The present French Tax Update will focus on an overview of several noteworthy publications, including decisions issued during the past few months by the French Administrative Supreme Court (Conseil d'Etat) and French Constitutional Court (Conseil Constitutionnel), as well as the European Commission decision in respect of the Belgian Excess Profit Scheme, and publication of the draft anti tax-avoidance package.
EXCLUSION OF NON-VOTING SHARES FROM PARENT-SUB REGIME: CONSTITUTIONAL COURT STRIKES DOWN REVERSE DISCRIMINATION
On November 12, 2015, the Conseil d'Etat requested from the Conseil constitutionnel a priority preliminary ruling on the issue of constitutionality (question prioritaire de constitutionnalité) of the provisions of former article 145, 6, b ter of the French tax code (FTC), now article 145, 6, c of the FTC. Under these provisions, profits deriving from shareholdings with no voting rights were not entitled to the 95 percent exemption available under the French participation-exemption regime.
On February 3, 2016, the Conseil constitutionnel struck
down the relevant provisions by ruling that the reverse
discrimination so created (i.e. the taxpayer was treated less
favorably on dividends received from its shareholding in a French
subsidiary than on those received from an EU subsidiary, thereby
infringing as such the rights and freedoms guaranteed by the French
constitution) was not justified.
We will provide a full coverage of the Conseil
constitutionnel decision in our upcoming update. Please see
our Update for December 2015 for further details
on the underlying case.
FRENCH CFC RULES
For French corporate tax purposes, the basic rule is that of a
strict territoriality, i.e., a French corporate taxpayer is taxed
in respect of the income generated in France, and/or in respect of
any income the taxation of which is attributed to France under a
given international tax treaty.
As an exception to the above principle, under the Controlled
Foreign Corporation ("CFC") rules
(article 209 B of the FTC) a French taxpayer may be, under certain
conditions, taxed in respect of income generated by a foreign
subsidiary or foreign permanent establishment; such taxation is,
inter alia, conditional upon the subsidiary or permanent
establishment being located in a jurisdiction where the effective
tax charge is significantly lower than the equivalent French tax
charge.
The CFC rules, however, enable the taxpayer to avoid taxation if,
inter alia, it can be proven that the operations of the
subsidiary (or the foreign permanent establishment) were not
principally motivated by tax enhancement ("Safe
Harbor").
In two decisions dated December 30, 2015, involving a major French
banking institution, the Conseil d'Etat has provided
some clarity as to the application of the Safe Harbor.
In one case, the financial institution had a subsidiary located in
Hong Kong, dealing with Asian currencies; in the other case, the
relevant subsidiary was based in Guernsey and dealing in private
banking.
In the case of the Hong Kong subsidiary, the Conseil
d'Etat decided that the Safe Harbor should be applicable
given that (i) the subsidiary was, effectively, active in dealing
with Asian currency assets of the financial institution, and (ii)
such activity could not be organized from France because of the
specificities of the functioning of the relevant Asian
markets.
The French tax authorities ("FTA") were
arguing that it has not been proved that some of the clients of the
subsidiary were not French tax residents, and some of the funds
used by it were not of French origin. However, the Conseil
d'Etat ruled that any such consideration was beside the
point, i.e., they had no relevance to the finality and reality of
the subsidiary's operations in Hong Kong.
In the case of the Guernsey subsidiary, the Conseil
d'Etat again ruled that the Safe Harbor should be
applicable. The approach taken by the Conseil d'Etat
was the same as in the above Hong Kong case: the financial
institution has proved the effective operations of the subsidiary,
and these operations were feasible because certain clients were
attracted only by the specificities of the Guernsey banking and tax
environment.
Again, the Conseil d'Etat rejected as non-relevant the
argument of the FTA whereby certain of the clients of the
subsidiary were French tax residents and some of the assets managed
by it were of French origin.
In other words, the Conseil d'Etat makes it clear that
the application of the Safe Harbor is based on the actual
non-principally tax objectives of the relevant corporate taxpayer,
and not any tax motivations of the clients of the relevant
subsidiaries. Once the taxpayer has proved its business reason to
be in a certain jurisdiction, it is for the FTA to prove that the
tax reasons were nevertheless predominant.
NON BIS IN IDEM DOCTRINE
Literally "not twice in the same," non bis in
idem is basically a legal doctrine whereby no legal action can
be initiated twice for the same course of action.
A case, currently before a French criminal court, has provided the
occasion to establish whether the non bis in idem rule may
be applied in a situation where a person may be potentially
sanctioned under both tax and criminal rules.
