Candice Horbacz
On 24 June, the European Commission unveiled its Tax Omnibus proposal, a significant legislative package designed to streamline the EU’s intricate tax code and invigorate the bloc’s economic competitiveness. A cornerstone of this ambitious reform is the establishment of a harmonized minimum standard for the full expensing of specific tangible assets dedicated to research and development (R&D). Drawing inspiration from established expensing rules in the United States and the United Kingdom, the Commission’s impact assessment highlights the measure’s potential to stimulate investment and foster economic growth across the Union. However, a critical question emerges: does the EU’s proposed framework go far enough to truly level the playing field with its major trading partners? And what incentives exist for Member States to adopt such a policy, potentially risking short-term revenue reductions? While the new proposal undeniably narrows the gap with the US and UK, it appears to fall short of fully restoring competitive parity. Nevertheless, individual Member States retain the autonomy to transcend this EU-mandated minimum, thereby enhancing their own competitive standing against global economic powerhouses.
Understanding Full Expensing: A Catalyst for Investment
At its core, full expensing is a tax policy mechanism designed to minimize the tax cost of capital investment. Traditionally, tax systems employ depreciation schedules, requiring businesses to deduct the cost of assets like machinery, equipment, or buildings over several years, reflecting their estimated useful lifespan. While seemingly logical, this gradual approach often erodes the real value of deductions due to inflation and the time value of money, consequently increasing the cost of capital and discouraging businesses from investing. The longer the depreciation schedule, the less a business can effectively recover its investment costs, fostering hesitancy in capital-intensive projects.
By contrast, full expensing permits companies to immediately deduct the entire cost of capital expenditures in the year they are incurred. This immediate write-off ensures that businesses recover the full value of their investment in real terms, significantly reducing the tax burden on new capital and thereby incentivizing investment. Accelerated depreciation policies represent a step towards this ideal, compressing the timeframe for deductions to allow for earlier cost recovery, though they typically stop short of a full first-year write-off.
The economic rationale for full expensing is compelling. It achieves a substantial positive impact on investment at a relatively modest fiscal cost. Since each deduction for an investment cost can only be claimed once, accelerating depreciation merely shifts the timing of write-offs rather than increasing their total sum. Crucially, these rules apply exclusively to new investments, providing upfront benefits to firms without affecting tax revenue generated from returns on existing assets. Economists widely advocate for full expensing, or neutral cost recovery, as the most economically neutral approach to capital taxation, as it removes the tax code’s bias against investment.
For optimal effectiveness, full expensing should be applied broadly across all asset groups. Narrowly targeted policies, while well-intentioned, can create significant administrative complexities, compliance costs, and distortions. Businesses may misallocate funds towards tax-preferred asset classes, leading to inefficient capital allocation and undermining the broader goal of economic growth.
The Global Landscape: US and UK Lead in Broad Expensing Regimes
The United States and the United Kingdom stand out as examples of major economies that have implemented broad full expensing regimes for machinery and equipment, encompassing a significant portion of their respective investment expenditures. These policies serve as benchmarks against which the EU’s new proposal is being measured.
In the US, full expensing for equipment and other short-lived business assets was initially adopted in 2017 as part of the Tax Cuts and Jobs Act (TCJA). This measure, however, was designed to phase out starting in 2023, with first-year bonus depreciation allowances decreasing by 20 percentage points annually. Recognizing its economic benefits, the US later made full expensing permanent in 2025 through the One Big Beautiful Bill Act (OBBBA). This permanence provides businesses with long-term certainty, a crucial factor for major investment decisions. Beyond machinery, the US also temporarily extended 100 percent expensing to qualifying structures, specifically industrial buildings, where construction began between January 19, 2025, and January 1, 2029, and were placed in service between July 4, 2025, and January 1, 2031. This covers an estimated 10-15 percent of all buildings and structures in the US, signifying a substantial expansion of expensing benefits. Tax Foundation modeling projects that permanent full expensing for machinery and equipment alone will boost long-run US GDP by 0.6 percent, increase capital stock by 1.0 percent, and raise wages by 0.5 percent, compared to a return to pre-2017 law. This underscores the potent economic impact of such policies.
