In its Communication on Business Taxation for the 21st Century, the European Commission announced a legislative proposal to address the debt-equity bias in corporate taxation through an allowance system.
Tax systems in the EU allow for the deduction of interest payments on debt when determining the tax base for corporate income tax purposes, while costs related to equity financing, such as dividends, are mostly non-tax deductible. This asymmetry favours the use of debt over equity for financing investments and contributes to elevated debt levels for non-financial corporations, thereby exposing them to higher risk of insolvency.
The JRC contributed to the economic impact assessment of this initiative by analysing the effects of different forms of tax allowances for equity on important macroeconomic aggregates using the general equilibrium model CORTAX. 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 a notional interest deduction on investments, regardless of its firm (debt or equity), have been analysed.
To simulate the effects of the different policy options, the allowance for the cost of equity has been calibrated for each Member State and between multinational and domestic firms using data from ORBIS and the ECB Survey on the Access to Finance of Enterprises (SAFE).
The model results indicate that a combination of a tax allowance on new corporate equity and a partial limitation of the tax deductibility of debt interest payments is successful in addressing the debt-equity bias, while balancing the budgetary impacts and addressing the fairness aspects of the tax system. This policy option is expected to have a positive impact on investment and GDP, and moderate impacts on employment.
For more information on the DEBRA initiative and the impact assessment report, see the dedicated website of the European Commission.