The case concerns a famous art dealer family, the Wildensteins, who
did not declare their full assets to the tax authorities. They are
potentially liable to the relevant inheritance tax reassessment and
subject to criminal prosecution.
The family's lawyers pleaded before the criminal court, and the
latter agreed, that the non bis in idem question should be
remitted to the Cour de Cassation to decide whether it
should be then transferred to the Conseil
Constitutionnel.
The case law of the Conseil Constitutionnel (EADS decision
in 2015) suggests that four conditions need to be met for the
non bis in idem rule to apply: (i) the relevant facts must
be the same under both procedures, (here, the same facts are
effectively used for the tax and criminal prosecutions and the FTA
is the one initiating the criminal case), (ii) the interest
protected, under the relevant underlying legislations, must be the
same, (iii) the relevant sanctions must be the same under both
procedures (the penalty due, under the tax reassessment, is indeed
analyzed as a sanction, i.e., exceeding the financial loss of the
French Treasury, and (iv) the relevant jurisdictions must be the
same (inheritance tax matters are decided by judicial courts as
opposed to administrative courts).
The Cour de Cassation has three months to decide whether
or not to transfer the question to the Conseil
Constitutionnel.
If the case is indeed referred to the Conseil
Constitutionnel, and if the latter rules in favor of
application of non bis in idem, it would mean that the FTA
would have, potentially, to decide between a tax reassessment or
the prosecution for tax fraud.
TRANSFER PRICING BETWEEN FOREIGN HEAD OFFICE AND FRENCH BRANCH
The Conseil d'Etat ruled, on November 9, 2015, in a
case based on the financial dealings between a Belgian entity and
its French branch. The starting point of the case was that the
branch had provided cash advances to the Belgian head office
without stipulating any interest on the advances. The FTA had
reassessed the taxable basis of the branch (on the basis of article
57 of the FTC on transfer pricing between French and foreign
affiliates) by arguing that there was no justification for the
absence of interest, and, accordingly, interest should have been
charged to the head office.
The head office was arguing that, in its commercial dealings with
the branch, it had also claims against the latter for which no
interest had been charged to the branch either; but the Conseil
d'Etat took the view that, for such an ongoing normal
commercial relationship, it was not customary to charge
interest.
The other argument from the taxpayer was that, given the absence of
a separate legal entity for the branch, the advances should be
viewed as purely internal movements, within the same legal entity,
which are not supposed to bear interest.
The Conseil d'Etat rejects this argument by
considering that article 57 (and similar transfer pricing
provisions of the French Belgian tax treaty) are applicable in all
situations where the relevant persons are affiliates, including
between a head office and its branch. Given that the head office
and the branch were not able to justify the absence of interest on
the advances (i.e. there was no reciprocal advantage provided by
the head office to the branch), the Conseil d'Etat
ruled in favor of the FTA.
SPECIFIC ANTI-ABUSE PROVISION ATTACHED TO THE DIVIDEND WITHHOLDING TAX EXEMPTION: PRELIMINARY RULING REQUESTED
On December 30, 2015, the Conseil d'Etat decided to
request a preliminary ruling from the European Court of Justice
("ECJ") in respect of a case that is
part of a series of cases involving the same group and pertaining
to operation of the specific anti-abuse provision (i.e., different
from the general abuse of law theory) attached to the dividend
withholding tax exemption provided, in accordance with the EU
Parent-Subsidiary Directive, by Articles 119 bis and 119 ter of the
FTC.
Following an audit performed in 2010, the FTA challenged the
withholding tax exemption applied by a French company
("FrenchCo") in respect of the dividends
it distributed in 2007 to its sole shareholder, a company located
in Luxembourg ("LuxCo"). All of the
shares of LuxCo but one was held by a company located in Cyprus
("CypCo"), itself held by a company
located in Switzerland
("SwissCo").
Under Article 119 bis of the FTC, the standard 25 percent
withholding tax applicable to dividends is in essence eliminated,
provided inter alia that the recipient of the dividends is
not part of a holding structure that is constitutive of an
artificial arrangement whose main purposes is the benefit of the
withholding tax exemption. The burden of the proof is generally on
the taxpayer.
As described in our Update for August 2015, the Administrative
Court of Appeal of Versailles ("Versailles
CAA") reviewed the elements provided by FrenchCo and
ruled that they were all insufficient to demonstrate that the main
purpose of the holding structure was not the benefit of the
withholding tax exemption provided by Article 119 bis of
the FTC. In order to deny the benefit of the official guidelines
published by the FTA in respect of such withholding tax exemption,
the Versailles CAA further elaborated that the interposition of
LuxCo, which had neither premises nor staff in Luxembourg, and
CypCo, which had no real economic activity and was an artificial
arrangement aimed at concealing the identity of the actual
recipient of the dividends.