Across the Atlantic, the UK has similarly embraced full expensing. In the Spring Budget 2023, the government introduced full expensing for machinery and equipment, alongside a 50 percent first-year allowance for certain "integral features" and "long-life items" that do not qualify for full expensing. Both provisions were subsequently made permanent in the Autumn Budget 2023, providing long-term stability for businesses. Furthermore, the Annual Investment Allowance (AIA), which grants 100 percent first-year relief for plant and machinery investments up to £1 million for all businesses, was also cemented as a permanent feature of the UK tax code. Joint modeling by the Tax Foundation and the Centre for Policy Studies indicates that making full expensing permanent in the UK will elevate GDP by 0.9 percent, increase capital stock by 1.5 percent, and boost wages by 0.8 percent relative to the pre-2021 tax regime.
R&D-Specific Expensing: A Targeted Approach
In addition to their broader full expensing frameworks, both the US and the UK maintain specific expensing regimes tailored for R&D activities, reflecting the critical importance placed on innovation.
In the US, the OBBBA reinstated full expensing for domestic research or experimental expenditures, superseding a temporary R&D amortization regime that had been in effect from 2022 to 2024. This full expensing applies to domestic R&D expenses (net of any R&D tax credit amounts), crucially including software development costs. For eligible small businesses, this measure has been made retroactive to R&D expenses incurred after December 31, 2021. However, certain categories remain outside the scope of full expensing, such as foreign R&D expenses, acquired patents and licenses, exploration costs for oil and gas discovery, and specific land acquisitions.
The UK’s research and development allowance (RDA) provides a similar targeted incentive. It allows taxpayers to fully deduct capital expenditures for plant, equipment, buildings, structures, exploration for oil and gas discovery, and software development, all when used for R&D purposes, in the year of acquisition. Exclusions from the RDA include licenses, intellectual property (IP) rights, dwellings, and bare land.
The EU’s Varied Landscape and the New Proposal
Within the European Union, the adoption of capital cost recovery provisions equivalent to full expensing has historically been limited to a select few countries. Estonia and Latvia, with their distribution-based corporate tax systems, effectively operate regimes comparable to full expensing for all asset classes, as corporate income taxes are levied only upon profit distribution. Lithuania has also moved towards this ideal, implementing permanent full expensing for machinery and equipment, software, and acquired rights, effective from 2026.
However, for the majority of EU Member States, capital allowance provisions generally fall short of enabling businesses to recover the full cost of their capital investment in real terms. As of 2026, the average weighted capital allowances among EU Member States (excluding Estonia and Latvia) stand at approximately 69.2 percent. This stark figure means that, on average, 30.8 percent of the net present value of capital investment costs are not recovered by businesses, representing a significant disincentive to investment across the bloc.
The European Commission’s Tax Omnibus proposal, while a significant step, does not aim to fundamentally overhaul this diverse landscape. Instead, it strategically focuses on introducing an R&D full expensing regime across the EU. This narrower scope is likely influenced by concerns regarding subsidiarity – the principle that decisions should be taken at the lowest possible level – and the technical complexities of implementing a broad full expensing regime without a fully harmonized corporate tax base across the diverse EU Member States.
Under the proposal, Member States would be mandated to introduce a minimum R&D expenditure-based incentive allowing for full expensing of specific tangible assets directly used for, or in support of, R&D activities. This covers tangible assets such as machinery, equipment, and even land and dwellings (with certain limitations) when utilized for R&D purposes.
A notable exclusion from the proposal is intangible assets. While this might initially seem like a significant omission, many R&D costs associated with intangible assets, such as wages for software developers or researchers, are typically expensed immediately for accounting and tax purposes, rendering a separate full expensing rule unnecessary for these. However, two crucial categories remain outside the proposal’s scope: acquired intangible assets that are capitalized (e.g., patent rights, IP licenses) and internally developed intangible assets whose development costs (which can include wages in some cases) are capitalized. This exclusion of capitalized intangible assets presents a significant point of divergence from the US and UK models.
