a) The use of financial futures by companies has significantly increased for the last ten years. This trend, which is not especially a French one, is in line with a more general international behaviour, characterized by a constant instability of the capital and currencies markets, likely to impact as much the value of companies assets as the performance of their business and financial operations.

This increase indeed triggered a modification of the comparative importance of derivative products negotiated on organized markets with underlying listed products. The number of derivative products has so much increased that, in numerous cases, the operations on derivative markets have now a value superior to that of listed markets.

For instance, regarding the situation of derivative bonds upon shares and stock exchange index treated on the MATIF and MONEP, the growth of the latter products was as follows:

- regarding the MONEP, the number of treated contracts (options on shares and CAC 40 index) in 1993 was about MF 7, i.e. a 20% increase compared with 1992, whereas the volume of exchanged capital (premiums) amounted to FF 25.9 billions with an increase of only 1.2%;

- regarding the MATIF, the volumes exchanged on the firm long term options on the CAC 40 index have increased by nearly one-third in 1993, amounting to MF 5;

- finally, regarding warrants (on the Paris stock exchange), the notional value increased from FF 3.8 billions at the end of December 1992 to FF 8.7 billions at the end of October 1993

b) In the same way, a legal and statutory corpus applicable to derivative products has been set up. This system is composed of three series of distinct rules which are nevertheless closely linked to one another. These rules are applicable to the following:

- isolated or speculative positions,

- operations of offsetting of risks linked to future transactions and so-called symmetrical positions,

- rates and currencies exchange agreements held by credit institutions.

It could be interesting to study the tax treatment of two instruments used to hedge the share risk. The tax regime described hereafter takes into consideration a speculative position.


2.1 Definition

Schematically, these instruments concerning securities and shares, grant to their holder the right, upon expiry, to receive a sum computed by the difference between a guaranteed exchange rate and the market exchange rate of the underlying share at this time.

The French Exchange Company (SBF), in a recent restructuring operation, considered this security as issued by a legal person of private law, which may be transmitted by booking in the accounts or tradition, granting similar rights to its holders and corresponding to a general receivable right on the assets of the issuing legal person (Schneider/Spie Batignoles operation).

From an economical point of view, the certificate of warranted value represents for the holder a term price warranty. The shareholder is sure that even if the underlying shares have an unfavourable evolution, he will anyway receive the guaranteed price.

In view of these characteristics, the exact qualification of this instrument is still uncertain. Indeed, it may be considered as a warrant for one part, and securities and shares for the other.

2.2 Example for use

In the case of a takeover bid, the shareholders were proposed the following alternative:

- answer the proposition and immediately sell their shares at an agreed price;

- or, keep their shares and receive for each share of the target a certificate of warranted value. The latter would give right to receive in cash, at the end of a two-year period of time, the difference between the target shares price at the time of the takeover bid capitalized at the rate of 7.5% per year, and the exchange rate of the shares of the purchaser.

The minority shareholders chose not to sell their shares in the context of the takeover bid and were freely granted certificates of warranted value which were submitted to stock exchange listing (Schneider/Spie Batignoles operation).

2.3 Tax qualification of the certificates of warranted value

It seems possible to assert that the certificate of warranted value constitutes a financial futures instrument insofar as, by definition:

- it relates to an underlying instrument constituted of securities and shares;

- it gives right to the payment, upon a two-year expiry in the above-mentioned example, of a differential computed by the difference between the takeover bid exchange rate of the target shares and the exchange rate of the purchaser's share at this date.

Moreover, this conclusion is reinforced, in a certain manner, by the argument of the Tax Authorities related to warrants. Indeed, it has been noticed, at the time of the issuing, that the characteristics of the certificate of warranted value were quite similar to those of option certificates.

The fact that the issuer of the certificate of warranted value and the one of the underlying instrument may be the same company (indeed, in the above-mentioned example, the target was afterwards absorbed by the purchaser) does not seem to be contrary to this analysis. The financial characteristics of the agreement remained unchanged. Now, from the viewpoint of the financial characteristics of the warrants, the Tax Authorities precisely pronounced themselves about the latter in 1993.