The taxpayer appealed before the Conseil d'Etat, which
has decided to request a preliminary ruling from the European Court
of Justice as to whether the above-described anti-abuse provision
complies (i) with Article 1-2 of Directive 90/435/CE (to the extent
that such compatibility may be reviewed), and (ii) EU
freedoms.
Interestingly, the ECJ ruling could provide guidance not only in
respect of the above-described anti-abuse provision (i.e. in
relation to withholding exemption) but also in respect of the new
anti-abuse provision (i.e., in relation to the parent-subsidiary
regime, please see our Update for January 2016).
PRIOR APPROVAL FOR CROSS-BORDER REORGANIZATIONS : PRELIMINARY RULING REQUESTED
The FTC sets forth an elective regime pursuant to which under
certain conditions the taxation of capital gains resulting from
corporate reorganizations such as mergers, contributions of
businesses and demergers/spin-offs, is deferred (i.e., a
Tax-Neutral Regime). This regime is applicable to contributions
made to foreign companies, but prior approval from the FTA is
required in any situation where the absorbing entity is
foreign.
Pursuant to article 210 C of the FTC, such approval is granted if
the following conditions are met : (i) the transaction has a valid
business purpose, (ii) the main objective of the transaction is not
tax evasion or tax avoidance, and (iii) the structure of the
transaction preserves the French treasury's ability to tax, at
a future date, deferred capital gains (which implies the existence
of a permanent establishment in France of the foreign
"absorbing" entity after the completion of the
transaction).
On December 30, 2015 the Conseil d'Etat decided to
request a preliminary ruling from the ECJ with respect to the
compliance of the prior approval requirement set out under article
210 C of the FTC with European Union
("EU") law.
The case involved a French real estate company
("French SCI") which had been dissolved
without being liquidated (so-called dissolution sans
liquidation French law mechanism under article 1844-5 of the
French Civil code) into its sole shareholder, a Luxembourg company
("HoldCo"). The dissolution without
liquidation of the French SCI into HoldCo was carried under the
Tax-Neutral Regime, without prior approval from the FTA. This
transaction was followed by the sale of the real estate assets of
the now-dissolved French SCI to a third company.
The FTA challenged the eligibility of this transaction to the
Tax-Neutral Regime on the grounds (i) that the French SCI had not
requested prior approval from the FTA and (ii) that such request
would have, in any case, been denied, as the dissolution without
liquidation did not have a valid business purpose and was mainly
motivated by tax evasion or tax avoidance.
The Administrative Court of Appeal of Paris ("Paris
CAA") dismissed the taxpayers' arguments that the
French SCI would have benefited from the Tax-Neutral Regime without
prior approval from the FTA had HoldCo been a French company, by
ruling that: (i) the prior approval requirement is not incompatible
with the freedom of establishment principle set forth under EU law,
and (ii) that the transaction had for main objective tax evasion or
tax avoidance.
Hearing an appeal against the decision of the Paris CAA, the
Conseil d'Etat stayed the proceedings and decided to
refer to the ECJ the question whether the prior approval
requirement under article 210 C of the FTC, which solely applies in
cases where the contribution is made to a foreign company, is
compliant with EU law.
Interestingly, it is pointed out by the Conseil d'Etat
that article 210 C of the FTC implements into French law article 11
of the EU Merger Directive which states that a Member state may
refuse to apply the benefit of the Tax-Neutral Regime where it
appears that the transaction has as its principal objective or as
one of its principal objectives tax evasion or tax avoidance.
As such, the first question submitted to the ECJ, prior to the
review of article 210 C of the FTC in light of the freedom of
establishment principle, is whether a domestic provision adopted by
a Member State for the implementation of a EU directive can be
reviewed in light of the principles set out under EU primary law,
such as the freedom of establishment principle found in article 49
of the Treaty on the Functioning of the EU.
TREATY SHOPPING : THE ABUSE OF LAW PROCEDURE MAY BE APPLIED IN RESPECT OF A DOUBLE TAX TREATY
In a decision issued on December 17, 2015, the Versailles CAA
ruled that the interposition of a Luxembourg company in order to
carry out the sale of French real estate assets without triggering
capital gains taxation in France falls under the abuse of law
("AoL") doctrine.
