Uncomp 
SME 
EU-NIR 

Change in CIT rate (change in 
percentage points) 

Cost of capital (change in 
percentage points) 
Investment (change in % of 
GDP) 

-0.077 

-0.047 

0 

0 

0 

0 

0.002 

0.003 

0.005 

0.005 

0.002 

0.002 

-0.016 

-0.008 

-0.045 

-0.023 

-0.015 

0.009 

92 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Share of debt-financed total 
assets (level, ex-post) 

46.52 

46.52 

46.62 

46.61 

46.6 

46.59 

Wages (change in %) 

-0.004 

-0.001 

-0.016 

-0.006 

-0.007 

0.003 

Employment (change in %) 

0.001 

0 

-0.005 

-0.003 

-0.003 

-0.001 

GDP (change in %) 

-0.003 

-0.001 

-0.017 

-0.008 

-0.009 

0 

Source: Joint Research Centre of the European Commission (2021). 
Note: Results are GDP-weighted EU-27 averages 

3.  Calibration of the preferred Option 5  

The preferred Option 5 is the only option which achieves a far-reaching mitigation of the 
debt-equity bias without incurring substantially cost on society either by contracting the 
economy  (full  non-deductibility)  or  contracting  public  budgets.  It  provides  an 
equilibrated  approach  tackling  the  debt-equity  bias  simultaneously  from  the  equity  and 
debt  side,  and  while  doing  so  balances  out  the  budgetary  effects  of  both  actions.  The 
correct  calibration  of  this  approach  has  not  yet  been  determined  due  to  data  limitation 
and the requirements for further political decision making. Research is ongoing.   

On the equity side the decisive parameters are the notional interest rate, the duration of 
allowance  and  the  year  to  year  increase  in  equity.  The  growth  rate  on  equity  is 
determined by economic agents investing. The duration of the measure has been fixed to 
10 years. For the notional interest, currently two options are being considered. The NIR 
is determined by a risk free rate plus x. For the risk free interest rate the EIOPA risk free 
rate for the Euro area would be applied to all Member States. The risk premium is would 
be either 2 percentage points or 3 percentage points. 

On  the  debt  side,  the  interest  deductibility  could  be  reduced  either  through  a  more 
stringent application of the ATAD 1 ILRs or through a specific DEBRA ILR. The latter 
could  take  up  design  elements  from  ATAD  or  simply  propose  a  proportional  interest 
limitation applying to all companies uniformly.  

The specific calibration has not been determined. Table A5.9 shows the implications of 
different parameter values in the context of CORTAX modelling. Specifically, a notional 
interest rate of 2.2% and 3.2% is considered and an interest limitation of 10% and 25% 
(i.e. instead of all interest only 90% or 75% could be deducted). As already discussed in 
Chapter 6 and Annex 6, CORTAX does not  model  ATAD 1 and thus  does not  include 
ILRs in its base line. The situation where ATAD exists and interest deductibility would 
thus  be  differently  parametrises  in  CORTAX  compare  to  the  empirical  reality.  We 
consider IRLs of 10% and 25% useful lower and upper bounds to guide further research 
on the matter. 

Table A5.9 indicates that higher NIRs would lead to more effective but also more costly 
measures. A higher IRL would reduce cost but also reduce costs. Both work together in 
mitigating the debt-equity bias. It is noteworthy that the change of the NIR from 2.2% to 
3.2% has much more pronounced effects that the switch from 25% ILR to 10% ILR.  

Table A5.9. Economic impacts of Option 5 – uncompensated approach, EU-wide NIR 
3.2% NIR 
10% ILR 

3.2% NIR 
25% ILR 

2.2% NIR 
25% ILR 

2.2% NIR 
10% ILR 

93 

 
 
 
Cost of capital (change in 
percentage points) 

Investment (change in % of 
GDP) 

Share of debt-financed total 
assets (level. ex-post) 

Wages (change in %) 

Employment (change in %) 

GDP (change in %) 

1.371 

1.371 

42 

0.594 

0.018 

0.431 

2.287 

2.287 

43.17 

0.917 

0.187 

0.824 

CIT revenue (change in % of 
GDP) 
Total tax revenue (change in % 
of GDP) 
Source: Joint Research Centre of the European Commission (2021). 
Note: Results are GDP-weighted EU-27 averages 

-0.163 

0.066 

-0.386 

0.003 

2.772 

2.772 

40.73 

1.12 

0.184 

0.964 

-0.437 

0.03 

3.982 

3.982 

41.67 

1.561 

0.376 

1.461 

-0.709 

-0.035 

94 

 
 
 
ANNEX 6: STATISTICS ON CORPORATE INDEBTEDNESS 

1. 

Interest limitation rules 

There is  very limited public information  on the quantitative  implications of the interest 
limitation  rules  (ILR)  of  ATAD  1.  This  section  uses  ORBIS  company  data  to  gather 
some insights. 

1.1. 

