What does the new EU Directive Proposal (DEBRA) mean for the Belgian notional interest deduction?

On 11 May 2022, the European Commission published a new legislative proposal aimed at tackling the tax induced debt-equity bias (DEBRA). This initiative is part of the EU vision on Business Taxation for the 21st Century and addresses the debt-equity bias in corporate taxation.

The DEBRA proposal includes two separate measures that apply independently: (i) a notional interest allowance on changes in the company’s equity level, and (ii) a limitation on interest deduction to 85% of the exceeding borrowing costs (being: interest paid minus interest received). The proposal should contribute to the re-equitization of companies and applies to all undertakings in the EU that are subject to corporate tax in one or more EU Member States, except for financial undertakings.

Allowance on equity

The proposed allowance on equity would 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, which is multiplied by a notional interest rate. This notional interest rate equals the 10-year risk-free interest rate (for the relevant currency), increased by a risk premium of 1.5% for small and medium-sized enterprises (SMEs) or 1% for non-SMEs.

If the difference between the above-mentioned equity levels is a negative amount (loss), the computation results in a positive amount being added to the company’s taxable income, unless the taxpayer provides sufficient evidence that this is due to accounting losses incurred during the tax period, or due to a legal obligation to reduce capital.

The deductibility of the allowance is limited to a maximum of 30% of the taxpayer’s EBITDA (earnings before interest, tax, depreciation, and amortization) for each tax year, to prevent abuse. If the allowance on equity is higher than the taxpayer's net taxable income, the taxpayer may carry forward the excess of allowance on equity without a time limitation. Taxpayers will be able to carry forward their unused allowance on equity, which exceeds the 30% of taxable income, for a maximum of 5 tax years.

Finally, the DEBRA proposal includes several anti-abuse measures to ensure that equity allowance is not used for unintended purposes (e.g. specific conditions for accounting equity increases following contributions in kind, exclusion from the calculation base for equity increases originating from intra-group loans, certain cash contributions, intra-group transfers of participations and/or existing business activities, etc.).

Limitation to interest deduction

The allowance on equity is accompanied by a new limitation of the deductibility of debt-related interest payments to 85% of exceeding borrowing costs (interest paid minus interest received).

Given that interest deduction limitation rules already apply in the EU under Article 4 of the Anti-Tax Avoidance Directive (ATAD), the DEBRA proposal clarifies the interaction between the ATAD-interest deduction limitation rule and the newly proposed interest deduction limitation rule. In case the ATAD-interest deduction limitation rule provides for a lower deductible amount (compared to the proposed rule), then the taxpayer will be entitled to carry forward or carry back the difference (in accordance with Article 4 of the ATAD).

What does this mean for the currently existing NID in Belgium?

Currently, only a handful of Member State address the debt-equity basis from a corporate income tax perspective (such as Belgium, Italy, Portugal, Malta and Cyprus), but these domestic measures differ significantly. Adoption of the DEBRA proposal would mark a significant step towards addressing the tax-induced debt-equity bias across the single market in a harmonized way.

The equity allowance as included in the DEBRA proposal shows certain similarities with the currently existing notional interest deduction (NID) in Belgium – which was significantly redesigned by the Belgian corporate tax reform in 2017. Initially, the Belgian NID was introduced to align the tax treatment of equity and debt funding. For Belgian companies to strengthen their equity structure, without compromising the benefit of tax-deductible interest payments, the NID was a deemed (off-balance) tax deduction for which no cash payment or interest expense is booked.

The reformed Belgian NID (applicable as from 1 January 2018) is calculated on the incremental five-year average adjusted equity multiplied with the applicable annually set NID percentage. The average increase is computed as 1/5th of the positive change in equity at the beginning of the current financial year compared to the equity at the beginning of the fifth preceding financial year.

Whereas the mechanics for calculating the equity allowance under the DEBRA proposal show various similarities with the currently existing NID in Belgium, the DEBRA proposal seems to offer new possibilities compared to the current Belgian NID – e.g. unused NID can be carried forward to future taxable periods under the DEBRA proposal (not the case for the Belgian NID), the NID percentage under the DEBRA proposal is not capped (capped at 3% for the Belgian NID), etc. The currently existing NID will then need to be redesigned to fit within the DEBRA proposal.

Entry into force

The DEBRA proposal will now move to the negotiation phase among all Member States with the aim of reaching a final agreement. The adoption of this proposal requires unanimity among all 27 Member States. It is currently envisaged that the Member States should transpose the Directive (once unanimously approved) into domestic legislation by 31 December 2023 for the rules to come into force as of 1 January 2024.