Member State R&D Incentives and the Challenge of Integration
The treatment of intangibles varies across EU Member States, often depending on their adherence to international accounting standards (IAS 38 – Intangible Assets) and national tax rules. IAS 38 typically requires the capitalization of development costs for intangible assets when specific recognition criteria are met. National accounting standards may align or diverge from this approach. Consequently, development costs for intangible assets may either be depreciated over time or immediately expensed, depending on how closely a tax system follows accounting standards and whether separate tax rules are provided. Wages and payroll costs, however, are almost universally deductible in the year of expenditure.
This creates three general scenarios within the EU: Member States that disallow immediate expensing of capitalized intangible development costs because they follow IFRS or comparable national standards without specific tax overrides; those that permit immediate expensing only if a company does not capitalize these costs for accounting purposes; and those that allow immediate expensing regardless of the accounting treatment.
Beyond expensing, EU Member States utilize a wide array of R&D incentives, including super-deductions, tax credits, and accelerated depreciation. These incentives aim to encourage R&D spending, with the implied tax subsidy on R&D expenditures averaging 17 percent for profitable, large companies across the EU. However, this average masks a vast disparity, ranging from a generous 39 percent in Portugal to negligible relief (below one percent) in countries like Bulgaria, Denmark, Latvia, Luxembourg, and Malta.
While such R&D tax incentives can boost innovation, they also pose challenges. Targeting genuine innovation with positive spillovers is difficult, and tax preferences often lead to increased administrative and compliance costs due as authorities seek to contain fiscal losses and define qualified expenditures. The EU’s new R&D-specific expensing requirement will face similar hurdles. Its ultimate effectiveness will hinge on its interaction with existing Member State policies. Simply adding the expensing of R&D equipment to existing preferences could correct biases favoring labor over equipment but might also inflate administrative and fiscal costs. Replacing existing R&D preferences with a broader R&D expensing regime could capture benefits while mitigating some costs. Ultimately, extending full expensing to broader asset classes offers the greatest potential to improve the overall investment climate and reduce delineation problems.
The Competitiveness Gap: EU vs. US and UK
A direct comparison of the full expensing approaches of the US, UK, and the new EU proposal reveals significant differences, particularly when distinguishing between general and R&D-specific regimes. The US and UK have enacted broad full expensing provisions that cover a vast proportion of capital investments across their economies. In contrast, the EU exhibits a patchwork of approaches, with only Estonia, Latvia, and Lithuania offering regimes equivalent to full expensing for all or broad asset classes. The Tax Omnibus proposal, by limiting its scope to tangible assets used for R&D, deliberately avoids a wholesale transformation of this fragmented landscape.
Examining the R&D-specific full expensing systems, all three jurisdictions tend to favor investment in qualified plant and machinery and restrict the coverage of land, while generally excluding IP rights and licenses. The critical divergence lies in the treatment of software development. Both the US and UK regimes explicitly allow immediate expensing for software development costs. The EU proposal, however, does not appear to extend this benefit.
This omission of intangible assets, especially software development, is a significant weakness in the EU’s bid for competitive parity. In modern, innovation-driven economies, intangible assets – software, patents, data, and brand equity – constitute an increasingly vital component of R&D investment and overall capital stock. Leaving them outside the scope of the EU proposal means that taxpayers will generally still have to amortize the acquisition costs of these essential R&D ingredients. Furthermore, Member States whose practices mandate the amortization of capitalized intangible development costs will remain unaffected by the EU proposal. This puts the proposed EU minimum standard for R&D expensing demonstrably behind the more comprehensive R&D-specific provisions in the US and UK.
It is crucial to understand that alternatives like super-deductions, tax credits, or accelerated depreciation do not yield equivalent economic results to full expensing. Full expensing allows a business to deduct capital investment costs in the year of expenditure, ensuring the recovery of their full value in real terms. Accelerated depreciation moves in the same direction but stops short of a full first-year deduction, leaving some potential gains on the table. For instance, if Germany were to make its accelerated depreciation policy for machinery permanent, it would boost long-run GDP by 0.8 percent. However, moving to full expensing for all machinery and equipment could potentially double these gains, raising GDP by 1.6 percent, capital stock by 2.5 percent, and wages by 1.4 percent.
Conversely, a super-deduction goes beyond full expensing by allowing businesses to deduct more than the actual cost of investment, effectively providing a subsidy that could encourage even unprofitable investments. Tax credits, by reducing tax liability directly rather than taxable income, have an effect largely independent of the marginal tax rate and may either fall short of removing tax penalties on investment or go beyond to provide a subsidy.