Sample 

For 2018, there have been about 25 million active companies in the EU, with about 2.5 
million  newly  born  in  2018.  ORBIS  contains  about  2.5  million  observations  of 
enterprises in the EU for 2019. Relevant information for the application of ATAD rules 
(EBITDA, EBIT, interest payments) is available for 1.97 million companies. A total of 
1.49 million  companies  have positive values  for  EBITDA, EBIT and interest  payments 
and thus constitutes the relevant (non-representative) sample of analysis. 

The  sample  of  1.49  million  companies  is  not  representative  for  the  EU-27.  There  are 
basically  no  observations  (less  than  20)  for  BG,  EE,  HR,  HU,  NL  and  PL.  Most 
observations are from Italy (31%), Spain (19%), Portugal (8.7%), France (8.6%), Sweden 
(8.6%), Romania (7%) and Denmark (4.5%). Given that the sample is not representative, 
we have no indication how well the statistical analysis can describe the empirical reality. 

The  sample  contains  about  93%  SMEs  (operating  revenues  of  not  more  than  EUR  50 
million) and about 7% larger firms. The larger firms account for 72% of revenues and for 
about 70% of all interest payments registered in the data. 

1.2. Understanding DEBRA ILR – Interaction with ATAD 1 (ORBIS) 

If DEBRA ILR would exist in parallel to ATAD 1, the more biting rule for the taxpayer 
should  apply.  From  a  practical  point  of  view,  the  simultaneous  application  of  two  or 
more rules is regularly done by tax authorities and does not pose a problem.  

Different sources (Member State authorities, more granular company data) indicate that 
about 10%-17% of net interest expenses could be covered by ATAD. Only a very small 
share of companies are captured by ATAD. These companies are responsible for a high 
share of interest payments and a large share of interests paid per company are captured 
by ATAD. Thus only a few companies move from ATAD to DEBRA ILR. Since these 
companies  had  their  interest  deduction  already  restricted,  only  very  limited  additional 
revenues (i.e. new money) will result from these companies which move from ATAD to 
DEBRA ILR.  

95 

 
 
 
 
2. Calibration of notional interest rate and interest limitation for Option 5 

2.1. Data and limitations 

There are three approaches available to support the analysis of DEBRA. The CORTAX 
model, national financial account data and ORBIS company data. This section will shorty 
discuss  what  each  approach  can  do  and  what  limits  there  are.  With  national  financial 
accounts not differentiation between large firms and SMEs can be made. For consistency 
the  following  analysis  thus  disregards  the  SME  top-up.  As  results  in  Section  6  have 
shown, the SME top-up scales up results but does not change the general message.  

CORTAX: CORTAX is a general equilibrium model, i.e. it is highly stylized (e.g. there 
is one representative household and two companies in each economy).  The model has a 
very detailed description of the tax systems and allows the analysis of tax policies. The 
results  the  model  provides  are  country  level  changes  in  tax  rates,  tax  revenues, 
investment,  employment,  wages  and  GDP.  There  is  however  no  time  in  the  model  and 
changes have to  be interpreted as change between the old  equilibrium pathway  and the 
new  equilibrium  pathway.  The  model  assumes  full  information,  i.e.  everybody  knows 
everything,  prices  contain  all  relevant  information  and  there  is  no  uncertainty.  In  the 
model,  an  allowance  for  equity  mechanically  reduces  the  cost  of  equity  and  effective 
taxation,  which  leads  to  more  investment,  employment  and  growth.  On  the  contrary,  a 
limitation  of  interest  deductibility  increases  the  cost  of  debt  and  effective  taxation  and 
leads to lower levels of investment, employment and growth. The model provides useful 
information  for  comparing  policy  options.  The  validity  of  specific  point  estimates 
however should be considered cautiously but due to its limitations should not be used for 
calibrating specific policy parameters. 

National  financial  accounts:  National  financial  accounts  (NFAs)  are  an  element  of 
national  accounting,  i.e.  bookkeeping  on  the  country  level.  NFAs  contain  aggregate 
information on equity, interest paid and interest received per sector of the economy. All 
observations are static, i.e. no growth effects can be considered. The data is provided by 
Eurostat and has the best data quality. For the calibration of the debt and equity side of 
option  5  there  are  however  a  few  problems.  Equity  in  NFAs  contains  a  few  elements, 
which would likely not qualify as equity under option 5. In addition, equity is reported as 
the market value of traded and non-traded shares. The market value of shares might differ 
considerable  from  the  book  value  of  equity,  which  is  the  relevant  base  for  the  equity 
allowance.  For  interest  payments  there  is  a  problem  with  the  aggregation.  Interest 
limitation  will  be  applied  to  net  interest  expenses,  i.e.  interest  paid  minus  interest 
received.  Since  both  values  are  only  available  in  the  aggregate,  many  relevant  interest 
payments  might  be  averaged  out  (example:  company  A  has  100  interest  paid  and  10 
interest received; B has 20 interest paid and 50 interest received. In total, there are 120 
interest paid and 60 interest received. Applying an ILR at the company level would result 
in (100-10=) 90 falling under the ILR. In the aggregate, only (120-60=) 60 fall under the 
ILR). In DE, LV, NL and SI net-interest expenses are smaller than zero, i.e. overall non-
financial corporations (NFCs) received more interest than they paid. This will not be the 
case for all companies. Aggregation thus results in lower levels of net-interest payments 

96 

 
than we would see on the company level. The estimated values are thus lower bounds for 
potential  tax  revenue  gains  through  an  ILR.  Gross  interest  payments  are  about  4  times 
larger than net-interest payments, which would constitute an upper bound on potential tax 
revenue gains from an ILR. The “truth” will lay somewhere in the middle.    

