Debra Directive: A Critical analysis

Abstract

This research aims to analyse the appropriateness of the tax measure to limit the deductibility of financial expenses imposed by the DEBRA Directive within the economic and tax principles framework. The results show that considering the capital structure irrelevance principle, the approval of measures limiting the consideration of debt interest may represent economic consequences for the company. The non-deductibility of financing costs implies that the company's value does not increase in proportion to the value of the debt, questioning the Modigliani-Miller Theorem. Moreover, the limitation of financing expenses deductibility may evidence non-compliance of the ability to pay principle because it imposes taxation on taxable income that is not effective. Tax measures that limit the deductibility of financial expenses do not comply with the tax principle of ability to pay. Not accepting actual expenses, without considering the real economic situation of companies, imposes taxation on a profit that is not real. Regarding financing costs, the Portuguese legislature requires three standards to be met, each with different criteria. This study contributes to the literature by analysing the applicability of a tax provision from an economic and fiscal perspective, in particular, it relates the capital structure irrelevance principle to the ability-to-pay principle. Moreover, this study constitutes a further step in the literature towards understanding the ability-to-pay principle. It also contributes to a more comprehensive understanding of the capital structure irrelevance principle in a legal context.