The two Finance Acts provide an additional restriction on the deductibility of interest paid to related legal entities, an obligation to disclose analytical accounting and consolidated accounts to the French tax authorities during tax audits, a tax on high compensations, an increase of the corporate income tax surcharge for companies whose annual turnover exceeds €250m.
The Constitutional Court struck down several provisions of the two bills, such as the reporting obligation of tax optimization schemes, the change of the "abuse of tax law" definition and the new rules regarding business restructuring.
SIGNIFICANT NEW MEASURES FOR 2014
New restriction on the deductibility of interests paid to a related entity
The Finance Act for 2014 introduces new prohibitions on the deduction of interest paid to related companies where such interest is not subject to a minimum taxation (so called "hybrid loans").
Pursuant to the new rules interest paid to a related lending company will be deductible only if the French borrowing company proves that the lending company is subject to a corporate income tax of an amount at least equal to 25% of the corporate income tax liability as determined under French standard rules. This proof is to be provided upon request of the tax authorities.
Where the lending company is established outside France, the foreign corporate income tax liability should be compared to the French corporate income tax that would have been levied if it were established in France.
For interest paid to tax-transparent entities (including investment funds), the condition of minimum taxation is examined at the level of the partners or shareholders. The partners must also qualify as related entities of the borrowing company.
This new restriction applies to interest paid to a related entity not subject to a minimal taxation on such interest either because it is considered as non-taxable dividend (qualification mismatch resulting from a genuine hybrid loan) or because the interest income is taxed at a low rate (favorable tax regime).
It applies to fiscal years ending as from September 25th, 2013 i.e. with retroactive effect for qualifying loans contracted before that date.
Comments – The new rules remain vague and contain a number of uncertainties that should be clarified by the French authorities in tax regulations to be issued shortly. The conformity of the new rules to EU law remains highly debated.
Communication of analytical accounting and consolidated accounts
The analytical and consolidated accounts must now be disclosed to the tax authorities upon tax audits. This disclosure requirement applies to taxpayers with revenue exceeding €152.4m or €76.2m depending on the type of activities, or with total gross assets exceeding €400m. Companies that file consolidated accounts are also required to present them during tax audits.
In practice, these requirements apply to tax audit notices sent as from December 31st, 2013. A penalty for failure to present these documents remains to be defined.
Comments – Although infringing the right to privacy of audited companies and their related entities, the Constitutional Court held the new provision to be constitutional as a reasonable anti-tax evasion measure. However, the penalty for failure to present the analytical accounting or consolidated accounts i.e. a fine equal to 50of annual revenue, was struck down as being disproportionate. Agents of the tax authorities also have liberty to make copies of such documents and remain subject to fiscal secrecy.
Transmission of foreign rulings to the French tax authorities
Companies with annual revenue or assets exceeding €400m, as well as any related entities of such companies, must make available an extensive transfer pricing documentation during tax audits. As from 2014, this documentation must also include foreign advance tax agreements obtained from foreign tax authorities for all related entities.
Comments – The Constitutional Court formally stated that the new provision shall not result in an obligation to provide a document that the company does not have in its possession. Therefore, confidential documents issued by foreign tax authorities should not be communicated.
Increase of the corporate income tax surcharge
The corporate income tax surcharge imposed on companies whose total revenue exceeds €250m is increased from 5% to 10.7% (Article 235 ter ZAA of French Tax Code). Therefore, the corporate tax rate is now 38% for such companies. This new measure is enforced for fiscal years ending as from December 31st, 2013.
No suspension of payment during mutual agreement procedures
The mechanism of suspension of payment provided by Article L. 189 A of the French Tax Procedure Code in ongoing mutual agreement procedures was repealed. Previously, when an agreement procedure in order to eliminate double taxation was initiated following a rectification offer, on the basis of a bilateral tax treaty, the corresponding tax was suspended from the opening of the mutual agreement procedure to the end of the third month following the date of notification to the taxpayer of the agreement or disagreement. This mechanism no longer applies.
Introduction of a corporate venture incentive
All companies subject to corporate income tax may depreciate over five years subscriptions to the capital of innovative small or medium enterprises (SME). The objective is to encourage investments in favor of innovative SMEs.