ORBIS data: ORBIS provides company level data and thus needs to be used whenever 
the analysis is contingent on specific company characteristics. All observations are static, 
i.e. no growth effects can be considered. A problem of ORBIS is sample bias and simple 
incompleteness.  ORBIS  is  a  collection  of  all  publicly  available  information  about 
companies.  Since  reporting  requirements  differ  across  countries  and  legal  forms  of 
companies,  there  is  generally  no  guarantee  about  the  representativeness  of  the  sample. 
On  the  contrary,  it  seems  very  likely  that  the  sample  is  biased  because  company 
characteristics  as  well  as  specific  country  requirements  will  decide  what  information  a 
company is reporting and thus what information is part of ORBIS. This data can thus not 
be used to obtain absolute values (like the equity allowance costs in billion EUR) since 
only a (unknown) fraction of companies is covered and the coverage differs across MS. 
However, ORBIS can still be used to analyse ratios, like e.g. what is the proportion of the 
reduction  in  interest  limitation  to  the  equity  allowance.  Another  major  problem  in  the 
current context is that ORBIS does not have information about interest received but only 
about interest paid.  In order to  approach net interest payments, the share of net interest 
expenses  from  national  financial  accounts  could  be  used  (interest  received  is  75%  of 
interest  paid  so  that  net  interest  paid  make  25%  of  gross  interest  paid).  This  of  course 
would transfers the problem of averaging out interest received and paid across companies 
from the macro data to the micro data.  It is thus assumed that net interest expenses are 
equal to 50% of gross interest expenses. 

2.2. Why move from alternative 5a (2.2% NIR / 25% ILR) to alternative 5b (1.2% NIR/ 

15% ILR) 

This section will discuss several pieces of evidence around Option 5 which justify why 
the preferred option is alternative 5b, i.e. a notional allowance on equity with a notional 
interest  rate  defined  by  the  risk-free  rate  plus  1%  risk  premium  combined  with  a 
limitation on interest deductibility of 15%. While CORTAX suggests that a higher NIR 
and  higher  ILR  are  more  effective  in  mitigating  the  debt-equity  bias  without  much 
additional  fiscal  costs,  static  evidence  presented  in  the  following  paints  a  different 
picture.  Since  many  real  life  events  can  break  the  mechanical  model  link  between  the 
reduction of the costs of capital and investment and growth (e.g. pandemic, war etc.) the 
policy  evaluation  should  not  rely  too  much  on  the  assumption  of  growth.  It  is  thus  a 
measure  of  caution  and  the  aim  to  prevent  excessive  fiscal  costs  which  lead  to  a 
preference  for  alternative  5b.  Note  that  the SME top-up is  not considered separately  in 
this  exercise  due  to  data  limitations.  Inclusion  of  the  SME  top-up  shifts  up  results 
proportionally. The line of argument remains unaffected. 

97 

 
2.2.1. Evaluation with CORTAX 

The  CORTAX  model  has  been  used  to  estimate  macro-economic  impacts  of  DEBRA. 
Table A6.1 exhibits the main findings for two different designs of DEBRA:  

Alternative 5a: a 10 year equity allowance with NIR = 2.2% and DEBRA ILR = 25%. 

Alternative 5b: a 10 year equity allowance with NIR = 1.2% and DEBRA ILR = 15% 

Column  ‘Inv’  reports  investments  (i.e.  the  percent  change  in  capital  stock),  column 
‘Wage’  reports  the  percentage  change  of  the  wage  rate,  ‘Empl.’  reports  the  percentage 
change  in  employment,  ‘GDP’  reports  GDP  change  in  percent,  ‘Rev_CIT’  reports  the 
change  in  CIT  tax  revenues  expressed  in  %  of  GDP,  ‘Rev_tax’  reports  the  change  in 
overall tax revenues expressed in % of GDP and finally, ‘Diff’ reports the change in the 
share of debt used in the economy.  

Inspection of Table A6.1 indicates that both approaches mitigate the fiscal impact of the 
measure. A lower notional interest rate and less interest deduction has less impact on the 
economy and on the mitigation of the debt-equity bias. 

Table A6.1: Comparing the alternatives with CORTAX  

Alt. 5a: 
2.2% NIR/25% NIR 
Alt. 5b: 
1.2% NIR/15% ILR 

Inv. 

Wage 

Empl. 