Finally, the analysis consisting in the determination of the certificate of warranted value tax result by analogy with the warrants seems to be confirmed by the wording of the information note stamped by the French Commission on Stock Exchange Operations in the Schneider operation: it has been pointed out that "the applicable taxation is that of the warrants".

2.4 Valuation rule

Insofar as the qualification as futures financial instrument can be retained (1st criteria of article 38-6-1 of the French General Tax Code), the "mark-to-market" valuation rule is applicable to this instrument.


3.1 Definition

The so-called "assets swaps" especially provide for the exchange of a fixed or varying rate with the performance of variation of an asset which is not linked to the interest rate, like for instance a share or a basket of shares or a determined stock exchange index.

3.2 Charging of incomes and charges

Determination of the tax year during which the variation of the index may be considered as constituting a receivable or a positive debt in its principle and determined in its amount.

According to a traditional case law of the State Council (receivables and debts denominated in foreign currency, indexed loan), the latent gains are not taxable and latent losses are recorded as provisions.

However, the reserves for losses for term liabilities on financial instruments are tax deductible if the company can draw up a general estimated balance showing the existence of a probable negative variation of the net assets. But the practical application of this jurisprudential system is however quite uncertain, more particularly:

- the possibility to deduct the reserves for term liabilities on derivative instruments admitted by the Tax Authorities (Administration Instruction 4 A-4-88 dated April 20, 1988) gave only few specifications regarding the practical modalities of application;

- this possibility does not appear to be challenged in any case by the provisions of the new article 39-1-5 of the French General Tax Code relating to the reserves for works in progress, the deductible reserve from a tax point of view being only challenged for a part of the loss (Administrative Instruction 4 E-3-92 dated April 24, 1992);

- the determination modality based on the drawing up of a general estimated balance of the operations should show a net negative variation of the assets and not only a loss of profits;

- a comparison may be drawn with the provisions of article 38-6-3 of the French General Tax Code (symetrical positions). There is a quite common philosophy regarding the globalization of operations. There is the same link between symetrical positions and realized or underlying losses as between an estimated general balance and underlying losses. But the theory of the estimated general balance does not take into account the already fixed characteristic of gains contrary to the rule of symetrical positions.

3.3 Example for use of an equity swap

a) Example

A French company holds shares of foreign companies. An equity swap agreement is concluded after a few years between the French company and a bank in order to guaranty the first one against the "share" risk which it supports regarding the holding of foreign shares. It may also be provided that the warranty covers the risk linked to the insufficiency of dividends divided out during the warranty period.

Therefore, according to this swap agreement, if the difference between the value of the share at maturity and its purchase price added up with the amount of dividends received is negative, the French company will receive a "compensating" sum from the bank.

In the contrary case, the payment will be made by the French company for the benefit of the bank.

b) Question

In those conditions, when the equity swap is concluded, may a French company benefit from the parent companies regime insofar as its assets benefit from such a cover?

Should the conditions of common law be fulfilled, and especially those regarding the rules of holding, can it be considered that an equity swap agreement may challenge the parent companies regime following the example of loans on securities, and even in the case of pledging of securities? Indeed, the parent-daughter regime only concerns, according to the law, securities giving jointly a voting right and a right to dividends.

Under this assumption, insofar as no ownership transfer of the principal or profits is organized for the benefit of the bank, the company should be able to validly benefit from the particular regime as defined in Article 145 of the French General Tax Code, except if the Tax Authorities prove that, in the case of an abuse of right procedure, this arrangement has only a tax purpose.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be brought about your specific circumstances.

For additional information contact Claire Acard on 33/(1)/55 61 10 10, Lionel Benant on 33/ or Joel Fischer on 33/ or enter text search: "ARCHIBALD ANDERSEN Profile". The members of ARCHIBALD ANDERSEN Association d'Avocats (S.G. Archibald and Arthur Andersen International) are registered with the Hauts-de-Seine Bar and the Lyon Bar.