Companies have to be EU SMEs i.e. companies with (i) less than 250 employees and (ii) either with an annual revenue not exceeding €50m or total assets not exceeding €43m.
Innovative companies are companies whose research expenditures represent at least 15% of deductible expenses (or 10% for industrial companies), or which support the creation of products, processes or techniques with an innovative perspective for economic development.
Corporate investors shall retain the shares in the SME for at least two years and shall have only a minority interest in each SME. The gain realized on a sale occurring after two years of holding will be taxed (i) at the standard corporate tax rate for the portion corresponding to the depreciation and (ii) at the rate of 4% for the excess (if the participation is over 5% of the outstanding share capital of the SME).
Comments – As this measure constitutes a State aid for France, its entry into force is subject to prior review and validation by the European Commission.
Securitization of R&D tax credits
R&D tax credits can be utilized by eligible entities to pay the proper income tax liability of the year of the recognition. R&D tax credits in excess can either be refunded in cash to SMEs, or sold to a financial institution, or set-off against the corporate income tax liability of the following three fiscal years. The Amended Finance Act for 2013 offers the right for eligible companies to sell their R&D tax credits to a securitization vehicle. This new possibility enters into force on December 31st, 2013.
Tax on high compensations
A tax on the portion of compensations exceeding €1m paid in 2013 and 2014 is established:
- The tax is paid by companies, corporations, partnerships and other unincorporated entities paying such compensations;
- The tax base consists of salaries, wages and similar income, fees, pensions, indemnities, allowances, employees profit participation, stock options and RSUs that are deductible from the taxable income of the company;
- The tax rate is 50%;
- The tax liability cannot exceed 5% of the annual revenue realized by the company in the year for which the tax is due;
- The tax is deductible from the taxable income for the calculation of the corporate income tax, but it is not deductible for the calculation of the corporate income tax surcharge.
- The tax is payable on February 1st, 2014 for compensations included in the tax base for 2013;
- The tax is payable on February 1st, 2015 for compensations included in the tax base for 2014.
Comments – Despite arguments that this highly anticipated tax would result in a breach of several fundamental rights, the Constitutional Court did not strike it down. The Court stressed that the tax was "exceptional" and "non-renewable", and also pointed out that this was not a tax on income because it is borne by the paying companies, not by individuals. Other arguments regarding the retroactivity of this provision for compensations paid in 2013 were also rejected.
PROVISIONS CANCELLED BY THE CONSTITUTIONAL COURT
Significant measures have been struck down by the Constitutional Court.
Reporting obligations of tax optimization schemes
This provision created a reporting obligation of "tax planning schemes" by persons selling, developing or implementing such schemes. A "tax optimization scheme" was defined as a "combination of tax, accounting or financial procedures and instruments which main purpose is to reduce the tax burden of a taxpayer, to defer payment or to obtain a refund of taxes and which meets the criteria set by decree taken by the Government". Highlighting the imprecision of the definition, the abusive restrictions on economic freedom and the severity of the penalties, the Constitutional Court held that this new obligation was unconstitutional.
Change of the "Abuse of tax law" definition
To date, a transaction can be challenged by the tax authorities where they can demonstrate that it is fictitious or exclusively tax driven.
The objective of the new measure was to embrace fictional acts or any act whose "main purpose" (instead of "sole purpose") is to evade or mitigate tax burdens. Once again, accessibility and clarity principles require the legislator to draft provisions that are sufficiently unambiguous.
The Constitutional Court underlined that the new definition had the effect of conferring an overly wide discretion upon the tax authorities and struck it down.
Reversing of the burden of proof in case of business restructuring
If, following a business restructuring resulting in a transfer of functions and risk associated to a foreign related company, the EBE (similar to EBITDA) of the transferring company was lower compared to prior to the transfer, the company was required to prove that it obtained fair compensation from the foreign related company as it would have obtained from an independent party. If not, deemed transferred profits would be included in the taxable profits of the French transferring entity.
In striking down the measure, the Constitutional Court noted that the concepts of "functions" and "risks" are not defined, and the period for deemed profits that have to be incorporated in the results is not determined. This measure was also found to be contrary to other provisions of tax law and therefore incomprehensible.
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