GDP  Rev_CIT  Rev_tax 

Diff 

1.077 

0.471 

-0.008 

0.32 

-0.111 

0.068 

4.17 

0.296 

0.128 

-0.005 

0.084 

-0.038 

0.018 

2.09 

Alternative  5a  thus  has  a  more  pronounced  effect,  leading  to  higher  investments  more 
growth  and  a  stronger  reduction  of  the  debt-equity  bias  than  alternative  5b.  While  CIT 
revenues  are  being  lost,  overall  tax  revenues  are  positive  and  more  so  for  option  5a. 
Specifically, in 2021 values estimates would amount to CIT revenue losses of about EUR 
16 billion for  alternative 5a and about  EUR 5.5  billion for option 5b. Due to  increased 
investment and associated growth, overall tax revenues are predicted to increase for both 
options. In 2021 values the overall increase in tax revenues for alternative 5a is estimated 
to be about EUR 9.8 billion, for alternative 5b about EUR 2.6 billion.  

CORTAX would suggest that alternative 5a is preferable to alternative 5b. These results 
obviously  depend  strongly  on  the  growth  mechanics  resulting  from  the  maximizing 
behaviour  of  the  agent  in  the  model.  Note  however,  that  there  is  no  uncertainty  in  the 
model  so  that  exogenous  crisis,  which  could  prevent  additional  investments  for  other 
reasons cannot be taken in consideration. 

2.2.2. Evidence from national financial accounts 

National  financial  accounts  are  used  to  compare  the  potential  tax  revenue  costs  of  an 
allowance for equity with potential revenue gains resulting from a proportional limitation 
on interest deductibility. This exercise is undertaken for alternative 5a and alternative 5b 
differently.  Several  assumptions  are  required  to  derive  results.  The  analysis  shows  that 

98 

 
 
 
even  under  optimistic  assumptions  a  substantial  fiscal  gap  to  finance  the  equity 
allowance remains in this static approach.  

Optimistic  scenario  (this  scenario  assumes  low  equity  costs  and  high  revenues):  only 
50% of equity is relevant for DEBRA, equity growth with 4% p.a., NIR is 1% or 2%81, 
10  years  duration.  All  companies,  which  have  been  captured  under  ATAD  would  now 
fall  under  the  proportional  DEBRA  ILR  with  15%  or  25%  of  interest  being  non-
deductible. Since interest deductibility has already been limited under ATAD, additional 
revenue  gains  are  limited,  only  “new  money  is  considered”.  In  addition,  higher  net 
interest  payments  are  assumed  than  what  is  reported  in  the  data.  As  discussed,  interest 
received is 75% of interest paid overall. Since there might be companies with very high 
positive net interests and others with negative net interests, the actual contribution of an 
ILR  might  be  higher  than  the  aggregated  difference  between  interest  paid  and  interest 
received. In the optimistic scenario it is thus assumed that net interest payments are 50% 
of gross interest payments (as opposed to 25% as indicated by the data). 

Pessimistic  scenario82  (this  scenario  assumes  higher  equity  costs  and  lower  revenues 
from interest limitation): 80% of equity is relevant for DEBRA, 4% growth, NIR is 1% 
or 2%, 10 years duration. All companies, which have been captured under ATAD remain 
under ATAD. Net interest expenses are 25% of gross interest paid. 

The central assumptions of the optimistic and a pessimistic scenario focus on the share of 
relevant  equity,  the  growth  rate  of  equity  and  the  relationship  between  gross  and  net 
interest  payments.  The  policy  parameters  of  interest  are  of  course  the  notional  interest 
rate (NIR) and the proportional interest limitation rule, as expressed in option 5a and 5b.  

Table  A6.2  reports  the  financing  gap  in  billion  EUR  that  could  result  for  given  policy 
options  and  scenarios.  The  brackets  report  the  share  of  fiscal  costs  of  the  equity 
allowance which would  be covered in  the specific context.  It  becomes obvious that the 
share  of  the  costs  covered  is  similar  for  both  options.  However,  in  absolute  terms  the 
potential financing gap of alternative 5a is more than twice as high as for alternative 5b. 

Table A6.2: Financing gap in billion EUR (share of equity costs covered) 
Pessimistic 
43.6 (4.3%) 
21.6 (5.1%) 

Optimistic 
23.1 (19.0%) 
11 (22.8%) 

Alternative 5a 
Alternative 5b 

These static results indicate a potential financing gap and thus highlight the importance 
of  economic  growth  for  the  CORTAX  results.  If  in  an  uncertain  environment  effective 
tax  rate  reductions  and  lower  costs  of  equity  do  not  mechanically  translate  into  more 
investments  for  exogenous  reasons  like  a  war,  drought  or  other  major  disruptions, 

81 For simplicity a risk free rate of 0% has been assumed. A risk free rate of 0.2% as assumed in CORTAX 
and the ORBIS calculation would result in even higher allowance costs. The financing gap accordingly 
increases and the arguments gets even stronger.  
82 The pessimistic scenario has a priori the more probable assumptions. 

99 

 
 
 
                                                           
CORTAX  results  might  be  too  optimistic  about  the  revenue  impacts  of  alternatives  5a 
and 5b.  

2.2.3 Evidence from ORBIS 

ORBIS allows for a company level analysis. While the data suffers from sample bias and 
net  interest  expenses  cannot  be  directly  observed,  the  data  might  still  be  useful,  to 
understand  proportions.  In  line  with  the  assumption  in  the  optimistic  scenario  for  the 
national  financial  accounts,  net  interest  expenses  are  approximated  as  50%  of  gross 
interest expenses. 

