During the last 15 months or so, French tax courts have issued various decisions that may have a significant impact on the application of the French CFC rules (article 209 B of the French tax code (Code général des impôts, or "FTC")).
Basic Operation of the French CFC rules. The French corporate tax rules are on a strict territoriality basis, i.e., only profits generated in France are liable to tax.
Article 209 B introduces an exception to the above territoriality principle, and it may be summarized as follows:
- If a French corporate taxpayer owns, directly or indirectly, more than a certain threshold (currently 50 percent) of the share capital or voting rights or financial rights of a non-French entity; and
- Such non-French entity benefits from a so-called "privileged tax regime" in the jurisdiction where it is located (i.e., its effective tax rate in such jurisdiction is more than 50 percent lower than the effective French tax rate that would have been applicable in similar circumstances); then
- The French corporate taxpayer would be deemed to receive fully taxable dividends, from such non-French entity, in proportion to its participation in the latter.
When the non-French entity is located within the European Union, a specific safe harbor rule applies whereby article 209 B is applicable only if the participation of the French corporate taxpayer, in the above entity, is an artificial scheme targeting the avoidance of French tax legislation.
When the non-French entity is located outside of the EU, article 209 B is disapplied if the French taxpayer can prove that the principal purpose and effect of the operations, effected by the above entity, do not consist of a transfer of profits to a tax-privileged jurisdiction ("General Safe Harbor"). Article 209 B provides that, inter alia, such evidence is deemed to be provided when the non-French entity has, principally, an effective industrial or commercial activity in the jurisdiction where it is located ("Deemed Safe Harbor").
Case Law Interpretation of the Safe Harbor Rules. The case law referred to, at the beginning of this section, concerns the interpretation of the above safe harbor rules, and although they relate to a period where the wording of article 209 B of the FTC was a bit different, the resulting principles are valid under the current version.
The case law refers to two different situations, both involving a French bank:
- In one case, the potential CFC subsidiary, based in Guernsey, had a private banking activity; the local effective rate of taxation was about 4 percent, and, accordingly, article 209 B would have been applicable unless the safe harbor rule could protect the French bank.
- In the other case, the potential CFC subsidiary, based in Hong Kong, was active in the currency markets of the surrounding region; the effective taxation rate in Hong Kong was de minimis, i.e., as with the Guernsey entity, article 209 B would have been applicable if the safe harbor rule was not an effective defense.
Without going into the procedural details, the cases were first decided by the lower courts, and afterward, the Supreme Court (Conseil d'Etat) voided these decisions and referred them back to the lower courts. They were finally decided in summer 2013.
In both cases, the initial query was whether, for the purposes of the safe harbor rule, one should refer to the "purpose" or to the "effect" of incorporating the non-French entity in a tax privileged jurisdiction.
The position of the French tax authorities was that only the "effect" should be taken into consideration, i.e., if the presence in the non-French jurisdiction enabled a reduction in tax liability (as defined by article 209 B), then any question about the motivation or "purpose" of such presence would be irrelevant. Actually, the position of the French tax authorities seemed correct on the basis of the then-current version of article 209 B, which was indeed referring only to the effect (Note: the current version refers to the object and the effect). However, the Conseil d'Etat decided that, despite the wording of article 209 B, one should refer to the motivation of the taxpayer for the purpose of the safe harbor rule.
Indeed, the Conseil d'Etat took the view that, from a constitutional perspective, the taxpayer should be in a position, when challenged on the basis of an anti-abuse legislation (such as article 209 B), to provide the evidence that its operations were not principally tax motivated despite the local low effective rate of taxation. In other words, if only the effect were taken into account (i.e., the low tax rate), it would have been extremely difficult for the taxpayer to be protected under the safe harbor rule. Once this principle was established by the Conseil d'Etat, the lower court decided as follows:
- In the case of the Guernsey subsidiary of the French bank, the lower court took the view that the subsidiary was targeting international individual clients who were attracted by the banking and tax legislations applicable in Guernsey; in other words, these international clients, given their specific needs, would not have been attracted by the French bank acting from France. Interestingly, the lower court added that even if some of these clients were French, and they used French-sourced funds, the above reasoning should not be modified given that article 209 B targets the motivation of the French bank and not the motivation of its clients.
- In the case of the Hong Kong subsidiary of the French bank, the lower court took the view that the subsidiary was managing the Asian currency position of the banks' affiliates in the region (specifically by investing in the Korean market), and that such an activity could not have been effected from France given the time difference and the required expertise that may only be found locally. As with the Guernsey situation, the French tax authorities were arguing that some of the clients and funds available to the subsidiary were potentially of a French origin, and the court decided that even if these allegations were true, they would be irrelevant for the purposes of the application of the safe harbor rule.
While it is too early to decide whether there has been a definitive change in terms of application of article 209 B (from a safe harbor rule perspective), one can expect certain tendencies:
- Contrary to the position of the French tax authorities, the courts would take into account the motivation of the French taxpayer (and not only the effect of being located in a low tax jurisdiction); and
- The Deemed Safe Harbor would be less used in the future as it would imply that the relevant activity is performed in the jurisdiction where the entity is located; typically, in the Guernsey situation discussed above, the General Safe Harbor was more efficient given the bank's international clients (who are obviously not located in Guernsey)
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.