No harm to EU investment under corporate debt-bias tax reform, Commission paper concludes

by Davide Anghileri

Fundamental tax reform can address the current debt bias in tax systems in the EU member states while allowing for a revenue neutral implementation and maintaining EU investment, an October 27 EU Commission working paper concludes.

EU Commission Working paper n. 65-2016, titled “The effects of tax reforms to address the debt-equity bias on the cost of capital and on effective tax rates,” has the objective of analysing current interest deduction limitation rules in the EU Member States, assessing the effect of interest deduction limitation rules on effective tax rates, providing insights on the effects of the fundamental tax reform options on current tax systems, and considering a revenue-neutral implementation of the reforms and possible consequences for the level of investment in the EU Member States.

The report states that debt bias could be addressed by counteracting excessive use of debt financing through deduction limitation rules or through some type of fundamental tax reform. The study finds, though, that the two solutions can increase the risk of double taxation, and therefore these options are not analysed in detail.

The paper states that the main goal of financing neutrality at the corporate level can be achieved under the following tax reform options:

  • Comprehensive Business Income Tax (CBIT)
  • Allowance for Corporate Equity (ACE)
  • Allowance for Corporate Capital (ACC)
  • Cost of Capital Allowance (COCA)

The report points out that only the CBIT and the COCA ensure financing neutrality at the shareholder level.

Moreover, the report states that the investment behaviour of corporations might be influenced differently by fundamental tax reform, in fact, the introduction of the CBIT will increase the cost of capital and profitable investments (EATR), while the ACE will lead to a decrease of their costs at the corporate level.

With regard to ACC and COCA, the impact depends on the underlying chosen notional interest rate, the paper states.

From a theoretical perspective, the level of investment and the tax attractiveness of the EU Member States might be influenced by the reform options in different ways. In fact, the introduction of a CBIT might have a negative impact whereas the ACE promotes investment and tax attractiveness of the EU Member States. For the ACC and COCA, the overall effect cannot be determined a priori.

The study then notes that the ACE has an overall positive effect on the scale of investments and the tax attractiveness of the Member States at the shareholder level whereas the effect of ACC depends on the notional interest rate.

Regarding the COCA, the largely reduced tax burden at shareholder level will lead to an increase both the scale of investment and the tax attractiveness. While, the CBIT has a negative impact on the level of investment at the shareholder level, it lowers the EATR and might thus positively impact discrete location decisions

Furthermore, the study addresses the revenue neutral implementation of fundamental tax reform. The choice of the CBIT would lead to a decrease of the corporate income tax rate as it broadens the tax base, while in case of ACE or ACC or COCA there will be an increase in the corporate income tax rate due to the additional deduction granted that narrows the tax base. Hence, the tax rates must be adjusted accordingly to achieve the same effective tax level as in the pre-reform scenario, the paper states.

Finally, the study provides evidence that the revenue neutral implementation of fundamental tax reform has only minor effects on the resulting cost of capital.


Davide Anghileri

Davide Anghileri is a PhD candidate at the University of Lausanne, where he is writing his thesis on the attribution of profits to PEs. He researches transfer pricing issues and lectures for the Master of Advanced Studies in International Taxation and Executive Program on Transfer Pricing.

Anghileri, a Contributing Editor at MNE Tax, previously worked as a policy advisor to the Swiss government on BEPS issues. He can be reached at

Davide Anghileri

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