Skip to main content

DEBRA: considerations for real assets fund managers

Alternative Universe

Marcell Köves

3 minutes read

On 11 May 2022, the European Commission published a new EU Directive proposal1 for a debt-equity bias reduction allowance (DEBRA) and a new interest limitation rule.

The proposal supposes that most of the EU’s corporate tax systems create a tax bias for financing businesses through debt, by allowing the deduction of debt financing costs but not equity funding costs. The European Commission’s Communication on Business Taxation for the 21st Century first raised this issue in 20212, citing concerns about an over-reliance on debt financing and its potential negative impact on the EU market.

DEBRA aims to provide a tax incentive encouraging companies to finance their investment through equity contributions rather than debt financing. This should increase these businesses’ resilience to unforeseen changes in the market and decrease their insolvency risk3.

While DEBRA’s goal is commendable, it might also pose challenges for real assets fund managers active in the EU. This article highlights some of the early observations and considerations of the proposal.

What is DEBRA?

The draft proposal would apply to taxpayers subject to corporate income tax (CIT) in one or more EU Member States, including permanent establishments but excluding financial undertakings (as defined).

DEBRA is expected to be transposed by 31 December 2023 and apply from 1 January 2024. However, the current proposal allows EU Member States with similar equity allowance provisions in their national law to defer DEBRA’s application for up to 10 years.

a. Allowance on equity

Currently, DEBRA introduces an equity allowance deductible for CIT purposes from the relevant taxpayer’s taxable base, with a 30% EBITDA limit per tax year. The equity allowance would be granted for 10 consecutive tax years to approximate the maturity of most debt financing.

The allowance would be calculated with reference to:

  • The allowance base: the difference between the net equity at the end of a tax period and at the end of the previous tax period, less the tax value of own shares and participations in associated enterprises; and
  • A notional interest rate (NIR) in two components: (1) a risk-free interest rate paid for the relevant currency with a 10-year medium maturity, and (2) a risk premium of 1%, rising to 1.5% for small-and-medium-sized enterprises (SMEs).

The draft proposal also makes it possible to carry unused equity allowance forward. Allowances that exceed the 30% EBITDA limit could be carried forward for 5 years, and deductible allowances that exceed the taxpayer’s taxable income before DEBRA could be carried forward indefinitely.

If the equity is reduced, a negative allowance would be taxable for 10 consecutive tax years, unless the equity reduction was due to accounting losses or a legal obligation to reduce the equity. However, the taxable amount would be limited to the increase of net equity for which the allowance was previously obtained.

Finally, the proposal includes various anti-abuse provisions of specific interest to real assets fund managers. For example, any increase from granting loans or transferring participations/business activities as a going concern between associated enterprises is excluded from the allowance base4. Another excludes equity increases due to reorganization if the equity (or part of) already existed in the group before the reorganization5.

b. Additional limitation to interest deduction

The proposal also introduces a new layer of interest deduction limitation, where a relevant taxpayer could only deduct 85% of its exceeding borrowing costs from its taxable base for CIT purposes (as defined in the first Anti-Tax Avoidance Directive, ATAD I)6.

Next, the taxpayer would need to determine the interest deduction limitation that applies under the ATAD I’s provisions.

Then, the taxpayer would be entitled to deduct the lower amount calculated under these two rules. The difference between the two amounts could be carried forward or back, based on the local implementation of ATAD I.

What real assets fund managers should consider

Based on the typical setup of real assets fund structures (i.e., fund, holding and asset level), real assets fund managers should consider these potential pressure points:

  • Fund vehicles would be out of DEBRA’s scope if they meet the definition of a financial undertaking (e.g., an alternative investment fund within the meaning of the Alternative Investment Fund Managers Directive)7. However, unregulated and co-investment structures would need to be carefully considered.
  • Holding platforms would need to be assessed on a case-by-case basis depending on the fund’s investment strategy, for example, how each entity is financed (e.g., debt versus equity) and the type and recurrency of income flows. While “core” strategies focused on long-term appreciation and regular income flows could be affected, DEBRA may have limited impact (apart from the related compliance obligations) for “value-add” or “opportunistic” strategies where primarily tax-exempt capital gains are expected.
  • Asset holding companies and operational entities are expected to be in the proposal’s scope. For example, if these entities are already debt leveraged and subject to current interest limitation rules, a restriction on interest deductibility is expected, while they may be only partially compensated by the equity allowance. DEBRA’s impact, opportunities and downsides would need to be carefully taken into account.

