On May 11, 2022 the European Commission published its proposal for a Council Directive on laying down rules on a debt-equity bias reduction allowance and on limiting the deductibility of interest for corporate income tax purposes. The proposal introduces an equity allowance and the proposal also introduces a reduction of debt interest deductibility by 15% (in other words only 85% of the interest remains deductible (Article 6, Paragraph 1 (“Limitation to Interest Deduction”)).

The Directive applies to taxpayers that are subject to corporate income tax in one or more Member States, including permanent establishments in one or more Member State of entities resident for tax purposes in a third country. It should however be noted that Article 2 (“Scope”) of the proposed Directive contains quite a long list of financial undertakings to which the Directive does not apply.

The equity allowance

The regulations on how the equity allowance is to be calculated are laid down in Article 4 (“Allowance on Equity”) of the proposed Directive.

The equity allowance is to be computed based on the difference between net equity at the end of the current tax year and net equity at the end of the previous tax year, multiplied by a notional interest rate. This means that the allowance would be granted only for the sum of equity increases over a specific year. The aforementioned notional interest rate is the 10-year risk-free interest rate for the relevant currency, and increased by a risk premium of 1% or, in the case of SMEs, a risk premium of 1,5%.

The equity allowance is deductible for 10 consecutive tax years, with a maximum 30% of the taxpayer's taxable income. If the equity allowance a is higher than the taxpayer's net taxable income, the taxpayer may carry forward the excess of allowance without a time limitation.

Taxpayers will also be able to carry forward their unused equity allowance which exceeds the 30% of taxable income, for a maximum of 5 tax years.

In order to avoid that taxpayers abuse the equity allowance a set of anti-abuse measures are laid down in Article 5 (“Anti-Abuse Rules”) of the proposed Directive.

The proposal for the Directive as published by the European Commission on May 11, 2022 can be found here.

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