If  we  sum  up  all  equity  allowances  and  all  interest  limitations,  what  is  the  share  of 
revenue losses of the equity allowance which can be covered by the reduction in interest 
deductibility overall? Table A6.3 reports the shares of expenditure losses covered under 
the two policy options (columns 2 and 3). Columns 4 and 5 report the share of companies 
for  which  the  equity  allowance  is  larger  than  the  non-deducted  interest  payments.  It 
becomes  obvious  that  a  considerable  majority  of  companies  profits  from  the  measure. 
Note  however  that  a  growth  rate  of  4%  for  equity  is  assumed,  i.e.  all  companies  are 
assumed to increase their equity in each year.    

Table A6.3: Share of expenditure losses covered by DEBRA ILR (overall) 

Alternative 5a 
(2.2%/25%) 
Alternative 5b 
(1.2%/15%) 

share covered overall 

share winner 

net 

34,7% 

38,2% 

gross 

69,4% 

76,3% 

net 

79,7% 

78,2% 

gross 

67,9% 

66,2% 

ORBIS data suggests a higher coverage of the costs of the equity allowance as compared 
to what the estimates based on national financial accounts have suggested.  

2.2.4 Conclusion 

The combination of three three available data-sources indicates that the calibration of the 
preferred  option  achieves  an  optimal  trade-off  among  conflicting  objective,  while 
accounting  for  possible  (model)  uncertainties.  While  in  the  dynamic  context  both 
alternative calibrations of option 5 indicate revenue neutralitiy, a static picture indicates 
potential  substantial  fiscal  costs,  possible  only  in  the  short  term.  A  calibration  with  a 
lower  notional  interest  rate  and  a  limitation  of  interest  deductability  to  85%  of  net 
financing costs (15% ILR) reduces the risk of substantial fiscal costs.  

The  preceeding  paragraph  does  not  consider  the  SME  top-up  separately  due  to  data 
limitations  with  national  financial  accounts.  In  general,  the  SME  top-up  will  shift  up 
results  and  make  the  argument  for  a  more  prudent  approach  based  on  1%/1.5%  risk 
premium and 15% interest limitation rule even stronger.  

100 

 
 
 
 
3. Disentangle the effect of equity allowance and ILR on debt bias 

While it is inherently difficult to disentangle the effect of the equity allowance from the 
effect of the interest limitation rule, four different model runs of CORTAX can be used 
to develop some preliminary understanding of the issue. 

Table  A6.4  reports  the  reduction  in  the  debt  share  in  the  EU-27  for  given  parameter 
values of option 5. The first four specifications will be used to disentangle the effect of 
the NIR and the ILR. 

Table A6.4: Reduction in debt share for different calibrations of Option 5 in CORTAX  

change in debt share 
(in percentage points) 

3.2%/25% 

2.2%/25% 

3.2%/10% 

2.2%/10% 

5.69 

4.17 

4.75 

3.25 

The  results  are  presented  in  Table  A6.5.  In  line  three  the  specification  with  3.2%  NIR 
and 25% ILR is compared with the specification with 2.2% NIR and 25% ILR. The NIR 
is thus reduced by 31.3% while the ILR is held constant. This leads to a reduction in the 
change in the debt share by 1.52 percentage points (5.69-4.17=1.52)  

There are thus two main insights: The notional interest rate has a stronger effect on the 
reduction of the debt shares compared to the interest limitation rule. While a reduction of 
the NIR by 31.3% (from 3.2% to 2.2%) leads to a change in the debt change of about 1.5 
percentage points,  a reduction in  the ILR by 60% (from  25% to  10%) results only in  a 
change  in  the  debt  change  of  about  0.95  percentage  points.  Secondly,  there  is  a 
complementarity between the NIR and the ILR. A given change in the NIR has a larger 
effect if the ILR is higher. Similarly, a given change in the ILR is more impact full when 
the NIR is higher. 

Table A6.5: The effect of changes in NIR and ILR on changes in the debt share 

effect of NIR change 

Change in NIR 

from 
3.2%/25% 
3.2%/10% 

to 
2.2%/25% 
2.2%/10% 

31.3% 
31.3% 

effect of ILR change 

Change in ILR 

from 
3.2%/25% 
2.2%/25% 

to 
3.2%/10% 
2.2%/10% 

60% 
60% 

Change in 
debt share 
(in pp) 

1.52 
1.5 
Change in 
debt share 
(in pp) 

0.94 
0.92 

ANNEX 7: OVERVIEW OF EXISTING MEASURES IN MEMBER 

STATES 

101 

 
 
 
 
 
 
 
 
1.  Existing measures of interest allowance for equity in EU Member States 

   Table A7.1: Overview of existing notional interest allowances 

Country  Period 

Details 

Belgium 

Since 
2006 

Cyprus 

Since 
2015 

Italy 

Since 
2011 

Malta 

Poland 

Portugal 

Since 
2018 

Since 
2019 

Since 
2017 

The notional interest deduction allows all businesses subject to 
Belgian corporate income tax to deduct a fictitious amount of interest, 
calculated based on their shareholders' equity (net assets) from their taxable 
income. In 2013, legislative changes ruled out the carrying-forward of 
unused allowances. The base rate for the NIR is the ten year linear treasury 
bond. Small firms receive an additional 0.5% risk premium on their 
notional rate. By law, the notional interest rate cannot exceed 3%. Since 
2018, the deduction no longer applies to the full equity stock but on the 
incremental adjusted net accounting equity of a company over a period of 5 
years. It includes anti-avoidance provisions to prevent the cascading of the 
tax benefit and the re-categorisation of old capital in new capital. 

