The context

In France, like in many other countries, debt financing will often be preferred by businesses as it generates, subject to certain conditions and limits, tax deductible financial expenses, instead of non-deductible dividends, had equity financing been instead chosen.

This “debt bias” phenomenon is not new (especially in France, where the CIT rate has always been quite high), but has been exacerbated by the Covid-19 health crisis which showed that too high a level of indebtedness may weaken the capacity of businesses to face economic turmoil.

The aborted initiative

On 30 June 2021, the French Senate decided to tackle this issue by introducing in the French Amended Finance Bill for 2021 a temporary allowance aiming at placing debt and equity financing on equal footing, to a certain extent.

Sharing similarities with the Belgian and Italian mechanisms, the measure consisted in allowing businesses, from 2021 to 2023, to deduct from their French result for corporate income tax purposes a “notional” remuneration of their qualifying net equity under inter alia the following conditions:

• rate: 5%, or 7% for certain SMEs within the meaning of the EU regulation 651/2014 – to be compared with a 0% rate (circa 0.4% for SMEs) for FYs 2020/2021 in Belgium and a 1.3% rate in Italy (exceptionally temporarily increased under certain conditions and limits to 15% for the first fiscal year commencing from 31 December 2020);
• basis: the positive difference, if any, between (i) the net equity as at the end of the relevant FY and (ii) the net equity as of 31 December 2020, but only up to the additional net equity contributed between 23 June 2021 and 31 December 2023 – which is to a certain extent similar to the philosophy of the Belgian and Italian mechanisms, which also apply the allowance on an incremental basis;
• limit of deduction: the higher of €3m  or 30% of an adjusted tax EBITDA. 

The implementation of this measure would certainly have raised questions, such as the consequences for the shareholders of the entity benefiting from the allowance of this legal “hybrid” situation, or potential discussions with the French tax authorities on the market rate applied to debt interest deduction, as compared to the “normative” notional interest on equity.

On 8 July 2021, however, the French Assemblée Nationale (which has the last word in the legislative process) voted the removal of this measure from the French Amended Finance Bill for 2021, notably in consideration of its significant cost for the French budget (up to €6.5 billion).

What’s next? 

Although this initiative will not enter into force, it certainly paves the way for future official discussions to tackle the “debt bias” phenomenon. And if a consensus cannot be found at the country level, the solution may come from the European Union.

On 14 June 2021, the European Commission indeed published an initiative aiming at placing debt and equity on equal footing across the European Union, which can be achieved either (i) by disallowing the tax deductibility of financial expenses or (ii) by creating an allowance for corporate equity.

According to the preliminary impact assessment, the allowance for corporate equity would be the preferred option, as disallowing interest deduction may depress investment and then have a negative effect on growth and employment. Such harmonized regime could enter into force from 2024: stay tuned!