Pursuant to the AoL doctrine, the FTA may, subject to court review,
re-characterize a given transaction on the basis of its substance
where they can establish that such transaction is either (i)
fictitious, or (ii) if, by seeking the benefit of a literal
application of texts or decisions, against the initial objective
pursued by their authors, it was inspired by no other reason than
to avoid or reduce the tax burden which would have normally been
borne by the taxpayers─due to their situation or to their
real activities─if this transaction had not been entered
into.
It is often debated whether a given taxpayer may abuse a double tax
treaty, and in particular how French tax courts would analyze the
objective pursued by the authors of a double tax treaty.
In the case at hand, a French tax resident
("FTR") held 99,99 percent of the share
capital of a French company ("F1"). FTR
undertook to purchase French real assets from French resident
individuals. On the same day, FTR incorporated a Luxembourg company
("F2") by contributing its shares of F1.
On the day of the closing of the sale, FTR substituted F2 as
purchaser. At a later point in time, F2 on-sold the real estate
assets to a French company managed by a relative of FTR. The
capital gains so realized by F2 were not subject to capital gains
taxation in France under Article 4 of the France/Luxembourg double
tax treaty ("Treaty").
The FTA challenged the application of the Treaty on the basis of
the AoL doctrine. The lower court sided with the FTA. The taxpayers
appealed before the Versailles CAA. The Versailles CAA confirmed
that the AoL doctrine was applicable as both its conditions were
satisfied: (i) the sole purpose of the transaction steps was to
lower or eliminate the taxpayers' liabilities, and (ii) the
taxpayers sought the benefit of a literal application of texts or
decisions, against the initial objective pursued by their
authors.
On the first condition, it is interesting to note that the
Versailles CAA did not analyze the substance of F2 in Luxembourg,
but rather the rationale behind its interposition. The Versailles
CAA even concludes that, even though F2 had been an active holding
with an actual financing activity (and would thus not qualify as a
wholly artificial scheme), its interposition is not justified by
any non-tax considerations.
On the second condition, which was the most uncertain given the
lack of public preliminary or negotiation documents around double
tax treaties, the Versailles CAA followed the generally accepted
interpretation principles (including the 1969 Vienna treaty,
although not ratified by France), and concluded, in line with prior
case law, that the intention of the authors of the
France/Luxembourg double tax treaty could not be to grant its
benefit to an artificial scheme.
Whilst, in the Bank of Scotland case decided by the Conseil
d'Etat in 2006, treaty shopping had fallen under the AoL
doctrine by virtue of the general fraud principle, the provisions
then at stake were specific provisions of the France/U.K. double
tax treaty. In the case at hand, the AoL doctrine is applied in
respect of a general provision (i.e. business profits) of the
France/Luxembourg double tax treaty.
CLARIFICATION OF THE SCOPE OF THE FRENCH PAYROLL TAX
Employers established in France which have less than 90 percent
of their turnover liable to Value Added Tax
("VAT") are subject to a payroll tax
(taxe sur les salaires) imposed at rates up to 20 percent.
This tax is in practice mostly due by financial institutions and
holding companies which are likely to receive revenue either VAT
exempt or outside the scope of VAT (e.g., dividends).
Pursuant to article 231 of the FTC, the payroll tax applies to
"sums paid as compensation to employees". A literal
interpretation of this provision led many taxpayers to challenge
the FTA's position in their official guidelines which states
that any compensation paid to non-employee corporate officers of
French limited liability companies, such as the
société anonyme (SA) and
société par actions simplifiée (SAS)
is also subject to payroll tax. The taxpayers argued that executive
compensation could not be subject to payroll tax since corporate
officers could not be viewed as "employees" within the
meaning of French labor law.
In two decisions dated January 21, 2016 the Conseil
d'Etat ruled by reference to the parliamentary debates,
that the tax basis of the payroll tax was intended to be identical
to the tax basis of French social security contributions as defined
under the French social security code, which includes compensation
paid to non-employee corporate officers of French limited liability
companies.
These two decisions ruling on the actual and former wording of
article 231 of the FTC settle this much debated issue which had led
to opposing decisions of lower tax courts, and put an end to any
hopes of payroll tax recovery on these grounds.
PRIORITY PRELIMINARY RULING ON EARN-OUT PAYMENTS
As discussed in our Update for November 2015, the Conseil
d'Etat had referred in a decision dated October 14, 2015,
to the French Constitutional Court (Conseil
Constitutionnel) a priority preliminary ruling request
(Question prioritaire de constitutionnalité) with
respect to rules governing the taxation of earn-out payments
relating to a sale of shares made prior to January 1, 2013, the
date on which a new personal income tax regime applicable to
capital gains was introduced.
