Notional interest deduction - impact on the cost of equity in investment projects

Abstract

Purpose: The Notional Interest Deduction (NID) was introduced to achieve equal treatment of debt and equity financing by granting an additional tax deduction from self-financing. Our purpose was to analyze the practical meaning of the introduced mechanism as a factor of the Weighted Average Cost of Capital (WACC) calculation and evaluation of the efficiency of development projects. In the art, the WACC is used to determine the rates of discount for the calculation of future cash flows (CF) and net present value (NPV) of investment projects. Design/Methodology/Approach: The NID mechanism is recognized as the Allowance for Economic Growth (ACE) and the countries benefiting from this relief are recognized as applying the ACE regime. The individual ACE regime is monitored and evaluated for compliance with the European Code of the Conduct Group for business taxation. The documents published by the Council of the European Union became the basis for the tax shield rate analyses and assessment of the impact of NID on WACC changes. Findings: It has been shown that the benefits of NID mechanism can correct Weighted Average Cost of Capital in minus and the differences between countries result from the ACE regime model used, the method of calculating the qualified base and the method of determining the reference rate for the calculation of the notional interest deduction. Practical Implications: The presented use of the notional interest deduction mechanism will fill the gap in the literature on the subject and indicate new opportunities to study the efficiency of the development of organizations. The results can also help practitioners to identify a mechanism whose use may be beneficial to the company due to the possibility of a more precise assessment of the efficiency of the investment project. Originality and Value: The NID mechanism is relatively new and the issues related to it have not yet received much analysis, in particular in connection with non-tax benefits. Meanwhile, taking into account the effects of ACE regime in discounting cash flows may affect the decision to implement or reject an investment project.