Applicable new equity is calculated against 2015 as a base year. The 
notional interest deduction is limited to 80% of the taxable profit generated 
from the new equity as calculated before the application of the notional 
interest deduction and applies only to fully-owned subsidiaries if their 
assets are used for business (non-financial) purposes. The notional interest 
rate is the 10-year government bond rate plus a 5% risk premium. The 10-
year Cypriot government bond rate only applies if the country in which the 
new equity is invested has not issued any government bond up until 
December 31 of the previous year. 

The NID is applicable on new equity compared to the end of 2010 situation. 
The considered new equity includes the equity contributions and retained 
earnings, excluding the profits allocated to a non-disposable reserve. It 
deducts reductions to the net equity with assignment to shareholders 
(especially dividend distributions), investment in controlled businesses, and 
certain intra-group business acquisitions and  transactions. The notional 
interest rate is fixed annually by the authorities. 

Notional interest deduction is applied on the stock of equity. The notional 
interest rate is set to the rate of 20 year Maltese government bonds (1.37% 
in Q3 2020), plus a risk premium of 5%. 

Incremental NID. The notional return is deductible up to approximately 
EUR 55000. The notional interest rate is the National Bank of Poland’s 
reference rate (as applicable on the last day of the preceding calendar year), 
plus 1 p.p. The allowance is applied for three years. 

The notional return is deductible up to EUR 2 million and capped at 25% 
of firm EBITDA. It applies to capital increases for 6 years, provided equity 
capital is not reduced in that period. The notional rate is fixed by law. 

Notional interest 
rate and equity 
base 

NIR in 2020 is 0.0% (0.5 
p.p. higher for SMEs, 
i.e. 0.34%), new equity 

NIR in 2020 is 5%.  
min. 4.5%; max. 
18.5%, new equity 

1.3%, new equity 

6.47% (in 2020) 

2.5%, full equity stock 

7.0%, new equity 

102 

 
 
 
 
 
2.  Transposition of ATAD 1 interest limitation rules in EU Member States 

Table A7.2: Transposition of the ATAD 1 interest limitation rule 

Which deductibility 
threshold is used? 
(deductibility up to 30% 
of the EBITDA under 
article 4(1) of the ATAD) 

Is a safe harbour threshold 
implemented?  
(article 4(3)(a) of the ATAD) 

Austria 

Belgium 

Bulgaria 

Croatia 

Cyprus 

Czech 
Republic 
Denmark 

Deductibility up to 30% 
of the EBITDA 
30% of the calculation 
base1 
Deductibility up to 30% 
of the EBITDA 
30% of the calculation 
base1 
30% of EBITDA 

Yes - EUR 3 million 

Yes - EUR 3 million 

Yes - EUR 3 million 

Yes 

Yes - EUR 3 million 

30% of the EBITDA 

Yes - CZK 80 million 

30% EBITDA 

Estonia 

30% EBITDA 

Finland 

25% of the EBITD 

France 

30% of the EBITDA 

Yes. Full deductibility up to 
DKK 22,313,400 (equivalent 
to EUR 3 million) 
Yes, EUR 3 million 

Yes - EUR 500,000 for loans 
between related parties and 
EUR 3 million for loans from 
unrelated parties 
Yes - EUR 3 million 

Germany 

30% of the EBITDA 

Greece 

30% of EBITDA 

Hungary 

30% of the EBITDA 

Yes 
Full deductibility of exceeding 
borrowing costs up to EUR 3 
million 
Yes - EUR 3 million 

HUF 939,810,000 (approx. 
EUR 3 million at the time of 
the implementation) 

Ireland 

Interest limitation rule is 
not based on a threshold, 
but on qualification 
criteria 

No 

Are financial 
undertakings 
excluded 
from the 
scope of the 
rule?  
(article 4(7) of 
the ATAD) 
No 

Is it possible to 
carry-forward or 
carry-back 
borrowing costs 
that are not 
deducted?  
(article 4(6) of the 
ATAD) 
Yes 

Yes 

Yes 

Yes 

Yes 

Yes 

Yes 

Yes 

Yes 

No 

Yes 

Yes 

Yes 

Yes, carried forward 
indefinitely 
Yes, carried forward 
indefinitely 
Yes, carried forward 
for 3 years 
Carry-forward is 
possible. 