Empowering Member States: Beyond the EU Minimum
The EU Tax Omnibus proposal establishes a crucial minimum standard, but Member States have the opportunity, and indeed the imperative, to go further. Previous Commission recommendations rightly underscored the necessity of pairing accelerated depreciation with more flexible loss-carryover rules, a principle equally applicable to the new R&D full expensing proposal.
Capital-intensive projects often incur significant losses in their early stages before generating profits. Liberalizing Net Operating Loss (NOL) carryover provisions, by lifting time and deductibility caps, would enable companies to "smooth" their risk and income profiles. This makes the tax code more neutral across different investments and over time, preventing the penalization of early-stage losses or risk-taking. Conversely, strict limits on loss offsets raise the after-tax cost of capital, deterring investment, especially in sectors characterized by volatile income. Ideally, a tax code should permit businesses to carry over losses for an unlimited number of years, ensuring that taxation is based on average profitability over time.
Currently, 20 out of 35 major European countries already allow unlimited NOL carryforwards, and nine permit some losses to be carried back to prior years. However, several countries still impose deductibility limits. Even in the absence of time and deductibility limits, loss-making firms may not fully leverage accelerated depreciation, as early write-offs must be postponed without sufficient taxable income, eroding their real value.
For such scenarios, Neutral Cost Recovery (NCR) offers a powerful solution. By adjusting depreciation allowances for inflation and a notional return on capital, governments can preserve the real value of capital deductions. To date, only Chile, Israel, and Mexico among OECD nations index capital allowances for inflation, thereby shielding firms from the erosive effects of high price growth and removing tax barriers to risky, long-term investments. During negotiations for the final Tax Omnibus directive, the Council could consider offering Member States the option to adopt NCR as an alternative to R&D full expensing. NCR provides economic benefits broadly equivalent to full expensing while offering Member States greater fiscal flexibility.
Addressing the Debt-Bias: A Critical Caveat
One valid concern associated with accelerated depreciation schedules, especially when combined with interest deductibility, is the potential for negative effective marginal tax rates (EMTRs) for highly leveraged investment projects. In such instances, the tax value of deductions can exceed the actual return on investment, effectively transforming the tax code into a subsidy for debt-financed capital investment.
The root of this issue lies in the asymmetric tax treatment of debt and equity. Interest payments are typically deductible from taxable income, whereas returns to equity are not. When both interest and investment costs are fully deductible, it can lead to over-investment in certain assets that are particularly amenable to high leverage.
A practical and effective solution to this debt bias is to disallow interest deductions at the corporate level. This approach harmonizes the tax treatment across different financing methods, ensuring that full expensing operates as intended for all asset and financing combinations. Furthermore, disallowing interest expenses can help offset the upfront fiscal costs associated with implementing full expensing.
Conclusion and Outlook
Acknowledging the inherent difficulties in proposing a generalized full expensing regime across the entire European Union, detached from specific R&D activities, the European Commission’s Tax Omnibus proposal for R&D full expensing represents a valuable "second-best" option. It establishes a meaningful minimum incentive for investment in capitalized tangible assets crucial for innovation.
However, the deliberate exclusion of intangible assets, particularly software development costs, creates a notable divergence from the more comprehensive regimes in the US and UK. This gap risks leaving the EU at a competitive disadvantage in an era where intangible capital increasingly drives economic growth and productivity.
While the proposal sets a floor, Member States possess the autonomy and the opportunity to build upon it by improving other aspects of capital cost recovery, such as liberalizing Net Operating Loss provisions. Yet, a broader, more harmonized approach to full expensing across a wider range of asset classes would undoubtedly do more to bolster the EU’s overall competitiveness and reduce the fragmentation that continues to hinder the potential of the Single Market. The journey towards a truly competitive and innovation-friendly tax environment in the EU is far from complete, and the Tax Omnibus proposal marks a significant, but initial, step on that path. The ultimate success will depend on the willingness of Member States to embrace and even exceed the proposed minimums, fostering an environment where European businesses can truly compete on a global stage.