Under these rules found at article 150-0 D of the FTC, capital
gains derived from the sale of shares are subject to the
progressive scale of personal income tax (up to 45 percent) but can
also benefit from tax-exempt allowances of either 50 or 65 percent
depending on the holding period (between two and eight years for
the first deduction, and more than eight years for the second).
These tax-exempt allowances also apply to earn-out payments, but
only to payments made with respect to sales of shares made after
January 1, 2013.
In the case at hand the taxpayers argued before the Conseil
Constitutionnel that the fact that earn-out payments relating
to sales of shares made prior to January 1, 2013 cannot benefit
from the above-mentioned tax-exempt allowances infringes the rights
and freedom guaranteed by the French constitution.
In a decision dated January 14, 2016 the Conseil
Constitutionnel ruled that even though no infringement could
be characterized on the grounds of the taxpayers' legitimate
expectations or the entrepreneurial freedom principle, article
150-0 D of the FTC creates a breach of equality between taxpayers
having received earn-out payments with respect to sales of shares
made prior to January 1, 2013 and those made after that date, and
with respect to sales of shares that gave rise to a taxable gain
and those that did not. As such, individuals receiving earn-out
payments made with respect to a sale of shares made prior to
January 1, 2013 will now be able to benefit from the favorable
tax-exempt allowances.
EUROPEAN COMMISSION CONCLUDES BELGIAN EXCESS PROFIT SCHEME ILLEGAL
Since 2005, the Belgian so-called excess profit tax scheme
("EPS") is a tax regime allowing certain
international groups to pay substantially less corporate taxes in
Belgium. In practice, the Belgian tax authorities issue a ruling
allowing the relevant Belgian corporate taxpayer to reduce its
corporate tax base by 50 to 90 percent, to discount for the deemed
excess profits resulting from being part of an international group.
According to the European Commission ("EU
Comm"), the rulings were typically valid for four
years and could be renewed.
In February 2015, the EU Comm launched an investigation on the
basis that the EPS derogated from standard Belgian corporate tax
rules and could thus constitute illegal state aid under EU law.
Following this investigation, Belgium has put the EPS on hold.
Belgian corporate taxpayers benefitting from an EPS ruling have
however continued to benefit from it.
On January 11, 2016, the EU Comm published a press release
indicating that its conclusion is that the EPS is illegal under EU
state aid rules as it provides the relevant Belgian corporate
taxpayers with a preferential tax treatment derogating from both
(i) standard Belgian corporate tax rules and (ii) the arm's
length principle (without being justified by the fact the corporate
tax base reduction was necessary to prevent double taxation, as
claimed by Belgium).
Interestingly, the EU Comm has inter alia highlighted the
facts that the EPS (i) was heavily "marketed" by the
Belgian authorities under an "Only in Belgium" logo, (ii)
only benefitted certain international groups whilst stand-alone
companies could not obtain similar benefits, and (iii) was always
granted within the frame of a ruling procedure.
The EU Comm thus requires that Belgium (i) stops applying the EPS,
and (ii) recovers the tax savings obtained by the relevant Belgian
corporate taxpayers from them, and estimates the total amount to be
around EUR 700m. The Belgian tax authorities now have to determine
which companies have benefitted from the EPS, the amount of the
corresponding tax savings, and the procedure under which the
corresponding amounts may be recovered.
EUROPEAN COMMISSION PUBLISHES DRAFT ANTI TAX AVOIDANCE PACKAGE
On January 28, 2016, the EU Comm has published several draft
measures to combat aggressive tax planning, increase tax
transparency and create a tax level playing field within the
European Union ("Anti Avoidance
Package").
The Anti Avoidance Package inter alia includes what
appears to be minimum required standards (i.e., the member States
could go beyond) towards: (i) a general anti-abuse rule
("GAAR"), (ii) provisions to prevent
hybrid mismatches, (iii) a formulaic limit on interest deductions
(e.g. the higher of 30 percent of EBITDA or EUR 1m), (iv) a
generalized exit tax, (v) a so-called switch-over clause (i.e.
taxing certain flows in the recipient State with a credit for taxes
paid in the source State in order to prevent the localization of
certain income items in low-taxed entities), and (vi) an
harmonization of CFC rules.
It is currently scheduled that the Anti Avoidance Package will be
discussed by the European Council by May 25, 2016. It will need to
be unanimously approved by all 28 member States in order to be
adopted.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.