Real assets fund managers should also closely monitor the following areas of the draft directive:

  • The lack of alignment between DEBRA and existing tax provisions. For example, the proposal does not specifically align with ATAD I regarding calculation methods and does not provide for the same de-minimis8 or carve-outs (such as loans granted to finance EU long-term infrastructure projects)9. Also, its interactions with anti-hybrid rules and other existing national tax legislations is unclear10. Asset managers would need to carefully assess the related impacts on financial models.
  • Certain key terms, such as “equity”, need to be carefully considered. Quasi-equity instruments that play a vital role in SMEs and mid-cap financing may not meet DEBRA’s equity definition if recorded as debt in the financial statements, even if treated as equity for tax purposes.
  • The additional compliance burden of the various equity tracing requirements should not be underestimated, such as for the wide range of anti-abuse provisions and a relevant item for an acquisition due diligence.
  • Certain areas are not addressed in the proposal, such as how to apply the rules in case of tax consolidation, the arm’s length principle, and the option to opt in or out of DEBRA.
  • The proposal may also impose an unintended compliance burden and resulting incremental tax costs for bona fide structures, especially those unable to take advantage of the proposed equity allowance.

The current proposal is a first draft, subject to further discussions, amendments and the unanimous approval of EU Member States. Even if the draft proposal has good intentions, it leaves certain aspects unclear; therefore, some amendments may be necessary to make the proposed measures more transparent and comprehensive for taxpayers.

The European Commission’s timeline is ambitious, considering the various draft directives that are currently being discussed at the EU level11. However, initial communications on DEBRA—for example, from Sweden12 and Germany13 —suggest that Member States are better equipped to address DEBRA’s policy goals through national measures.

In addition, the 10-year exemption for EU Member States that already have similar equity allowance provisions in their national law may create inconsistencies and an unlevel playing field among EU Member States. Particular attention would need to be drawn to this draft proposal in the coming months.

The authors acknowledge the contribution of Sarah Lemaire in preparing this article.


1European Commission, 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, 11 May 2022.
2European Commission, Communication on Business Taxation for the 21st Century, 18 May 2021.
3European Commission, 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, Explanatory Memorandum, 11 May 2022.
4Article 5.1 of the DEBRA proposal.
5Article 5.3 of the DEBRA proposal.
6Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market.
7Consolidated text: Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010.
8Article 4.3 of Council Directive (EU) 2016/1164.
9Article 4.4 of Council Directive (EU) 2016/1164.
10Regarding Luxembourg, it is currently unclear how DEBRA will interact with the Luxembourg recapture rules (laid down in Article 166 of the Luxembourg income tax law and the relevant Grand Ducal Decree of 21 December 2001) as well as net wealth tax.
11The European Commission published two draft directives on 22 December 2021; one regarding the OECD Pillar Two Model Rules on a 15% minimum effective tax rate, and another on the misuse of EU shell companies in the context of its ongoing fight against aggressive tax planning.
12The Swedish parliament (Sveriges Riksdag) released its opinion about DEBRA on 22 June 2022;
13The German Federal Council (German Bundesrat) released its initial thoughts regarding DEBRA on 16 October 2022 via a “Beschluss des Bundesrates”;

Alternative Universe

Read more articles


Marcell Köves
Partner | Tax
Tel: +352 451 454 299

Did you find this useful?

Thanks for your feedback

If you would like to help improve further, please complete a 3-minute survey