Yes, carried forward 
indefinitely 
Yes, carried forward 
indefinitely 

No 

Yes (only carry-
forward) 

Yes 
1) Non-deducted 
borrowing costs: 
carried forward 
indefinitely 
2) Unused interest 
capacity: carried 
forward up to 5 years 
Yes 

Yes, carried forward 
indefinitely 
Carry-forward is 
generally available 
for 5 years 

No 

No 

Italy 

30% of the EBITDA 

No 

Yes 

Yes, carried forward 

103 

 
 
 
 
Latvia 

30% of the EBITDA 

Yes, EUR 3 million 

Lithuania 

30% of the EBITDA 

Luxembourg 

30% of the calculation 
base1 

Yes, full deductibility of 
exceeding borrowing costs up 
to EUR 3 million 
Yes, EUR 3 million 

Malta 

30% of  EBITDA 

Yes, EUR 3 million 

Netherlands 

30% of the calculation 
base1 

Yes - EUR 1 million 

Poland 

30% of the EBITDA 

Yes - EUR 3 million 

Portugal 

30% of the EBITDA 

Yes - EUR 1 million 

Romania 

Slovak 
Republic 

Slovenia 

Spain 

Sweden 

30% of the calculation 
base1 
Interest deductions 
limited to 25% of 
EBITDA 
No3 

30% of the calculation 
base (i.e. adjusted 
operating income)3 
30% of the EBITDA 

Yes - EUR 1 million 

No 

No 

Yes - EUR 1 million 

Yes - SEK 5 million 

No 

Yes 

Yes 

Yes 

No 

Yes 

Yes 

No 

Yes 

No 

No 

No 

No 

Yes, carry-forward 

Yes, carried forward 
indefinitely 

Yes, carry-forward is 
possible. 
Yes - Carried 
forward indefinitely 

Yes, carried forward 
for 5 years 
Yes, carry-forward 
for the following 5 
tax periods 
Yes, carried forward 
indefinitely 
n.a. 

No 

Carried forward 
indefinitely 

Yes, carried forward 
for a maximum of 6 
years 

1. 

2. 
3. 

Calculation base = the difference between the gross accounting profit and the tax-exempt income to which corporate income 
tax, exceeding borrowing costs and deductible tax depreciation, is added back. 
Slovenia has a thin capitalization rule in place but has not yet transposed the ATAD rule. 
“Operating income” is defined as earnings from the income statement of the year, after the deduction of (i) amortization and 
depreciation expenses for fixed and other non-current assets, (ii) subsidies for non-financial fixed assets and others, and (iii) 
any impairment losses on, and gains on disposals of fixed and other non-current assets, and the addition of any financial 
income from investments in equity instruments. This financial income only includes income from dividends, or profit 
participations where the taxpayer directly or indirectly holds at least 5% of the distributing company, or the acquisition cost of 
the holding in a company was higher than EUR 20 million

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ANNEX 8: ANTI TAX AVOIDANCE RULES 

1.  General Anti Avoidance Rule (GAAR) 

A  first  layer  of  the  anti-abuse  framework  should  be  a  general  anti-abuse  provision  that 
would  deny  notional  deduction  for  operations  carried  out  without  any  substantial 
economic purpose or carried out with related parties and that have the main purpose of 
converting  old  equity  into  new  equity  with  the  aim  of  benefiting  from  the  notional 
deduction. 

2.  Special Anti Avoidance Rules (SAARS)  

The Code of Conduct Group issued a Guidance on notional interest deduction regimes83 
based  on  past  decisions  of  the  Code  of  Conduct  Group  concerning  Notional  Interest 
Deduction regimes (NID) in EU Member States and in some neighbouring countries. It 
presents a non-exhaustive list of elements and characteristics which indicate that a NID 
may be harmful when assessed against the criteria of the Code of Conduct Group.  This 
Guidance  will  serve  as  a  basis  for  the  development  of  the  anti-abuse  framework  of 
DEBRA.  The  following  elements  could  be  deducted  from  the  base  of  the  allowance. 
Reflection is on-going on which elements will finally be incorporated in the Directive.  

a)  Intra-group loans and loans involving related enterprises;  

This  measure  is  designed  to  prevent  that  an  equity  injection  granted  to  company  A 
located  in  the  EU  is  used  by  company  A  to  grant  a  loan  to  a  related  company  B. 
Company B uses this money to inject equity in another related company C, located in the 
EU. This would allow multiplying the allowance on equity with only one genuine equity 
increase.  A  related  company  is  defined  using  the  associated  enterprises  definition  (see 
chapter 5).   

b)  Cash contributions and contributions in kind;  

Cash contributions can be used to cascade the allowance within multinational groups. A 
group  could  circulate  a  cash  contribution  through  related  companies  to  multiply  the 
allowance deduction at the level of different subsidiaries. 

Contributions in kind can also be used to abuse the allowance deduction. The value of the 
asset  should  not  exceed  the  market  value,  the  value  of  the  asset  and  the  related  costs 
should  not  exceed  reasonable  professional  needs.  The  part  of  the  value  of  the  asset 
contributed in the accounting books of the company that exceeds the market value of this 
asset will be deducted from the base of the allowance. 

