1. General remarks

Consultation on a Debt Equity Bias Reduction Allowance

1. General remarks

Today, many corporate tax systems favour debt financing over equity resulting in a corporate tax bias towards debt financing. To put it bluntly, the debt equity bias penalizes equity finance as it is one of the roots for businesses to favour debt financing over equity. Given this diverging tax burden resulting from different financing sources, we share the European Commission’s assessment which inter alia has been laid down in the Capital Markets Union Action Plan1 that funding for businesses through bonds and private equity is playing an increasingly important role and acts as a complement to bank financing. In our opinion ending the favourable treatment of debt and promoting equity financing would provide a welcomed complement to traditional bank financing arrangements as the corporate sector needs more equity investment. Access to financing is vital for any business at any time. This is especially true for the post Covid-19 recovery period as, inter alia according to the European Systemic Risk Board (ESRB), many businesses are confronted with higher levels of debt.2 In this context, capital markets can play a crucial role in supplying more equity. Making the costs of an investment which is funded through equity financing tax deductible would provide support for businesses not only during economic downturns, but foster investment and long-term growth. This is even more important as European businesses, in contrast to the United States, are still mainly financed by conventional bank loans making European companies potentially more affected by economic crises. The Debt Equity Bias Reduction Allowance (DEBRA) initiative could therefore also help to mitigate the imbalance between Europe and the United States.

BDI thereforestrongly welcomes the European Commission’s aim to support the post-Covid-19 recovery and increase equity financing of the private sector via tackling and mitigating the potential tax induced debt-equity bias.

However, the effectiveness of the measure strongly depends on its final design. German industry would especially welcome the creation of an allowance for equity-financed investments by offering a tax deductibility for

1 European Commission, Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions, A Capital Markets Union for people and business-new action plan, Brussels, 24.9.2020, COM(2020) 590 final, 7. 2 European Systemic Risk Board, Prevention and management of a large number of corporate insolvencies, April 2021. The study inter alia concludes that “the worst-hit sectors have seen substantial deterioration in their financial position since the pandemic. Profits have significantly deteriorated, own equity has decreased, and debt levels have risen in the most heavily impacted sectors (…).”

Consultation on a Debt Equity Bias Reduction Allowance

notional interest on equity. At the same time, this implies that measures that would disallow the deductibility of interest payments would be counterproductive from the standpoint of strengthening equity investment. Interest deductibility is an essential part of the corporate tax system as it ensures tax neutrality of investments. Removing neutrality would raise the overall cost of capital. In order to address the debt financing advantage, the European Commission should therefore make changes to the treatment of equity rather to the treatment of debt. While the favourable tax treatment of debt should be maintained, new incentives for equity financing via allowing the tax deduction of notional interest should be created.

German industry also shares the likely economic impacts laid down in the Inception Impact Assessment, in particular regarding the “obvious benefits in terms of financial stability, as companies with a stronger capital base would be less vulnerable to shocks.” The importance of appropriate capitalization for the recovery from large economic shocks, not only for banks, became all too clear in the most recent crisis.

In any case, any measure which aims to encourage businesses to finance more investment through equity contributions instead via debt should be carefully designed in order to fully develop its potential for economic growth. In light of the possible design of the upcoming measure, the European Commission should strive for an ambitious proposal which is open to companies of all size that places debt and equity financing on equal footing across the EU. Overall, the underlying problem should be considered in a wider context as there are also other factors which play a role when it comes to the financing decisions of a company.

BDI has a long track-record of supporting the deepening of the European capital market in order to improve financing conditions for companies. Therefore, German industry also welcomes the European Commission’s objective to further strengthen the Capital Markets Union initiative which is designed to increase the capital market orientation of companies in parallel to conventional financing channels in order to remove barriers to investment in the EU. A true single market for capital that reduces the fragmentation of European financial markets can improve access to finance for industry, explore new sources of corporate finance and increase the efficiency and stability of the integrated European capital market. Easier access to the bond and equity markets, especially for larger SMEs, and the promotion of venture capital and equity financing are important areas of action that are highly significant from the perspective of the real economy.