Achieving debt-equity
parity in corporate taxation has long been a sought-after holy grail in the
quest for capital structure neutrality; however, the latter does not always
align with the former. The United States devoted significant thought on how to
reach both, especially in the 1990s, but eventually did not achieve either with
its tax reforms at the dawn of the twenty-first century.
Now, it is Europe’s
turn to try. This is what the European Commission aims to accomplish with its
Directive Proposal for a Debt Equity Bias Reduction Allowance (DEBRA). It would
introduce a notional interest deduction on increases in a firm’s equity and a
dual-limiting rule that would cap deductible interest at 85% of exceeding
borrowing costs (interest paid minus interest received) in addition to interest
deductibility already being restricted to 30% of a firm’s earnings before
interest, taxes, depreciation, and amortization (EBITDA).
This article shows
that DEBRA fails to achieve capital structure neutrality and does not ensure
debt-equity parity. It skews the tax treatment of debt without promoting
greater diversification in the portfolio choice of financing sources for
corporate Europe as European companies remain heavily reliant on bank lending
compared to their American counterparts.
Last, the article suggests that the risk of
debt-financing outsourcing as a potential consequence of DEBRA could
inadvertently impact direct investments between Europe and some of its main
trading partners, including the United States and the United Kingdom. This
process is already underway in America with more anti-abuse provisions emerging
in its tax treaties and federal tax regulations for the cross-border payment of
interest and dividends