83 WK 11093/2019 REV 1 of 19 October 2019 

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c)  Capital  increase subscribed by the company or one of its associated enterprises 

(as defined above); 

This measure aims at preventing that a company or a group of company subscribes to its 
own equity increase with the aim of benefiting from the deduction of the allowance on 
equity. 

d)  Intra-group transfer of participations;  

This measure aims at avoiding that measure the exclusion of participations embedded in 
the allowance base definition is circumvented. Since intra-group participations should be 
deducted from the allowance base, a group could maximise the deduction by transferring 
participations  to  companies  that  cannot  claim  an  allowance  deduction  in  order  to 
maximise the allowance deduction at the level of the group. 

e)  Prevent  re-categorisation  of  old  capital  as  new  capital  through  liquidations  and 

the creation of new companies; 

f)  Exclude acquisitions of businesses held by associated enterprises; 

This measure aims at avoiding that a company A of the group tax resident of a non-EU 
country transfers one of its businesses to company B of the group that is tax resident in a 
EU member to increase its allowance base. The price paid by company B to company A 
would come from an equity increase of company B that would lead to a notional interest 
deduction although there is  no actual investment, since the business  remains within the 
same group of companies. 

g)  Assets not linked to the activity; 

The  accounting  value  of  investments  which  by  nature  are  not  expected  to  produce 
recurring income (e.g. artwork, jewellery, gold, collector items …) will be deducted from 
the allowance base (passive investments). 

This  measure  aims  at  avoiding  that  the  allowance  on  equity  is  granted  on  a  capital 
increase  used  to  finance  luxury  goods.  The  aim  of  DEBRA  is  to  stimulate  productive 
investments, financed through equity.  

3.  SAAR based on the Arm’s Length Principle (ALP) 

The  idea  is  to  mirror  the  thin  capitalization  test  but  with  the  purpose  to  avoid 
overcapitalisation (also called fat capitalisation) and only allow for a deduction when the 
debt  to  equity  ratio  falls  within  a  certain  range  (thick  capitalization  rule).  Reflection  is 
on-going on this point. 

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ANNEX 9: MAIN CONCEPTS DEFINITIONS 

CORTAX 

A  general  equilibrium  model  covering  all  EU  Member  States,  featuring  different  firm 
types and modelling many key features of corporate tax regimes, including multinational 
profit  shifting,  investment  decisions,  loss  compensation  and  the  debt-equity  choice  of 
firms. In economics, a model is a theoretical construct representing economic processes 
by a set of variables and a set of logical and/or quantitative relationships between them. 
The  economic  model  is  a  simplified,  often  mathematical,  framework  designed  to 
illustrate  complex  processes.  General  Equilibrium  Theory  is  a  macroeconomic  theory 
that  explains  how  supply  and  demand  in  an  economy  with  many  markets  interact 
dynamically and eventually culminate in an equilibrium of prices.  

EBIT 

Earnings Before Interest, Taxes and Depreciation 

EBITDA 

Earnings Before Interest, Taxes, Depreciation, and Amortization.  

EIOPA 

The  European  Insurance  and  Occupational  Pensions  Authority  (EIOPA)  is  a  European 
Union financial regulatory institution. EIOPA’s  mission is to  protect  the public interest 
by  contributing  to  the  short,  medium  and  long-term  stability  and  effectiveness  of  the 
financial  system  for  the  Union  economy,  its  citizens  and  businesses.  This  mission  is 
pursued by promoting a sound regulatory framework and consistent supervisory practices 
in order to protect the rights of policyholders, pension scheme members and beneficiaries 
and  contribute  to  the  public  confidence  in  the  European  Union’s  insurance  and 
occupational pensions sectors. 

Equity  

Equity  is  defined  as  the  sum  of  paid-up  capital,  Share  premium  account,  Revaluation 
reserve, Reserves84, Profit or loss brought forward and Profit and loss of the year. 

Equity in the sense of this draft directive 

Equity means, in a given tax year, the sum of paid-up capital, the share premium account, 
revaluation reserve and reserves. 

ORBIS  

Orbis is a database of companies and other entities across the globe 

84 Reserves include: 1. Legal reserve, in so far as national law requires such a reserve; 2. Reserve for own 
shares, in so far as national law requires such a reserve, without prejudice to point (b) of Article 24 (1) of 
Directive 2012/30/EU; 3. Reserves provided for by the articles of association; 4. Other reserves, including 
the fair value reserve 

107 

 
                                                           
Notional interest deduction 

The  notional  interest  multiplied  by  the  capital  considered  eligible  for  the  allowance  is 
directly deducted from the tax base of the company, as if it were a professional expense. 

Notional interest rate  

Theoretical  interest  applied on the capital  of a company. The notional  interest  does not 
constitute an accounting charge and therefore does not affect the income statement of the 
company. 

Risk free rate 

The risk-free rate is the interest rate an investor can expect to earn on an investment that 
carries  zero  risk.  In  practice,  the  risk-free  rate  is  commonly  considered  equal  to  the 
interest  paid  on  a  government  bond,  generally  the  safest  investment  an  investor  can 
make. 

Risk premium 

The  risk  premium  is  the  compensation  that  investors  ask  for  investing  into  risky  debt 
instruments. It can be assessed as a spread between yields on risky debt instruments and 
risk  free  bonds.  The  risk  premium  would  be  determined  as  the  difference  between  the 
market rate and the risk-free rate. 

108